Why isn’t oil shock hurting more

Highlights: Markets have remained resilient despite Brent rising above USD100/bl, as stronger earnings and sustained AI investment help offset pressure from higher energy prices. Lower energy dependence, supportive financial conditions and healthy household balance sheets are also cushioning the US economy. With investors already anticipating Fed rate hikes this year, we remain positive on US equities, with our year-end S&P 500 target of 8,100. A prolonged energy shock or a broader tightening in financial conditions remain the key risks to this outlook.

• The key question is why markets have held up despite the oil shock. Brent has moved above USD100/bl as Middle East supply disruptions continue, yet US equities remain close to record highs. Higher oil prices are a headwind to this equity rally, but earnings and investment are providing enough support to keep investors positive
• The strongest support comes from corporate earnings. US earnings expectations have continued to rise since the conflict began, particularly in technology. This goes beyond higher profits for oil companies. European earnings have also been better than feared, despite the region’s greater exposure to natural gas prices
• AI investment remains an important driver of growth. Companies see spending on data centres and AI capabilities as essential to staying competitive in the AI trade. That makes this investment less sensitive to higher interest rates, while broader AI adoption is supporting the earnings outlook
• The economy is less exposed to oil than it was in previous decades. The US is increasingly service-based, and energy accounts for a smaller share of consumer spending. Domestic energy production also provides a cushion to external oil-related uncertainties, helping explain why higher oil prices have not caused a larger economic slowdown in the US
• Financial conditions and household balance sheets remain supportive. Credit spreads are tight, volatility is relatively low and banks remain willing to lend. Many households have also locked in low mortgage rates, limiting the impact of higher borrowing costs on their near-term spending
• Portfolio implications: Our conclusion is that the oil shock is manageable for now. Investors have already adjusted to the possibility of Fed rate hikes this year. We remain positive on US equities, with a year-end S&P 500 target of 8,100, supported by robust earnings and ongoing AI investment. The key risks to watch are a prolonged rise in energy prices and a broader tightening in financial conditions