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Strong earnings growth
The stock markets showed strong growth in April despite the Strait of Hormuz staying closed and energy prices remaining high. A ceasefire and initial peace negotiations maintained hopes that the Middle East conflict would settle down, and investors started setting their sights forward. In spite of the short-term geopolitical uncertainty we expect strong earnings growth to support stock market development, and thus continue to maintain an overweight in equities. In our regional recommendations we are upgrading the emerging markets to an overweight position and shifting Europe to an underweight position. Sector-wise we are overweighting technology as the industry growth forecast has further improved.
Stock markets recovered
The Iran war, which started at the end February, paused at the beginning of April as the US and Iran agreed to a ceasefire. The first round of the US-Iran peace negotiations did not yield any concrete results, however the truce and attempts at negotiating calmed the market sentiment. The stock markets did indeed rise strongly in April, and the world index rose above the pre-war level. In the fixed income market, credit spreads narrowed to the pre-war level. However, the Strait of Hormuz, a crucial route for marine transport, remained closed as Iran responded to a US blockade of Iranian ports.
The oil price remained high in April. Oil demand currently exceeds production by approximately ten per cent. Fortunately, crude oil reserves remain at a rather good level and can be released to a greater extent than agreed in March, if needed. However, the challenge lies in the lack of refining capacity, which hits the supply of jet fuel the hardest. Air carriers have already reacted to the rising fuel prices by cutting non-profitable routes. Fortunately, European gas markets have remained significantly calmer compared to 2022, when the war in Ukraine cut off the supply of Russian pipeline gas and led to a sharp spike in prices.
The high energy prices are slowing down economic growth and driving up inflation. The scale of these effects naturally depends on the duration of the conflict. President Donald Trump’s initial prediction of a 5 to 6 weeks’ “operation” has already been passed, but based on oil futures the energy market is expected to normalise in the coming months. This is not certain, but both Iran and the US have strong economic and political incentives to achieve peace.
There are still a lot of uncertainties, but we consider a scenario where an agreement to normalise traffic in the Strait of Hormuz within a couple of months most likely. It may take longer than that to resolve other issues and to negotiate a final peace settlement, but from the markets’ perspective the most important thing would be to get merchant ships sailing again. If this happens, the effects of the conflict on the world economy and companies’ earnings growth will remain small. This view is in line with the new IMF economic outlook, in which the global economic growth forecast is cut by only 0.2 percentage points to 3.1%. We thus recommend maintaining an overweight in equities.
Central banks remain in wait-and-see mode
For the central banks, supply shocks are trickier to solve than demand shocks. High energy prices are slowing down economic growth, which would call for interest rate cuts. However, the higher energy price is easily transferred to product and service prices, and to prevent this, interest rate hikes might be necessary. So far the central banks have decided to adopt a wait-and-see approach to avoid overreacting to energy prices hikes, which could remain short-term.
The European Central Bank (ECB) may hike policy rates in its June meeting if clearer signs of inflation pressures begin to emerge. The fixed income markets are currently pricing in two ECB rate hikes for the rest of the year, whereas the Fed is expected to hold its rates steady this year. Previously, Fed was expected to lower its policy rates this year. The fixed income markets’ expectations shift rapidly in reaction to the latest news, however, and many different paths remain possible.
Earnings forecasts on the rise
Amid all the uncertainty, corporate earnings have continued to grow steadily, and this year’s global earnings forecast has gone all the way up to 22%. A prolonged conflict in the Middle East would increase the forecast risk especially in the energy-intensive manufacturing sector, whereas the earnings growth of technology companies, which dominate a number of stock indexes, seems more secure.
The current first-quarter earnings season has so far exceeded expectations, and in the US the S&P 500 companies seem to be passing the 14% earnings growth forecast by a couple of percentage points. In Europe the earnings season has started on an unsteady note, although the interim results released by a number of technology companies such as Nokia, ASML and SAP have proven stronger than expected. Luxury goods companies, on the other hand, have suffered from the challenges in the important Persian Gulf market. In Europe earnings growth is expected to remain at 3% in the first quarter and to accelerate to double digits in the coming quarters.
Technology companies have led in earnings growth also in the emerging markets, where the annual earnings forecast has been raised more than in other regions. Forecasts predict an impressive earnings growth of 45% for the emerging markets, driven by the anticipated 200% earnings surge for South Korean companies. The largest companies listed on the South Korean stock exchange manufacture memory chips, the best of which are used in data centres running AI models.
