The S&P 500 Index rallied to reclaim its pre-Iran war levels this week, pushing into positive territory for the year as investors shift their focus to the first-quarter earnings season. The benchmark index is now just 20 points from its all-time peak reached in late January.
"Investors believe that the war will end soon, although whether that means in a couple of days, weeks or months isn’t yet clear," said David Morrison, senior market analyst at Trade Nation. "What is clear is that the markets don’t believe it will take years."
The recovery has been supported by a strong start to the earnings season, with JPMorgan Chase, Citigroup, and Johnson & Johnson all reporting results that beat Wall Street expectations. According to FactSet, collective S&P 500 profits are forecast to rise 12.2 percent from the same period last year. If the historic "beat rate" continues, that figure could climb to around 19 percent, taking the overall tally to approximately $632 billion.
However, significant headwinds remain. Bank of America’s latest Fund Manager Survey shows the world’s biggest investors are bracing for the fastest inflation pressures in five years and the slowest GDP growth in four. While a negotiated ceasefire between the U.S. and Iran sparked a sell-off in crude oil, the Cleveland Fed’s Inflation Nowcasting model predicts the annual inflation rate will jump to 3.56 percent in April, complicating the Federal Reserve's path forward on potential interest rate cuts.
One of the primary drivers of the market's premium valuation has been the expectation of further interest rate cuts by the Federal Reserve in 2026. The Federal Open Market Committee (FOMC) has already lowered the federal funds target rate six times since September 2024, based on the assumption that inflation was returning to the Fed's 2 percent target.
With the Cleveland Fed's projections showing inflation moving further away from that target, the case for additional rate cuts is weakening. The CME Group’s FedWatch tool now signals that the odds of a quarter-point rate reduction have been pushed out to the summer of 2027.
"Overall, the story that our models tell is that the S&P 500 can stay on a path headed to 7,750 over the course of the next year, supported by a recovery in investor sentiment from deeply bearish levels and a solid earnings growth and economic backdrop that don’t incur too much damage (as a whole) from recent disruption to energy markets and the Middle East," said Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets. Calvasina's model assumes inflation will hold above 3 percent for much of the year, with 10-year Treasury yields trending toward 4.5 percent.
This article is for informational purposes only and does not constitute investment advice.
