Market Update

Markets are once again climbing a “wall of worry.” Investors have been forced to digest an unusual mix of risks: one of the longest government shutdowns, tariffs, private credit concerns, and the Iran war. The S&P 500 declined about 8% from its January high, briefly entering correction territory. Global markets also began to price in a mild stagflation scenario as if the Strait of Hormuz remained closed for an extended period.

In my view, there is a notable gap between investor bearishness and underlying fundamentals. Earnings, employment, and overall growth still support this bull market—unless interest rates become restrictive enough to materially slow the economy. Sentiment and oversold technical conditions were discounting a scenario of higher oil prices for longer, which may not ultimately materialize. The second half of the year could look meaningfully different than the first.

Oil prices fell and equities rallied after the U.S. and Iran agreed to a two-week ceasefire, and Tehran signaled that it would move toward reopening the Strait of Hormuz to shipping. Investors welcomed the reduced risk of prolonged supply disruption. If energy prices were to remain elevated for an extended period, consumer spending could weaken. Historically, when energy prices spike more than 30%, consumers tend to pull back, corporate earnings soften, and equity markets follow. JPMorgan’s economists estimate that a sustained 10% increase in oil prices could reduce GDP by roughly 15–20 basis points.

The market now appears to be discounting a shorter conflict and the possibility that higher oil prices ease by mid-year. That, in turn, increases the likelihood of a Fed rate cut later this year. My main concern remains that restrictive rates could eventually tip the economy into recession; however, the odds of “higher for longer” have recently declined.

Earnings Picture

Consensus estimates call for S&P 500 earnings growth of 17.4% this year. While those forecasts may prove optimistic, earnings have meaningful tailwinds even after accounting for lag effects. Faster productivity growth supports profit expansion, and companies are increasing capital expenditures to develop AI capabilities that can improve efficiency and margins. Importantly, AI-driven demand for chips, data centers, and related infrastructure continues to support revenue growth across multiple industries.
Fiscal policy is also supportive. The One Big Beautiful Bill introduced additional tax reductions for households and businesses, encouraging spending and investment. Depreciation write-offs should continue to aid corporate capital spending. Bespoke research notes that S&P 500 forward 12-month earnings estimates have risen 12.3% over the past five months despite the government shutdown, tariffs, and the Iran war. Current earnings growth ranks in the top 95th percentile historically.

Recent equity performance has been driven more by earnings growth than by valuation expansion—a trend that may persist and broaden beyond the “Magnificent 7.” FactSet estimates that the seven companies will grow earnings 22.7% in 2026, while the remaining 493 S&P 500 companies are expected to grow earnings 12.5%. Overall, corporate guidance has improved, with S&P 500 companies issuing the highest level of positive guidance in five years. The Technology sector stands out, with projected earnings and revenue growth rates above the sector’s average of the past decade.

A key fundamental support for equities is net profit margins. Large-cap companies are reporting record-high margins, excluding the post-COVID peak. These robust margins provide an important buffer and help underpin the bull market’s fundamental case.

Finally, the U.S. economy continues to expand, and consumer spending—roughly two-thirds of GDP—remains a critical driver. The labor market is softening but not collapsing, and spending has held up because many households, especially higher-income ones, still have the capacity to consume. The “wealth effect” also matters: TD research notes that equity markets boosted household net worth by 3.5% year-over-year in 3Q25 (and higher as of today). The top 20% of households hold about 72% of total wealth, and their spending remains comparatively resilient. Lower-income households are more likely to cut back or trade down in what they buy.

Valuation Snapshot

Equity valuations have compressed during the correction as earnings expectations improved. The Invesco equal-weight S&P 500 Index fund’s forward P/E is about 16.7, which is not expensive. The S&P 500’s forward multiple is down roughly 20% from its recent high, and the index’s forward 12-month P/E is about 19.8—below its five-year average (FactSet). Citadel Securities similarly notes that the S&P 500’s forward P/E recently fell below its five-year average (under 20x), a level that has historically been associated with more favorable forward returns. If yields cooperate, the set-up is constructive.

Looking Forward

Midterm election years typically bring higher volatility, which often subsides after Election Day and can be followed by a year-end rally. Current surveys suggest Republicans may retain control of the Senate, while Democrats may regain the House—an outcome that could increase legislative deadlock. Meanwhile, de-escalation in the Iran war is in the world’s best economic interest. The Strait of Hormuz remains economically vital to global trade, and progress toward reopening it would reduce inflation risk and improve the backdrop for growth.

Oil shocks are a common source of market volatility because they can lift inflation and slow growth. Historically, markets have often rebounded. Capital Group notes that across the last seven oil shocks, the S&P 500 rose about 12% over the following 12 months, and peak oil prices tended to occur roughly one month into the shock. My approach to managing market risk is “time diversification”: the longer an investor’s holding period in a strategy such as the S&P 500, the higher the probability of a positive outcome. In that context, I view the correction as an opportunity to add selectively to high-quality AI infrastructure and AI adoption beneficiaries—assuming Brent oil does not remain near $100 for an extended period and the economy avoids recession.

Long-term yields have been trading near recent highs, driven less by accelerating growth and more by inflation concerns. Higher yields can weigh on equities by tightening financial conditions, slowing growth, and pressuring valuations through multiple compression. A key risk would be renewed inflation pressure if the Strait of Hormuz does not reopen in the coming months. In my view, the market is currently over-discounting that outcome.

The S&P 500 could resume its upward advance later this year as the inflation impulse fades and business investment, productivity gains, and fiscal stimulus support corporate earnings. FactSet reports that analysts project the S&P 500 bottom-up price target could rise by 27% over the next 12 months.
Bespoke analysis suggests that, based on past S&P 500 drawdowns, short-term forward returns over the next three months have often been negative to mixed. Returns tended to turn more consistently positive around six months later. One year later, the S&P 500 was higher every time, with a median gain of 14.1%—more than four percentage points above the average one-year performance across all periods since 1953.

My base case is that the Iran conflict de-escalates in the coming months as shipping normalizes through the Strait of Hormuz. Energy prices and inflation may remain elevated in the near term, but could moderate into year-end. U.S. growth may be sluggish in the first half, with a potential re-acceleration later in the year if inflation pressures ease and financial conditions improve.

Risks to Watch

Near-term upside for equities may be limited as the Iran war remains a risk and oil prices stay elevated. A reported 13 million barrels per day shortfall would take time to normalize, and shipping disruptions through the Strait of Hormuz could keep energy markets tight. If oil prices and inflation do not ease—and monetary policy shifts away from an accommodative stance—that could jeopardize the bull market.

A word of caution: historical analogies and patterns may not repeat. Future fundamentals may prove less supportive due to a range of factors, including fiscal and monetary policy, geopolitics, regulation, government actions, and a higher cost of capital. Investors should expect periodic pullbacks of 5–7% in equity indexes, and a 10–15% correction can occur in a normal year. Past performance is no guarantee of future results.