Ending 2025, US equity markets had enjoyed three consecutive strong years and were poised for continued upside. The economy showed resilience, absorbing tariffs and a government shutdown, while inflation remained relatively muted and on a downtrend. Corporate earnings growth accelerated, fueling expectations for mid-teens growth in the first quarter. The Fed signaled additional rate cuts, bolstering the case for ongoing market strength.
Equity markets experienced a notable rotation in the first quarter as the market navigated AI-driven concerns and private credit issues before the Iran conflict delivered an unforeseen disruption in late February. A rotation out of the tech sector into defensive stocks left the markets flat going into the war.
The Iran conflict has negatively impacted equity and bond markets due to spiking oil prices and fears of stagflationary impacts on the global economy. For the first quarter the S&P 500 index total return was down 4.4%, the NASDAQ declined 7.0% and the Bloomberg US Aggregate Bond Index generated a slightly negative return. As we reach mid-April, the equity markets have turned positive for the year.
Entering the second quarter, several issues – AI disruption and a possible bubble, private credit contagion, unsettled tariff policy and global economic stress resulting from the oil shock – are presenting challenges to the bull market’s staying power. Equity market valuations remain high at 19.7x forward earnings estimates relative to the 30-year average of 17.2x.
From a macro perspective, divergent scenarios – a strong economy and moderating inflation vs. stagflation (recession and high inflation) – have reasonably high probabilities.
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