Markets looking onward and upward, even as Middle East risks linger 

Key takeaways 

• The Middle East ceasefire continues to hold, but the ongoing closure of the Strait of Hormuz keeps risks to global energy markets elevated. A diplomatic solution remains likely, though clearer signs of progress are still needed, in our view.
• Despite these lingering concerns, markets have rallied as investors increasingly price out downside risks from the conflict and refocus on still‑healthy fundamentals around growth and corporate earnings.
• U.S. consumer spending is holding up well despite higher energy prices, with windfalls from tax cuts more than offsetting this hit. In Canada, spending has picked up this year, but households look vulnerable to the latest inflation spike.
• From a corporate perspective, we have seen only modest downgrades in earnings expectations for energy‑sensitive sectors, with these offset by continued strength and upgrades in technology, helping deliver a broad‑based earnings profile.
• A flood of earnings reports this week will provide more earnings color, while the Fed and Bank of Canada are expected to remain on hold given elevated inflation and geopolitical uncertainty.
• Amid uncertainty, volatility, and shifting market leadership this year, we continue to believe that staying invested across a well-diversified equity and bond portfolio provides the best strategy.

A Middle East stalemate 

President Trump extended the ceasefire with Iran last week, maintaining the welcome pause in hostilities and signaling, in our view, a desire for a diplomatic solution to this conflict.

However, talks on a more permanent peace deal have, for the time being, stalled. Reports suggest that a second round of formal talks could come soon, but it remains to be seen how quickly negotiators can bridge differences over critical issues such as Iran's nuclear program and security guarantees.

Meanwhile, the Strait of Hormuz, a conduit for around a fifth of global oil supplies, remains closed, pushing oil prices back up to $95 per barrel.

We continue to think that a diplomatic settlement that helps alleviate these pressures can be reached in coming weeks, especially with the rising costs of the conflict sharpening political incentives to find a deal. However, we will need to see more concrete signs that talks are progressing to avert further increases in oil prices that could weigh on economies and markets.

Markets looking beyond the conflict 

Markets have been pricing out the tail risk in the Middle East in recent weeks with equities having recouped the sell-off seen in March. This run could leave stocks vulnerable in the near-term should we see setbacks around a diplomatic solution in the Middle East.

The speed and scale of the April rebound highlight the importance of staying invested amid heightened uncertainty. An investor who sold the Nasdaq index when it hit correction territory in late March would have locked in these substantial losses and missed a near 15% rebound in this index since. Meanwhile, an investor holding through this period would be looking at a 7% gain from late February to the time of writing, albeit with significant volatility on the way. This provides a useful reminder of the old adage that time in the market beats timing the market.

As markets become more confident that a diplomatic settlement will be reached, they appear to be turning their attention back to still healthy-looking economic and market fundamentals.

Economy resilient for now 

Last week brought the first look at how U.S. households were weathering the latest inflation shock. Retail sales jumped 1.7% month-over-month in March as surging oil prices pushed spending at gas stations some 15% higher. However, rising gas costs did not deter other types of spending. The control retail-sales measure, which excludes spending on volatile items like gas, autos and building materials, was up a robust 0.7% over the month.

Stepping back, these data point to impressive near-term resilience in consumer spending, potentially helped by stronger tax refunds in the wake of last year's tax cuts. Estimates from the Congressional Budget Office suggest that refunds could be $150 billion higher this year, which alongside lower withholdings, will help provide a boost to consumer purchasing power.

To what extent can tax cuts shield consumers from higher gas prices? Based on our analysis, higher gas prices will only eat up around 40% of these windfalls if prices fall as anticipated in forward markets. If prices remain stuck at $4 per gallon this year, the additional spending at the pump would account for more like 60% of the boost from tax cuts and lower withholdings. Finally, we estimate that prices would need to rise to between $4.75-$5 per gallon, and stay elevated at these levels, to fully absorb all the benefits from lower taxes. This helps underline why markets are anticipating a near-term knock to U.S. growth from the Iran shock, but not a large downgrade.

Statistics Canada's advance estimate of Canadian retail sales is currently pointing to a 0.6% month-over-month gain in spending in March. Typically, this would represent strong sales growth, but much of the increase likely reflects higher spending on gas. We will get the full breakdown in the full retail-sales report released in May, but it seems likely that spending on other goods was weak in the month, in our view.

Prime Minister Carney announced a suspension of the fuel excise tax until Labor Day weekend to come into force last week, effectively lowering gas prices by 10 cents per liter. This will help households at the margin, but the tax cut falls well short of reversing the 50 cents increase seen since the Strait of Hormuz closed.

Central banks on the sidelines 

Despite a better tone in markets, the Fed is unlikely to make strong judgments around the outlook at its meeting this week. The central bank is widely expected to leave interest rates on hold, and we think Chair Powell will continue to talk to the significant uncertainty around the outlook. In practice, the signal will likely be that the Fed remains on hold as it looks to better understand the path forward in this conflict, and its fallout on growth and inflation.

This meeting could be Jerome Powell's last as chair. The path for Kevin Warsh, President Trump's nominee for chair, to be confirmed by the Senate, has cleared after the Department of Justice announced it will drop its criminal investigation into Powell following overspending on renovations of Fed buildings. The timeline for confirmation is unclear, but Warsh could be in line to take up the role of Fed chair in time for the June FOMC meeting.

Rates markets rallied in response to this news, in part likely in relief that the procedural roadblock has seemingly been eased, but also in anticipation that Warsh might be more likely to lead the committee to cut interest rates sooner than his predecessor, in our view.

We would be careful about expecting significant changes in near-term policy. It will likely be hard to build consensus for rate cuts at upcoming FOMC meetings with headline Consumer Price inflation running around 3.5% year-over-year. However, we do think a decline in gas and oil prices by the end of the year could open the door to a rate cut in late 2026.

The Bank of Canada is also expected to be on hold this week, leaving interest rates steady at 2.25%. It will likely continue to signal that inflation risks have risen on account of conflict in the Middle East, even if oil prices have fallen from their peak. However, the central bank might take comfort from the relatively moderate spike in March inflation – barring energy prices – and will likely be mindful that a deteriorating labour market this year will be adding slack to the economy.

Amid these cross currents we think the Bank of Canada will give limited signals on the direction for near-term policy this week, and instead highlight that the data in coming months will determine its next steps.

Markets continue to look for policy tightening later this year, even if these expectations have narrowed to just one or two 25 basis point (0.25%) rate hikes in 2026. By contrast, we think interest rates will remain on hold through this year, with uncertainty around the CUSMA trade agreement, and sluggish growth, persuading the central bank to keep policy moderately supportive of the economy.

Earnings in focus 

Alongside resilient looking economic fundamentals and building hopes for lower interest rates, markets also appear to be feeling upbeat on the earnings backdrop.

There have been some small downgrades to earnings expectations for this year in the face of higher oil prices, with these adjustments, as we might anticipate, showing up most in the consumer discretionary and industrial sectors. However, earnings growth estimates in these sectors remain solid, and across a wider range of sectors the outlook is still upbeat.

Moreover, we have seen upgrades in tech-earnings expectations to even more eye-catching levels amid a slew of positive earnings reports. Intel shares hit a new record high on Friday on much stronger-than-anticipated sales forecasts, adding to robust results in the semiconductor sector. The Philadelphia semiconductor index closed higher for an 18th consecutive session on Friday and is now up just shy of 50% over April so far. 

This week we look forward to further earnings reports from the tech sector, including Microsoft, Meta, Alphabet, Apple and Amazon, which will help provide litmus tests over the AI story. Meanwhile, reports from General Motors, Coca-Cola, Exxon, Visa and Chipotle will help provide insights into how conditions look across a broader swathe of sectors.

Diversification remains the best bet 

Canadian and international equities outperformed U.S. benchmarks at the start of the year, as improving earnings growth, more attractive valuations, and a weaker U.S. dollar all combined to drive a shift in market leadership. However, in the wake of the Iran shock, and the latest upgrades to U.S. tech-earnings expectations, we have seen U.S. stocks clearly outperform since the end of February.

These shifts in market leadership underline why we think investors should target a diverse basket of stocks in the current environment. Our asset allocation for the next one to three years is overweight U.S. small-, mid- and large-cap stocks, developed-market equities, and emerging-market equities too.

In our view, diversification allows exposure to a range of investment themes, from AI investment, to improving international earnings, to more attractive valuations. Moreover, it can help cushion shocks that might emerge to the macroeconomic and market outlook by spreading and diversifying risk across a wider group of companies and geographies.

Speak to your financial adviser to help ensure that your portfolio has appropriate diversification for the current environment, based on helping achieve your financial goals.

James McCann
Investment Strategy

All data in commentary sourced from Bloomberg, the Congressional Budget Office, and JP Morgan.

The Week Ahead 

Important economic events and data for the week ahead include the Bank of Canada meeting and GDP by industry for Canada and the Fed meeting, GDP, PCE inflation and Manufacturing PMI for the U.S.