Earnings and markets shake off geopolitics

Markets have had plenty to navigate this year—from a sharp geopolitical shock to staggering sums spent on artificial intelligence (AI). But it is earnings that drive equity markets and the outlook remains upbeat—for now.

The S&P 500 and Canada’s S&P/TSX set new highs recently after brushing off the Feb.-March sell off triggered by the Iran conflict. Most other major markets have followed suit.

The S&P’s standout performance—up 9.3 percent from the beginning of the year—is driven largely by the rapid upward revisions in index earnings. The Bloomberg consensus for 2026 earnings now sits at $341 per share, up 9 percent from where it started the year. If achieved, that would be a 23 percent increase from 2025.

Underpinning this forecast, the broad U.S. economy looks to be gaining momentum. Of the companies surveyed by the Business Roundtable, 81 percent expect their sales to increase in the next six months, up from 74 percent last quarter. The expectation of improved sales has provoked a notable increase in the percentage of surveyed companies looking to increase capital spending and hire more workers.

This rising U.S. business optimism is coming when productivity is improving, unemployment claims are low, and the Atlanta Fed’s GDPNow gauge is tracking a 3 percent gain in GDP for the second quarter. This suggests 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 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.

Canada’s TSX performed better than the S&P, gaining 10 percent through the end of May, driven by strong results in financials and energy. As with the U.S. index, TSX earnings gains were mostly responsible. However, unlike the U.S., Canada’s economy has been stagnating as it suffers from pressures such as: job security fears due to trade uncertainty and AI; a sagging real estate market; and high prices for gas and groceries, rent and mortgage costs. Some relief should come over the next 12-18 months, but things could also get worse before they get better.

The risk everyone’s watching

All economies are paying attention to the Strait of Hormuz. Restoring the free flow of shipping could lower oil and natural gas prices and reduce the risk of shortages—not just of fuels, but also for fertilizers and key industrial chemicals. This would substantially reduce operating costs for many businesses and sectors, especially agriculture, where fuel and fertilizer drive impact on global food costs. Lower prices at the pumps and grocery stores would welcome relief to household budgets and a boost to consumer confidence everywhere.

The longer the Strait remains closed, the greater the risk of inflation rising further and working its way into the broader economy. A standoff that continues into or through the summer could even push the Fed and perhaps the Bank of Canada to consider rate hikes.  

In our opinion, U.S. bond yields would likely move higher before any policy rate hikes were implemented. Higher bond yields could eat into profit margins, squeeze corporate cash flows, and dampen the appetite for capital spending, durables, and new housing—while reducing the value of future earnings in equity valuation calculations.

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

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

More momentum for AI

The outlook for the U.S. market will continue to be dominated by the AI juggernaut. The unprecedented spending by the mega-cap hyper-scalers is undeniable, with new commitments leaping to higher-than-forecast levels seemingly every few months.

More non-tech businesses are also reporting that they are engaging with AI. Few, so far, can point to any sustainable return on investment from their AI expenditures. This won’t slow down the spending anytime soon, but in our view, returns will be needed to justify the AI expense.

As things stand, 21x estimated forward earnings one year out for the S&P 500 sounds reasonable, given index earnings that are forecast to grow by 23 percent this year and a further 15 percent next. That said, anything that knocks those expectations or raises uncertainties could make upside targets for equity markets more difficult 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. And having a plan for how to become more defensive if conditions dictate is best done before it’s needed.

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