Five months through what feels like a strong contender for the longest year ever, and we also have a very strong contender for most hated bull market ever as well.
The rebound from the lows seen in late-March has been nothing short of meteoric on Wall Street, with the S&P having rallied around 20%, and the Nasdaq 100 having gained over 30%, in a little under two months.
Still, it’s not just on Wall St where the bulls are having all the fun - that face-ripping rally has been even more violent in Asia, most notably so far as the KOSPI is concerned, while even European equities have joined in with the party, as most bourses now trade above their late-February closing levels, before conflict in the Middle East began.
Geopolitical Optimism = Turnaround Trigger
Of course, hopes for a resolution in that conflict are a large part of the reason for markets having rebounded so strongly, but they are by no means the only factor, as we will discuss momentarily.
That said, geopolitical optimism was clearly the initial trigger for the market to begin to turn around, and for dip buyers to enter the fray en masse as the first quarter came to an end. While it is right to argue that the scale of the economic damage that the conflict is likely to prompt, both in terms of the inflationary impulse, and negative growth risks, is not yet known, it is also the case that for equities to endure a sustained sell-off there must typically be two factors. Not only must there be an unrelenting flow of negative headlines, but those headlines must become greater in magnitude over time in order to elicit a market reaction, and overcome the natural positive drift that equities tend to display. As of now, with a fragile ceasefire still in place, and with US-Iran negotiations ongoing, news flow simply isn’t becoming incrementally more bearish, thus isn’t deterring dip buyers.
Added to which, one must consider the intended audience of the news. If indeed a deal is to be done to end the conflict, as we must all hope proves to be the case, then it is unsurprising for each side to seek the ‘upper hand’ in negotiations, by obtaining as much negotiating leverage as possible, largely through hawkish public comments. On top of this, any deal that is agreed will need to be ‘sold’ at home as a win, not a surrender, again meaning that punchy rhetoric is employed in order to persuade a domestic audience. Participants would remain well-served by focusing on the overall direction of travel - which remains away from kinetic re-escalation, and towards an agreement being reached - and focusing less on relentless headline noise, which provides little signal on the whole.
Earnings Growth Impresses
In any case, the equity rally is not solely a geopolitical story.
Certainly, stateside, rip-roaring earnings growth is a major factor behind the equity upside, and arguably a much more important longer-run driver of a sustained bull run than anything that may be happening in the Middle East.
With Q1 reporting season now largely done & dusted, the S&P 500 is set to report earnings growth in excess of 28% YoY, the best such rate since the tail end of 2021. Undeniably, the Tech sector has been a huge factor in underpinning such a pace of earnings growth, though only the Healthcare sector has recorded a YoY earnings decline, while seven of the S&P’s eleven sectors have recorded a double-digit annual increase. Furthermore, of those index members to have reported for the quarter, 85% have surprised to the upside of consensus EPS expectations, while the average magnitude of that upside surprise is double the 5- and 10-year means.
AI Enthusiasm Returns
Coinciding with an impressive earnings season, there has also been a marked resurgence in enthusiasm around the broader AI theme.
By and large, said enthusiasm has shone through in the hardware space, where there remains a tremendous supply-demand mismatch, not only as has been well-documented so far as memory is concerned, but also when it comes to the cutting-edge chips needed to power the latest generation of AI models. However, what’s also been notable is the rebound seen in software names, where the whole ‘SaaSpocalypse’ appears to have come to an end, with more rational heads beginning to prevail in that, no, Fortune 500 companies will not be vibe-coding their own CRMs and putting firms like Salesforce out of business. Not yet, anyway.
Conclusion
Putting all this together essentially leaves us with three key pillars underpinning the case for further equity upside - geopolitical optimism, robust earnings, and AI enthusiasm. Of course, risks to this bull case are present, most notably if we were to see earnings growth falter, or more persistent inflation requiring a Fed policy response, though neither would represent the base case for now. Instead, it seems to me that the ‘path of least resistance’ continues to lead higher, with any dips likely to represent buying opportunities. Interestingly, on that note, only 5 of the S&P’s 11 sectors have yet reclaimed their pre-conflict level, suggesting that there is likely ample scope for a broadening of the rally to provide an impetus for a further leg higher.
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