Another fragile V-shaped rally

The glass is half full again. But having now clawed back all of March’s losses, stock markets are heavily exposed to ever more unpredictable news from the Gulf. Another tense week beckons.

Just when you think it is safe to go back in the water, the alarm is sounded again. Investors desperately want to look through the Middle East conflict to another buoyant earnings season. But no sooner did they dive back in again on Friday than another red flag was raised and they spent Monday morning swimming back to the beach.

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New high

Last week ended on a high that few investors could have expected just a few weeks ago. Seven weeks into the conflict and equity markets have completed a round trip that saw March’s 10% correction erased in just a couple of weeks.

The S&P 500 jumped by 1.2% on Friday to 7,126, above the previous peak of just under 7,000 reached in January. Oil fell, shares rose, the dollar weakened. All the usual risk-on signals.

But events over the weekend once again showed that wishful thinking can only take markets so far. Hoping for a return to the status quo is not the same as achieving it. Finding a face-saving solution for both sides in the Gulf remains a tough diplomatic ask.
A broad-based rally is taking shares back into uncharted territory. And, once again, it’s tech stocks in the vanguard. The Magnificent Seven has come full circle, ending a six month pause for breath.

Nvidia cleared $200 on Friday, up from $165 at the end of March. And it’s not just a US tech story. Samsung has quadrupled over the past year. The Korean Kospi index it dominates has doubled.

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All eyes on earnings

This week sees earnings season broadening out from the banks that kicked things off last week. There’s more finance, with American Express reporting. But plenty of industrials (Lockheed Martin), consumer stocks (Nestle) and energy (BP) too. First quarter results really get into their stride this week.

And, for now, the picture could not be rosier. Forecast year on year growth stands at 13% and that is likely to be beaten if history is any guide. The outlook for upcoming quarters is bright too. For the year as a whole, investors now expect 18% profits growth.

That means that earnings have done all the heavy lifting and helped offset a sharp decline in average valuations. At the low point three weeks ago, the average earnings multiple had fallen by 20% so the more modest 10% fall in the market was all due to rising profits.

It’s not unusual for earnings and valuations to go in opposite directions. That’s how markets work - investors anticipate the next move after the earnings boom. But the scale of the divergence is extreme. It offers support to both optimistic and pessimistic views of the market outlook.

Optimists will look to 2018, when earnings were rising on the back of first Trump presidency tax cuts but markets were growing more worried. A couple of big corrections that year illustrated the concern, but earnings carried the day, and shares carried on rising until Covid arrived.

But the early 1970s and 2000 show what happens when rising earnings are just papering over the cracks. Big market falls followed those earnings booms.

Joining the dots

As well as the ongoing Gulf uncertainty and earnings season, investors will have plenty to watch on the economic front this week.

Here in the UK, attention will focus on Wednesday’s inflation print. Expect a rise in rate of year-on-year inflation from 3% to 3.3%, driven largely by higher petrol prices.

The Bank of England will be watching closely, ahead of its April 30 rate-setting meeting. Rate expectations have been volatile, shifting from a couple of rate cuts this year to maybe four hikes and now back to just one increase in 2026. It changes by the week.

European data will also be in the spotlight this week, as evidence mounts up of how events in the Gulf are feeding into the real economy. Christine Lagarde says it is too early to draw conclusions about interest rates. A case can be made either way - higher inflation and slower growth point in opposite directions.

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