Equities

Quality Rebound in a Risk-Aware Market

The S&P 500 started rolling over a few sessions prior to the February 28 onset of the Iran war, but consensus earnings estimates have surprisingly grown in that time. This stocks down/earnings up phenomenon has greatly aided the broad market’s valuation calculus.

Consider where we were prior to the war: the S&P 500 briefly changed hands at levels north of 7,000, while a couple months ago the Street consensus for calendar 2026 earnings was $310-$315 per share. Use the lower end of that range: the market was trading for a 22.6x forward earnings multiple.

But according to Yardeni Research, the consensus is now looking for S&P 500 operating earnings of $323 in 2026. Those extra few earnings dollars help, but what really aids the bull case is the bold rate of growth relative to 2025 results. If the market does in fact manage earnings of $323 this year, that would be a 19% earnings boost over 2025’s earnings of $271.

For 2027, the Street sees another 17% earnings growth on top of that, bringing the figure to $377. At the current 6,378, the consensus P/E on 2026 and 2027 earnings is 19.8 and 16.9, respectively. For context, when the S&P was at 7,000 just a couple months ago, its trailing multiple was 25.8.

Meantime, it is our view that the Strait of Hormuz risks are being overamplified by the bears.

We say that because the U.S. industrial machine seems to be in satisfactory health; we have had some regional Fed surveys come out a couple weeks after the war started. Collectively, they weren’t half bad.

Additionally, the AI doom being prognosticated on the labor market is not yet showing up in the data, while stagflation forecasts from the Iranian war are premature when we consider other major military actions over the years. For example, the Vietnam War saw heavy fighting from 1965 to 1973, not to mention its foundations in the 1950s and spillovers to other parts of southeast Asia clear into the mid-1970s.

Also, the economic backdrop supports a constructive stance on risk assets , so long as we acknowledge that the junky rally of 2025 is not likely to be reincarnated for the speculative-minded. Even with multiples having come down hard in the first few months of 2026, this is still a market that is closer to a heavy valuation than to some notable bear market low like 1982, 2002 or 2009. Heck, it’s not even a bear market, to date.

Let’s not mince words either: it is okay to be completely at a loss on what happens to the oil price from here. As recently as January, this was a group that was nearly universally loathed, with common macro discussions ruminating on the prospect of $40 Brent crude, on account of burgeoning Venezuelan supplies post-Maduro. But fast forward just a few weeks to the March BofA Fund Manager Survey, where investors had become so universally convinced of the high-oil-forever consensus that only 4% of respondents predicted sub-$60 crude oil by year’s end. Never mind that sub-$60 crude oil was where we were two months ago.

In concert with the near-doubling in crude oil, Consumer Discretionary has become the market’s new pariah, registering one of the largest underweights in the BofA survey’s history. With the VIX slightly north of 30 as we write, nobody will accuse a consumer discretionary sector long of throwing caution to the wind by overweighting it at this point.

There is a ton of fear in the market, and recession talk is in the air. We think nerves will ease this spring and summer, enabling Discretionary to outperform relative to the market. We are seeing the sector show up in many of our SMID Value and Blend screens.

We think this energy “shock” is a classic example of a lot of smart people failing to differentiate between real and nominal numbers. For example, draw a line through the 2022 Russia-Ukraine shock because it is so recent, and let’s consider gasoline. The prior painful spike at the pump was in 2008.

That year, unleaded gasoline went above $4/gallon during the summer driving season. When putting $4 then against $4 now, it goes beyond inflation-adjusting. It would be macro malpractice to disregard 18 years of fuel economy advancement and today’s completely different wage scenario. Many don’t know it, but average hourly earnings today are almost double what they were in 2008. Our household gasoline calculus concludes that, with today’s modern cars and wages where they are now, it would require gasoline to hit $9.56 in order to be the equivalent of 2008’s low-$4 back breaker.

We also think the consensus will likely be wrong on hawkish forecasts for several central banks. As we write, the Street says the Fed will do about half-of-one hike in 2026, while the European Central Bank will hike by about ¾ of a point and the Bank of Japan will do two quarter-point hikes. Before the Iranian war, most seers anticipated that the Fed and ECB would cut rates this year.

We have a simple question: who would tighten policy when the stock prices of the private equity majors are waterfalling due to fears that private credit made too many iffy loans to software companies? Also, as it pertains to the Fed, the U.S. housing market is ice cold and mortgage rates are in the mid-6% range.

If it comes to pass that 2026 proceeds with none of these big three (the Fed, ECB, and BoJ) hiking rates, the beneficiary is USD, because the Fed is the one with the least amount of rate hikes currently priced in.

With dollar strength “on” for the rest of the year, that turns the focus to the beneficiaries: mid and small cap stocks. Other beneficiaries in this scenario where central banks aren’t putting up rates include consumer groups. Another is real estate, which would be pleasantly surprised by interest rates taking a breather. One of the losers from dollar strength tends to be Tech, and in turn, Large Cap Growth.

Needless to say, we think the OECD’s expectation of 4.2% CPI for 2026 is too high. One reason is that indicators such as the Atlanta Fed Wage Growth Tracker will soon have a fourth anniversary of waning year-over-year growth in almost every single report. That measure peaked at 6.7% in summer 2022 and has been steadily falling ever since; it was 3.7% in the most recent report.

Also, we are calm, cool and collected on another metric: marginal propensity to lend, and its influence on inflation. To wit, among all commercial banks, their C&I loan books have grown 4.4% year-over-year in February. For some context, this metric has gone north of 10%, and sometimes stayed there, on five separate occasions since the Global Financial Crisis. If your name is Ben Bernanke, or Janet Yellen, or Jay Powell, or Kevin Warsh, you could make a case for tightening policy in many of those episodes. But right now? It is very hard to justify tightening policy when the banking system is behaving itself and when the private equity houses are doing PR overtime to tame fund redemptions.

Factor-wise, we think the rest of 2026 will see a snapback for Quality screens. At the end of last year, we tallied a cumulative 1,090bps underperformance for the S&P 500 Quality Index relative to the S&P 500 over a 9-month window. That was the most extreme underperformance for the group since 1999. This year has brought some respite for the factor, but we think the rest of the year will see more mean reversion for the group.

Internationally, Japan has run so hard over the years that even we are sometimes surprised that the group hasn’t gotten wildly overvalued, owing to its stance as the sharpest earnings grower in the developed world over the last generation. For example, the MSCI Japan index has a shareholder yield (the sum of dividends and buybacks) of 3.3%. When we dividend-weight the whole country, our Value-tilted index has a shareholder yield of 4.1%. With the S&P 500 at 1.7% on this metric, the extra yield in the two Japanese indexes are in 91st and 92nd percentile, respectively, with high percentiles being the cheapest.