James Skubik, CFA® | May 01, 2026

The setup for stocks looked favorable coming into 2026, characterized by expectations for accelerating earnings growth and additional rate cuts from the Federal Reserve. The conflict in Iran and the resulting impact on energy markets has placed upward pressure on inflation and downward pressure on economic growth. This has injected greater uncertainty into the equation and reduced expectations for rate cuts this year. While the pieces remain in place for a strong 2026, the picture is a bit cloudier than it was at the start of the year.

With ups and downs in between, the S&P 500 has basically traded sideways since last October while earnings estimates have increased. After 12% earnings growth in 2025, earnings are projected to grow more than 17% in 2026, with Q1 marking the low point of the year at 12% growth. Consensus forecasts reflect expectations for 20% or better earnings growth in each of the final three quarters of the year. These estimates have moved higher since the start of the year with contributions from both the Magnificent Seven and the "Remaining 493."

This has helped support markets even during the Iran conflict, which touched off a nearly 10% decline in the S&P 500 from record highs in January and a difficult March for the market overall, with energy the only positive sector for the month. However, following a temporary ceasefire the index is back to where it was before the war began, driven by optimism for a more permanent agreement. Perhaps influenced by last year's quick rebound from the tariff-related selloff, investors have demonstrated a bias toward looking through the conflict as the market has remained impressively resilient.

The combination of the index treading water while earnings estimates levitate has taken some of the air out of multiples. The forward P/E multiple has compressed from 23x last October to approximately 20x, only modestly above the 10-year average. The technology sector has seen its multiple decline below 20x, its lowest since 2022, as investor enthusiasm for the sector has waned given concerns regarding AI-related spending as well as the potential for AI to disrupt software companies. The latter risk has led to a nearly 30% decline in the iShares Expanded Tech-Software Sector ETF this year through March, while all 22 members of the S&P 500 Software subindex have fallen. Conversely, memory stocks have been standout performers as limited supply causes rising prices due to AI demand.

Some are questioning the ability of firms to deliver the robust projected earnings growth this year given the sharp rise in energy prices. Since the end of February, West Texas Intermediate oil has increased more than 40% to approximately $100 a barrel. Earlier in the conflict, WTI reached nearly $120 a barrel. Even if an agreement were to be reached in the near term, normalization of the energy supply chain is likely to take some time. The head of the International Energy Agency indicated 13 million barrels a day of oil supply has been impacted by the conflict, while more than 80 energy facilities have been damaged.

While history suggests predictions about energy prices should be made with a healthy dose of humility, if energy prices remain higher for longer, it could further exacerbate the dynamics that have characterized the K-shaped economy, effectively serving as a tax on disposable income that disproportionately impacts more strapped consumers. Nationwide gasoline prices are more than $4 per gallon and at their highest level since 2022. Many measures of consumer sentiment have remained soggy, but the most recent data on U.S. retail sales showed a 0.4% increase in February excluding motor vehicles and gas versus the prior month, the strongest since last August and ahead of expectations. This suggests the consumer remains fairly resilient.

Higher energy prices don't just potentially impact demand but also operating costs for companies like airlines. If energy prices surprise to the upside, the ultimate impact to earnings could be greater than currently projected putting consensus earnings forecasts at risk. Notably, revisions to earnings estimates in response to oil price shocks have lagged by a surprising amount, meaning there could be pressure ahead for estimates. Still, market price action suggests investors remain optimistic and the related impact to earnings will be manageable.

Coming into the year, market participants were forecasting the Federal Reserve would cut rates twice in 2026 as a follow up to three quarter percentage point rate cuts toward the end of last year. The Fed's dual mandate of full employment and stable prices has it in a somewhat tricky position, as higher oil prices threaten to both slow economic growth and pressure inflation. In March, it chose to hold rates steady for a second consecutive meeting, and even prior to the conflict, expectations for rate cuts were getting priced out as the labor market stabilized while progress on achieving its 2% inflation target remained disappointing.

The Fed's preferred measure of inflation, the core personal-consumption expenditures price index, which excludes food and energy, increased 3.0% in February, down slightly from the prior month but still well ahead of the 2% target it has hovered above for approximately five years. Despite several years of above-target inflation, 10-year implied inflation expectations remain reasonably well anchored at 2.4%. The consumer-price index report for March showed prices rose by 3.3% over the prior year, with a meaningful contribution from higher gas prices. Excluding food and energy costs the index increased 2.6%.

The labor market has demonstrated low growth but appears to be near what could reasonably be labeled full employment. The March jobs report showed the U.S. economy added 178,000 jobs, reversing a loss of 133,000 jobs in February and well ahead of expectations. The unemployment rate in March ticked lower to 4.3%. Over the past six months the economy has generated an average of 15,000 jobs per month, well below the pace a year ago, but economists believe the decline in immigration and increase in retirees means modest job growth is consistent with a fully employed labor force.

Bond investors have weighed the tradeoff of slower potential growth with higher potential inflation following the start of the conflict. So far, inflation has been the bigger influence, as the yield on 10-year Treasury notes has increased to approximately 4.3% from 3.9% on February 28th. Since the start of the year yields are up only moderately. A breakout to new yield highs for the year in excess of 4.4% would likely serve as an indicator inflationary concerns have taken on increased importance for investors, serving as a headwind for stocks.

Investors will be watching first quarter results carefully to gain a better understanding of how companies expect to be impacted by higher energy prices. If earnings estimates for the year hold, it would likely continue to be supportive for markets. Over long periods of time, earnings are the primary driver of stock returns. For those investors choosing to focus on potential concerns, the market is always willing to accommodate. Constructing a portfolio of companies characterized by durable growth and reasonable valuations remains a sensible approach for the long run.