“With everything going on, how is this market at all-time highs?” That was a text I received from a friend this past week, as the stock market rocketed higher despite uncertainty over the war, still high oil prices, lingering private credit concerns (the Fed requested information on private credit holdings from financial institutions two weeks ago), still unresolved AI uncertainty and the unknown of how much of a stagflation burst the war will put into the economy.
Admittedly, this is not the type of environment where we’d see the S&P 500 surging to new all-time highs and trading at multiples that are well above historical averages. To that point, the S&P 500 is now trading above a 23X multiple based on $305 2026 S&P 500 earnings— well above the 22X typical valuation ceiling. But the fact is that markets being at all-time highs is not totally unreasonable. Yes, I am surprised that the market surged to these levels, but there are legitimate reasons for it.
First, the worst-case scenario for markets, which was that oil would surge to $200/bbl on an extended conflict in the Middle East, has been largely eliminated. Oil at $85/bbl is not enough to derail the economy or to negatively impact corporate earnings. It was never about elevated oil prices. It was about spiking oil prices, and that simply does not look likely, despite the back and forth. Whether oil is $85/bbl or $65/bbl really isn’t that important for the market. What’s important is that it isn’t heading towards $200/bbl (which it likely isn’t).
Second, earnings remain very strong. The Q1 earnings season is off to a strong start, especially from the banks, not just because of their financial results, which were impressive as usual, but more importantly due to their qualitative commentary. Banks know, as well as any company in the U.S. economy, how the consumer and businesses are doing, and there were virtually no words of warning from big bank CEOs. In addition, there were no major red flags about private credit becoming a systemic concern. So, while it’s still a problem for some alternative asset managers, it does not look like a problem for the broader financial sector.
Third, economic growth remains resilient. Fears that the U.S./Iran war would create a wave of stagflation across the global economy have, so far, gone unfulfilled. While it is still early, the initial data is good as inflation metrics are up, but outside of energy and commodities, they are relatively stable. Additionally, economic growth is not slowing. So, fears of stagflation appear for now to be overdone.
Finally, there are technical reasons for the new highs. Much of the torrid 10% rally in stocks over the past two weeks has been driven by funds chasing long exposure. We know that because Mag 7 stocks have been leading the market higher. Mega-cap tech stocks are what we historically have called “long only rentals,” in that they are large liquid stocks that offer an easy way for funds to put on exposure, if they are underweight or on the wrong side of a short-term move. That chasing begets more chasing, and that’s exactly what we’ve seen.
Bottom line, there are reasons for the new highs, and while stocks at these levels are an aggressive “bet” on everything working out, they must be respected. That said, this is not a perfect environment, and valuation and momentum have left this market vulnerable, and it’s reasonable to expect some giveback of this recent move because it is not being driven by fundamental evolution of the outlook. Instead, it has been driven by a series of events: 1) Not being a worst case scenario, 2) Reminders from data of the resiliency of corporate earnings and the economy, and 3) Funds that got too underweight too quickly, and then had to chase the market higher to add exposure as the worst-case scenarios, yet again, did not prove true.
From an exposure standpoint, while the new highs have surprised us, the reality is this is exactly why we did not advocate reducing exposure, even at the recent lows. The market is resilient and deserves the benefit of the doubt. However, some giveback of these recent highs should be expected because, again, they are not being driven by the positive evolution of the fundamental outlook, and instead by the positive sigh of relief that the worst-case scenario did not happen, and in a fevered attempt by funds to add exposure.
I continue to think that quality, minimum volatility, and other metrics remain the best strategies for this market. It is important to remember that before the U.S.-Iran war started, the market was negative YTD. Things have not gotten better since then. We have just been reminded that the market is resilient and that, combined with too-negative positioning, caused this run to recent highs. Our current allocation is perfect for this environment.