Despite ongoing U.S.-Iran tensions and elevated oil prices, the S&P 500 has surged to unprecedented highs, defying expectations of a market downturn. This resilience is attributed to a less oil-dependent U.S. economy, minimal impact of energy costs on corporate margins, and the explosive growth fueled by artificial intelligence in major tech companies.
The protracted U.S.-Iran conflict continues without an immediate resolution in sight. Yet, surprisingly, this geopolitical backdrop hasn't dampened the spirits of the stock market.
After a brief dip at the conflict's onset, the S&P 500 has staged a remarkable comeback, hitting all-time highs. On Monday, it impressively closed above 7,400 for the first time ever, even as global oil prices remain significantly elevated.
While some observers might attribute this market strength to mere speculative fervor, a deeper look reveals concrete fundamental drivers. These include a U.S. economy significantly less reliant on oil, robust corporate margins where energy costs are a minor factor, and the powerful surge of tech companies, particularly those benefiting from artificial intelligence, propelling S&P 500 earnings.
The index has quickly recovered from its March low, jumping approximately 17% from around 6,300 in just over a month.
When the U.S. initially retaliated against Tehran on February 28, the S&P 500 experienced a modest decline of only about 8% from its peak. This didn't even qualify as a market correction (a fall greater than 10%), confounding expectations of a major economic shock from escalating energy prices.
Since the conflict began, oil prices soared past $120 a barrel, currently stabilizing above $100. Concurrently, gasoline prices at the pump have surged beyond $4.50 a gallon, exceeding $5 in numerous states.
Initially, many investors viewed the market's resilience through the lens of 'duration,' hoping that companies could navigate temporary supply chain disruptions, especially concerning the critical Strait of Hormuz. However, with the U.S.-Iran conflict now in its third month and stocks continuing to rally, it's time to explore more optimistic explanations for this surprising market performance.
Here are the key factors underpinning the market's strength:
Low Corporate Exposure to Energy Shocks
Even if the Strait of Hormuz were to reopen tomorrow, the repercussions of higher oil prices would linger. Experts anticipate weeks for oil shipments to reach their destinations, and prices are unlikely to revert to pre-crisis levels soon. This means businesses and consumers will continue to face increased pricing pressures.
However, for the U.S. market, a significant portion of companies appears largely insulated. A Trivariate Research analysis of 1,465 earnings transcripts since early March revealed that only about 10% of the total U.S. equity market cap anticipates a negative or even mixed impact from the U.S.-Iran conflict. The firm suggests this 10% figure might even be an overestimation.
This implies that while specific sectors might face headwinds, the broader S&P 500 could maintain its upward trajectory. Trivariate Research advises caution regarding the consumer discretionary sector, where several companies have already noted impacts on consumer spending. Companies experiencing multiple contractions year-to-date, such as certain software firms, are also areas to approach with prudence.
Magnificent Tech-Driven Profits
The recent earnings season vividly highlighted another critical driver of the current bull market: artificial intelligence. The largest constituents of the S&P 500 are exhibiting unprecedented earning power. Apollo's chief economist Torsten Slok pointed out that the top 10 companies in the S&P 500 now command roughly 34% of the index's total profits, a staggering increase from 17% in 1996. JPMorgan's trading desk noted that the "Magnificent Seven" companies' earnings are outperforming the remaining 493 S&P 500 stocks by over 40%, a disparity not witnessed since 2014.
Admittedly, such a high concentration of market value in a few names can unnerve some investors, raising concerns about systemic risk. However, the accelerating earnings growth from these tech behemoths, driven by rapidly expanding AI applications and substantial capital expenditures, has convinced investors that this market concentration is a fundamental strength, not a weakness, affirming the robust underlying narrative of AI innovation.
Enhanced Oil Independence for the U.S. Economy
A crucial factor distinguishing this crisis from historical precedents is the U.S. economy's reduced dependence on oil. Antonio Gabriel, global economist at Bank of America Securities, highlighted in a recent note that the U.S. now requires only about a third of the oil it consumed in the 1970s to generate the same level of GDP.
This increased energy efficiency means that even if the Iran conflict were to intensify, a 10% oil price surge would translate into merely a quarter-percentage-point impact on current inflation, a stark contrast to the 0.90 percentage-point effect observed during the 1970s oil crises. Gabriel concluded that "A repeat of the 1970s appears as an unlikely scenario," underscoring the U.S. economy's improved resilience to oil price shocks.
