Inflation has been rising in recent months, moving further away from the Fed’s 2% target.  Consumer confidence is below its average levels.  Gas costs around $4.50 per gallon nationally. Interest rates have been rising.  We are at war with Iran and the Strait of Hormuz is effectively shut, cutting off the world from 20% of its sea-borne oil supplies.  All of this, yet stocks sit just off their all-times highs and have posted strong gains far in 2026.  Many investors are wondering: how can this be?

Earnings Extremely Strong in the First Quarter

While it is impossible to pin market behavior down to a single factor, it seems that the strong earnings growth in the first quarter and the optimistic corporate outlooks for the balance of 2026 are the main factors driving stocks to their all-time highs.  First quarter earnings were up 28% from a year ago, driven primarily by the technology sector. At the beginning of the year, analysts expected full-year 2026 earnings growth of around 15%.  Now, with the strong first quarter numbers in the books, the consensus outlook for S&P 500 earnings growth for 2026 is 21%.  Upward revisions like this often power stocks higher.

AI Spend is Dwarfing Everything

The market is now used to the fact that there is a large and unresolved problem in the Middle East.  While higher energy prices act as a drag on economic activity, they do not impact technology infrastructure spending as much as they do consumer spending.  And right now, the earnings momentum in the market is emanating largely from the huge amounts of cash that are being spent by the so-called hyperscalers (Alphabet, Meta, Microsoft, Amazon and Oracle).  The planned spending numbers are mind-boggling.  These five companies alone are planning to spend more than $750 billion in 2026 on data centers to fuel their AI ambitions.  Until the AI buildout arrived, all these companies had very strong cash flows.  Now it appears that nearly all that cash flow will be spent on infrastructure.  If the return on investment for this spending is strong, then both equity holders and debt holders should fare well.  If returns should begin to fall short, however, spending is likely to be reined in, and we will have a reckoning for many players in the AI food chain.

The New Fed Chair Inherits a Tricky Situation

New Fed Chair Kevin Warsh faces a tough early road.  Installed by an administration that expects him to lower the Fed Funds rate ahead of the fall mid-term elections, he is facing rising inflation that is being fueled by the Iran war and the resulting higher energy prices.  For now, however, the market seems to have forgotten about the Fed and is watching for continued earnings growth from the huge technology infrastructure buildout.

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