Stock Market Discrepancies Amidst Changing Conditions

Over time, it’s earnings that typically dictate stock prices. However, right now, we’ve got a unique situation. The resumption of oil shipments through the Strait of Hormuz, combined with concerns about the long-term returns on massive AI investments, has led to a rare disconnect between expected earnings for the S&P 500 and how U.S. stock indexes are actually performing.

Analysts have raised their earnings forecast for the largest U.S. publicly traded company by 8% for the period ending March 27, but during that same timeframe, those stocks saw an 8% decline. Historically speaking, it’s quite unusual to see stock prices drop this significantly while earnings estimates are on the rise.

If we look back, the closest comparisons are from around mid-2010—when double-dip recession fears were rampant post-financial crisis—and in 2018, after a recession. That’s when we noticed a sudden uptick in market volatility.

Interestingly, every time the S&P 500 has dipped at least 14% from its bull market peaks since the financial crisis, it only truly hit bottom once future earnings expectations started to falter.

Oil Prices and Economic Outlook

The reality of achieving those revenue projections seems inconsistent with the ongoing oil turmoil that could lead to an economic downturn in the U.S. High oil prices are known to negatively affect other consumer spending sectors, and ever since late February, durable goods and household products have been the poorest performers in the S&P 500.

But, markets don’t seem to be pricing in a heightened risk of recession. While there are lingering doubts about private credit, public high-yield credit remains stable. The spreads on U.S. junk bonds (excluding energy) are still below average levels seen since early 2015.

Even the oil market, despite a significant supply shock—greater than that which followed Russia’s invasion of Ukraine—hasn’t shown the same alarm. Stock markets tend to be more forward-looking compared to commodities, which need to be settled immediately. Oil has to be delivered at a specific place and price at a specific time, making it more sensitive to current supply and demand, rather than future hopes. It’s a bit concerning to equate the prospect of $150 per barrel of oil with unrealistic tariffs on imports from China.

The Impact on Major Companies

It’s worth noting the stark contrast between high earnings and falling stock prices over the last three months. Interestingly, risk-off sentiment has generally impacted stocks negatively, but particularly large AI stocks like Nvidia have seen shifts even before the conflict in the Middle East. The latest developments have caused the “Magnificent 7” stocks to lag behind.

There’s a growing skepticism among investors about whether future earnings for major tech firms will truly justify current valuations, particularly considering their hefty capital expenditures. Many are left wondering if aggressive spending will actually pay off in the long term or result in a drain on free cash flow. Nvidia’s prospects are closely linked to how its key customers are doing.

The war instantly reshaped trading dynamics. The main themes that had been sluggish—like software versus semiconductors, U.S. stocks against international stocks, and the Magnificent 7 versus the S&P 500—saw quick reversals at first. Yet, only the Magnificent 7 Equal Weight group has failed to recover fully.

No Clear Solution?

The current market environment echoes some aspects from earlier periods. The stock’s peak in the first quarter coincided with a grim full-year outlook from Walmart, a significant player in the Momentum Index. That situation initiated a momentum-based sell-off rather than one driven by tariffs.

This time, though, many segments within AI trading, particularly among the largest companies, seem to lack the energy they once had. Themes that once got investors excited are starting to fade.

The term “Trump Always Chickens Out” (or TACO) has been thrown around to explain why markets haven’t reacted more negatively to the potential economic fallout from the recent oil supply shock. It’s a reminder that in this kind of high-stakes game, both sides can charge headlong until a critical moment—when the stakes are simply too high to back down.

Both market participants and political figures appear increasingly hesitant to act quickly when faced with signs of potential decline. And it’s not just President Trump who holds sway here; changes in military strategy in response to shifting conditions don’t guarantee alignment among leaders in Iran or Israel.

At the moment, none of the fundamental market factors or stock price movements have triggered any significant crisis point, leaving many still to wonder what’s next.