Weekly market commentary

Emerging market and U.S. equities are leading global markets since the start of the Middle East conflict on strong AI-linked earnings. See the chart’s left set of bars. Countries exposed to the shock have lagged, while those tied to the AI boom, such as South Korea and Taiwan, have outperformed (middle set of bars). Sector trends tell a similar story, with AI-linked industries driving gains and inflation-exposed areas such as materials underperforming (right set of bars). Policy expectations have been moving in the same direction. Markets are now pricing in about three rate hikes in Europe as inflation pressures build, whereas no change is expected in the U.S. And U.S. credit spreads are below pre-conflict levels, underscoring markets are not pricing in much economic damage. Conclusion: These patterns suggest that markets are pricing in earnings strength and the supply shock’s fallout to date.

The resilience in U.S. equities reflects the scale and breadth of the AI buildout. Expected S&P 500 earnings growth for the first quarter has climbed to about 28%, roughly double early-April levels, while MSCI EM tech earnings growth expectations have surged to around 160%. This strength is being reinforced by an emerging AI-driven cybersecurity arms race, sustaining demand for compute, cloud infrastructure and advanced models. The numbers are staggering. The “magnificent seven” are tracking a 57% jump in quarterly earnings (with Nvidia yet to report), three times higher than Bloomberg estimates just last month. Capital spending is now estimated to reach as much as $725 billion this year, up some 10% from before earnings.

The AI buildout has so far outweighed the typical effect of a macro shock: a drag on growth and earnings that hurts equities. That leaves interest rates as the key mechanism through which the shock could challenge risk assets. Higher energy and input costs are adding to already sticky inflation, with a more pronounced impact in Europe because of its greater exposure. At the same time, the AI buildout is increasing demand for capital — not only for technology infrastructure, but also for energy security and broader infrastructure rebuilding amid geopolitical fragmentation. Capital that previously flowed to the U.S. is increasingly being diverted to these needs, raising competition for funding and adding to upward pressure on long-term yields. Equity markets are balancing growth against rates: Strong enough earnings growth can offset higher yields, as seen in the AI-driven surge since the launch of ChatGPT. The risk: If disruptions persist, the combined effect of higher inflation and rising capital demand could push yields high enough to weigh on valuations.

We stay pro-risk for now, overweighting U.S. and EM equities as beneficiaries of the AI buildout and commodity exports. We prefer equities over bonds and remain underweight long-term U.S. Treasuries, instead favoring short- and medium-term bonds for income. This stance is dependent on eventual normalization in the Strait of Hormuz even as there are still no signs of a reopening. A prolonged closure would likely shift the balance. It would lift inflation and rates enough to start weighing on valuations and tighten financial conditions, ultimately challenging both risk assets and the pace of the AI buildout.

We see no disconnect between record U.S. equities prices and elevated oil, commodities and yields. Markets are pricing both AI-driven growth and the impact of the Middle East supply shock. We stay pro-risk as a result.

U.S. equities pushed to record highs last week, led by tech as strong earnings and intermittent hopes of de-escalation in the Middle East supported risk appetite. The broader market picture was more uneven. Europe lagged and more energy-sensitive sectors came under pressure as higher input costs began to bite, while oil prices and bond yields remained elevated. This divergence highlights how markets are absorbing the shock: Equity performance is supported by resilient growth and AI-driven earnings, even as commodities and rates reflect the risk of a more prolonged disruption to global supply chains.

This week we watch for inflation data. U.S. price pressures through CPI are expected to stay firm, with signs that core inflation may rise further. PPI will show whether higher costs for goods and energy are still passing through. In China, consumer prices are expected to stay weak, while factory prices are rising, showing better pricing in industry but still weak demand at home. Together, the data will show how strong inflation pressures remain.