Earnings optimism vies with stagflation fears
CIO Daily Updates
From the studio
From the studio
Thought of the day
Thought of the day
The S&P 500 closed 1% higher at a fresh record high on Thursday as investors shrugged off stagflation fears to focus on strong corporate earnings.
Higher oil prices due to the ongoing closure of the Strait of Hormuz continue to stoke investor concerns over their impact on inflation and economic growth. These worries were evident in the hawkish tone from central bank officials at the European Central Bank, the Bank of England, and the Federal Reserve this week.
Early on Thursday, Brent crude traded above USD 126/bbl after reports that US President Donald Trump is set to receive a briefing from US Central Command on new potential military options against Iran. However, prices subsequently retreated sharply, closing more than USD 12/bbl lower at USD 114/bbl and trading at USD 111/bbl at the time of going to print. While likely related in part to the rolling of futures contracts, the drop in oil prices helped investors refocus on positive corporate earnings from megacap tech companies released after the close on Wednesday.
In the absence of significant progress toward a resolution to the US-Iran conflict, oil price volatility and economic uncertainty look set to remain high. Amid the volatility we highlight the following:
Tech leading, but earnings growth is broadening. Four of the Magnificent 7 companies reported first-quarter results late on Wednesday. Their results revealed sustained AI demand, with enterprise storage demand holding up, cloud and AI capex commitments being guided higher yet again, and semiconductor manufacturing equipment sales and chip exports both showing strength. However, as the mixed share price reactions following the results suggest, the market is no longer rewarding the AI spending race on its own. Investors are looking for a disciplined approach to capex, supported by strength in underlying core businesses and signs of monetization to point toward returns on capital invested.
With the first-quarter US earnings season more than halfway through, both results and forward guidance have been good. Earnings are on track to grow by 17%. Tech is leading the way, but earnings growth is broadening, supported by resilient consumer spending and signs of a cyclical upswing. The number of companies beating expectations is above the average, and the size of earnings beats is above the median. For full-year 2026, we expect low-double-digit percentage growth in earnings, but risks are biased toward a higher outcome than this forecast, given first-quarter strength.
Markets price tighter policy as central bank rate debate intensifies. While some investors had feared an immediate hike, the European Central Bank left benchmark rates unchanged at its policy meeting on Thursday, though President Christine Lagarde said that a possible rate hike had been discussed "at length." The Bank of England also left rates on hold, but maintained a relatively hawkish tone, noting that inflation risks have risen and leaving the door open to a potential hike should they increase further. On Wednesday, the Federal Reserve kept the fed funds rate at 3.50% to 3.75% and narrowly maintained its easing bias. But three regional presidents wanted the easing bias removed, while one governor again preferred an immediate cut, making it the most divided FOMC outcome since 1992.
Markets are currently pricing no Fed rate cuts this year, about three 25bps increases from the ECB, and a similar number by the BoE in the next 12 months. Our view is that this pricing is too hawkish. We acknowledge that risks are skewed toward higher borrowing costs, particularly if there is emerging evidence of second-round effects with inflation seeping into core measures. For example, a hike at the ECB’s June meeting is definitely a possibility. However, the energy supply disruption driving inflation concerns also presents a risk to growth should it prove prolonged, which could prompt a more dovish central bank response. We expect the Fed to resume rate cuts later this year, and for the ECB and BoE to remain on hold for the rest of 2026.
So, overall, we recommend investors remain invested despite near-term volatility.
In equities, we recommend that investors diversify exposure beyond megacap tech to capture broadening earnings growth. Within tech, we continue to position for gains in the broader AI opportunity, but favor a balanced approach to AI across the enabling, intelligence, and application layers, including semiconductors and chipmaking equipment, power and resources, infrastructure, and selected companies in the US, Asia, and Europe that we believe stand to benefit from AI adoption. Investors can also consider structured strategies with capital preservation features or that exploit pockets of volatility to accrue income and wait to buy AI stocks at lower prices.
We also remain constructive on quality fixed income. We continue to favor high grade and investment grade bonds of short- to medium-term maturities, where current yields still offer an attractive opportunity to lock in income. We also believe income-seeking investors can diversify their sources of portfolio income to include select exposure to more growth-sensitive credit markets, equity income strategies, and structured strategies.
We also recommend allocations to alternatives and commodities as useful portfolio diversifiers.