With all the recent commotion surrounding inflating oil prices, investors could be forgiven for briefly taking their eye off the US stock market. But in vindication of the old adage "a watched pot never boils", the S&P 500 and Nasdaq 100 have both managed to smash through multiple local resistance levels to reach several new all-time highs since the start of the Iran-US conflict. On 20 May, they were sitting at 7,432.97 and 29,297.70, respectively. Their respective gains since 30 March are 17% and 27%, which wipes out all Q1 losses and marks double-digit YTD increases for both indices.
Naturally, there's more to the recent rally than simple investor distraction, and it is, in fact, the result of several converging factors working in concert. In addition to a resumption of the AI optimism seen in the post-pandemic period, we've also got accelerating inflation from the oil crisis, causing a reduction in real yields and stronger-than-expected economic data, reinforcing investor confidence in the US. Geopolitical insecurity and a neutral Federal Reserve continue to act as a counterbalance, but expectations of an imminent peace deal and new dovish policy direction are also working in stocks' favour.
It's the economy
At the fundamental level, one of the main drivers of US equities' recent gains has been resilient corporate earnings and growing investor confidence that the US economy can withstand restrictive monetary policy without falling into a recession. The S&P 500 has been trading around the 7,400–7,500 level for much of this month, while the Nasdaq 100 passed its key resistance of 26,000 as early as mid-April. It thus appears that markets are increasingly pricing in the prospect of a "soft landing" for the US economy, despite ongoing trouble in the Strait of Hormuz. Much of this recent optimism has been driven by outperformance in the economic data, particularly with respect to the labour market.
Recent non-farm payrolls data showed the US economy adding roughly 175,000-180,000 jobs in March and 115,000 in April, which is more than double projections, while unemployment has remained relatively low near the 4% level in spite of elevated interest rates. Wage growth is also firm, with average hourly earnings still rising at around 3.5% year over year, which continues to support household spending and broader economic activity. Investors have interpreted the resilience in employment and consumer demand as evidence that corporate profitability can endure even as borrowing costs remain high. Q1 S&P 500 earnings growth is currently hovering around 27–29% year over year, with more than 80% of reporting companies beating analysts' expectations. At the same time, easing fears over a broader escalation in Middle East tensions and some stabilisation in oil prices have helped improve overall market sentiment after earlier concerns about energy-driven inflation shocks. While the Federal Reserve has continued to maintain a cautious tone on interest rates, investors increasingly believe the tightening cycle is approaching its later stages, particularly following the appointment of Trump's pick for Fed chairman, Kevin Warsh.
AI feeling good
The second major driver behind this fresh rally has undoubtedly been the continued surge in technology and AI-related investment, which has increasingly concentrated market leadership among a relatively small group of mega-cap companies. Despite endless talk of a bubble, investors have continued pouring into semiconductor, cloud-computing and infrastructure-related stocks amid expectations that artificial intelligence spending will remain one of the dominant themes shaping global markets over the coming years. Companies, such as Amazon, Microsoft, Alphabet and Meta Platforms, are collectively expected to commit hundreds of billions of dollars toward AI infrastructure and data-centre expansion, with analysts estimating that global AI-related capital expenditure could eventually exceed $700–$800 billion by 2026. This has helped fuel another strong advance in semiconductor stocks, with the Philadelphia Semiconductor Index rising sharply in anticipation of key earnings releases from major chipmakers.
Meanwhile, moderating Treasury yields have also provided support for high-growth sectors after earlier volatility linked to inflation concerns. The US 10-year Treasury yield has eased back below 4.6% after briefly pushing higher earlier in the month. When this is considered in conjunction with the above-target inflation we've seen due to the war in the Middle East (3.8% in April), a real rate of below 1% only improves risk appetite across technology shares and makes stocks in general more appealing to investors everywhere. Structural inflows into index funds and ETFs have brought additional support that has particularly benefited the largest companies that dominate benchmark indices. However, the rally has also become increasingly concentrated, leaving broader market performance heavily dependent on continued earnings momentum and investor enthusiasm surrounding the AI sector. This isn't necessarily a cause for concern for those investing in indices like the Nasdaq 100 and S&P 500, but their overweighting does leave valuations exposed to any significant crash in AI.
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