The wall of worry obscures a plausible path to higher ground

Major global stock markets have regained most of the ground lost in the February-March plunge triggered by the start of the Iran conflict and the closing of the Strait of Hormuz. The S&P 500, Canada’s S&P/TSX, Japan’s TOPIX, and the Shanghai Composite have all now posted new highs – the last three by a little and the S&P 500 by a lot, besting its past peak by nine percent. The MSCI Europe is very close to hitting higher ground while the MSCI UK is a notable laggard.

The Taiwan and South Korea stock market averages have left everyone else in the dust, surging by 40 percent and 70 percent respectively in just eight weeks. Chip making, driven by worldwide AI demand, has powered those two big winners and has also accounted for why the S&P has opened up a sizable gap over other developed equity markets, which have comparatively little exposure to chip making or AI hyperscaling.

Earnings expectations driving markets

The S&P’s standout performance – up 9.3 percent from the beginning of the year – is just about fully accounted for by the rapid upward revisions in index earnings. The Bloomberg consensus for 2026 earnings now sits at $342, up nine percent from $313 where it started the year. That estimate, if achieved, would be a 23 percent advance on the $279 per index share reported for 2025.

That big upward revision in estimated earnings and the outsized jump in the U.S. index have been mostly sourced from a fairly narrow selection of very large-cap tech and tech-related stocks. However, the broader U.S. economy looks to be gaining speed as well, in our view. Fully 81 percent of the companies surveyed by the Business Roundtable – a nonprofit lobbyist association based in Washington, D.C., whose members are chief executive officers of major U.S. companies – expect their sales to increase in the coming six months, up from 74 percent in the prior quarter. The expectation of improved sales has provoked a notable increase in the percentage of surveyed companies looking to increase capital spending and to hire more workers.

Hormuz matters more to some

This rising U.S. business optimism, coming when productivity is improving, unemployment claims are very low, and the Atlanta Fed’s GDPNow gauge is tracking a 3.3 percent gain in GDP for Q2, suggests to us that the U.S. economy is not holding its breath waiting for the Strait of Hormuz to reopen. To some extent, neither are China or Canada: China because it spent much of last year making large oil reserve additions at low prices, while Canada is a large net exporter of oil and natural gas.

However, the trajectories of all economies, to one degree or another, depend on when the Strait reopens. Restoring the free flow of shipping would act to lower oil and natural gas prices and remove or reduce the threat of outright shortages – not just oil and liquified natural gas but also fertilizers and some important industrial chemicals. This would substantially reduce operating costs for many businesses and sectors, especially agriculture where fuel and fertilizer are the largest inputs with a direct impact on global food costs. Lower prices at the pump and at the grocery store would provide welcome relief to household budgets and a boost to consumer confidence everywhere.

But as of this writing, while talks between the two sides are encouraging, there is as yet no done deal. The longer it takes to open and clear the Strait, the greater the risk of inflation rising further and working its way into the broader economy from which it might be more difficult to dislodge. A standoff that continued into or through the summer would raise the prospect of central banks, including the Fed, abandoning any plans for rate cutting and perhaps even forced to raise rates.

Correction watch

Bond yields would likely move higher before any policy rate hikes were implemented, in our opinion. At a time when government bond issuance everywhere and corporate issuance in the U.S. are both elevated, higher bond yields could eat into profit margins, squeeze corporate cash flows, and dampen the appetite for capital spending, durables, and new houses – while simultaneously reducing the discounted present value of future earnings in equity valuation calculations.

However, in our view, anything short of igniting a multi-hike Fed tightening cycle would be unlikely to push the U.S. economy into recession or seriously derail the prospects for worthwhile earnings gains this year.

That said, a correction of some degree can’t be ruled out for the back half of 2026, perhaps in response to Hormuz complications, or to an upside breakout in bond yields, or to the sheer weight of the very heavy IPO calendar building tentatively for this fall.

AI remains the dominant factor

But, while the outlook for most of the developed economies’ stock markets hinges on when the Strait reopens, the outlook for the U.S. market will continue to be dominated by the Artificial Intelligence juggernaut. The unprecedented spending on the part of the mega-cap hyperscalers is undeniable, with new capex commitments leaping to higher-than-forecast levels seemingly every few months. Recently, domestic chip makers have enjoyed a dramatic catch-up, while software companies have regained their composure after being declared “dead and buried” by equity markets in an unsettling November-to-March waterfall decline for the group.

Meanwhile, more and more non-tech businesses are reporting that they are engaging with AI. Their managements are speaking enthusiastically about what they expect this will do for their businesses, but comparatively few, so far, can point to any sustainable return on investment from these expenditures. That won’t stop or slow down the spending anytime soon because of what most businesses perceive as the unacceptably high cost of being left behind; for more on this, please see our midyear focus article, The Unstoppables. But, at some point, returns will be needed to justify the AI expense.

In our view, periodic worries about how soon these returns will arrive and just how sufficient they will be could roil equity markets from time to time. 21x estimated forward earnings one year out for the S&P 500 doesn’t sound like an extravagant multiple to pay for index earnings that are forecast to grow by 22 percent this year and a further 15 percent next. But anything that knocks a serious hole in those expectations or raises worries about the future beyond next year – such as any of the factors mentioned in the discussion above – could make RBC Capital Markets’ target of 7,900 12 months out more difficult or take longer to achieve.

Our positioning advice remains the same: portfolios should remain committed to equities up to but not beyond an investor’s long-term targeted exposure. Having a plan for how to become more defensive if conditions dictate should always be an element of prudent portfolio planning.

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