Markets at a watershed

This feels like a fork in the road. Stock markets stand close to all-time highs after a dramatic recovery in April. Where next is, however, far from clear.

On the one hand, surging AI-related capital expenditure is fuelling strong earnings growth. Lurking in the background, however, is the persistent and intractable conflict in the Gulf.

AI boom or oil crisis? That is the trillion-dollar question.

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Mixed messages from oil

The oil price is telling us two things at the same time. In the short term, the stresses are clear. Spot oil is well above $100. Further out, though, the futures markets point to a resumption of relatively cheap oil.

If markets are right, then perhaps the economic damage will be contained, and the AI narrative can prevail. If they are too optimistic, then the knock-on impact in financial markets, in the economy and for monetary and fiscal policy could be significant.

Positive earnings picture

The glass half full story has support from a buoyant corporate earnings picture. It might be a narrowly-focused earnings boom, but it is a powerful one.

Forecasts tend to edge higher as results season progresses but the last couple of weeks have seen a dramatic surge. Quarterly earnings growth estimates have doubled from 13% to 26%. For the year as a whole, investors now expect growth above 20%, nearly twice the level achieved in 2024 and 2025 and the third year on the trot of double-digit gains.

Bubble watch

Earnings growth goes some way to justifying the rise in stock markets, but the parallels with the dot.com bubble are hard to ignore.

Not least because the economic backdrop is potentially much worse than it was in 2000. An inflationary oil shock like 2022, or through the 1970s, is just not priced into markets today.

Such a backdrop would be bad news for both shares and bonds. This makes for a tricky environment for investors. Diversification is key, but safe havens are hard to find.

Labour pains

Here in the UK, the overall market dynamics are accentuated by Thursday’s consequential local government elections. Everyone expects them to be bad for the government and under-fire Prime Minister, Keir Starmer. The only question is how bad.

The traditional parties are deeply out of favour, opening the door to previously fringe contenders, Reform and the Greens.

Gilt yields reflect the uncertainty. The 10-year government bond now pays more than 5% to investors, which makes it increasingly difficult for shares to compete. And difficult too for investors to create a balanced portfolio, especially if gold continues to underperform in the face of higher yields from safe alternatives like bonds and cash.

With a number of markets closed for extended May Day holidays - including Japan, South Korea and China - earnings and geo-politics will continue to be the main market drivers this week.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.