Why global markets are looking beyond the oil shock

When oil jumps, everyone notices. It shows up at petrol stations, in transport costs, grocery prices and in the way financial markets talk about inflation. Recent oil price increase and volatility have therefore grabbed a lot of attention.

At first glance, the current market moves feel contradictory. Oil prices are high and the news from the Middle East is changing every day between escalation and de-escalation, yet the US stock market has been strong and is at all-time highs. How can markets rise when the headlines look so uncertain?

The answer is that markets are pricing not only today’s news. They are trying to price tomorrow’s world. Right now, investors can see a path where the current stresses do not turn into something lasting.

Why are markets holding up?

There are three important reasons.

• Earnings are strong - Share prices can be pushed around by headlines in the short term, but over time they are tied to company profits. So far, US companies have been doing better than expected. The economy is still holding up, consumers are still spending, and many companies are still growing.

• The Magnificent 7 are earning their place. It is easy to assume the rally is only about excitement around artificial intelligence or investors paying too much for fashionable names. There is some of that, and valuations are not cheap. But this is not just a story about hope. The largest technology companies (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta & Tesla) are producing real profits, strong cashflows and, in many cases, growing earnings faster than the rest of the market.

• Markets are looking for an exit from the conflict. Wars are unpredictable, but there are strong incentives for a resolution. US laws around war powers create a 60-day clock around military action without Congress’ approval, and high petrol prices are unpopular with voters everywhere.

In simple terms, the market is saying: the news is noisy, but the businesses are still making money.

Why oil may not be the whole story

There is an old saying amongst commodity traders that "the best cure for high oil prices are high oil prices". This is because higher prices often act like an additional tax on the economy. When costs rise across the board, households are left with less money to spend on discretionary items and this in turn creates a slowdown in demand.

But oil shocks can also create some unexpected solutions. When prices rise, consumers respond and try to adjust their habits - taking public transport instead of driving a car for example. Producers have more incentives to improve inefficiencies, and politicians face pressure to bring prices down. Whilst an increase in oil price has an impact on economic growth, it can be absorbed in the short term, as long as it doesn't last too long.

That may be why markets are rising - they are looking toward the next chapter: de-escalation.

If the conflict calms down and oil supply stabilises, oil prices could drop quickly. In that scenario, today’s oil shock could turn into tomorrow’s oil relief. Lower oil prices would lower inflation, support consumers and allow central banks to cut rates on signs of any material slowdown in the economy. That would be genuinely good news for equity and bond investors.

What does this mean for investors?

The main lesson here is not that the risks have dissipated. They have not. The situation could still worsen. However, markets often recover before the news turns positive. By the time everything looks safe, prices may already have moved.

For KiwiSaver and long-term investors, the message is simple: do not let the headlines get in the way of your long-term objectives.

The world economy is more resilient than it often gets credit for. Companies are still growing their earnings, technology is still improving and consumers are still spending. Even in difficult moments, markets keep looking for what comes next.

The engine of the global economy is still running, and it may be running better than the headlines suggest.

This commentary is provided for general information purposes only and does not constitute personalised financial advice. Investors should consider their own circumstances and seek professional advice where appropriate.