Imagine that on February 27, 2026, you were informed that a war was about to break out in the Middle East that would effectively block the Strait of Hormuz, and that you were in the privileged position not only of being certain of it but also of being able to prepare in advance. Faced with this unique opportunity, traditional investment logic would dictate reducing equity exposure within your portfolio and increasing classic diversification instruments, such as government bonds.
Incredibly, this strategy would have generated losses from the moment the bombings began until the end of April. The surprise at the decline of solid securities like the 10-year Treasury would have been surpassed only by the total disbelief at seeing the S&P 500 index in decidedly positive territory already by the end of April, after registering a V-shaped recovery within a few weeks.
The urgent questions investors ask in the wake of this surprise are whether the markets have somehow “got it wrong” – and might be about to return to normal in response to events in the Middle East – or whether fundamental changes in the market landscape are calling into question the “power” of diversification traditionally associated with US Treasuries, while at the same time conferring renewed resilience on the S&P 500.
Starting from the reaction of US Treasuries during the conflict with Iran, the yield on 10-year bonds rose from 3.9%* on the eve of the first airstrikes to 4.4%* on May 4, while prices fell. This surprised investors who considered Treasuries a reliable safe haven. But it is worth emphasizing that, in reality, yields do not automatically rise every time there is bad news in the market. Recent research1 by AQR shows that in the 20th century they were often quite correlated with equities and that it is only in recent decades that bonds have acted inversely to stocks (i.e., defensively) during periods of high volatility.
An inflation shock, not a growth shock (for now)
The fact that Treasuries can rise or fall during periods of volatility depends on whether the external shock is more related to growth or inflation. As AQR insightfully wrote in 2022, “Inflation levels have stabilized in some markets, but uncertainty about inflation remains higher than it has been in recent decades.” This relatively new inflationary context has probably made US Treasuries sensitive to expectations of rising prices. It is therefore unsurprising that they reacted quickly to the supply chain shock caused by the war in Iran with higher yields (and lower prices) to reflect greater future inflation. A “pure” non-inflationary growth shock would likely have behaved differently and produced the hoped-for “protective” effect that has been missing in recent weeks. Yields would probably have adjusted downward and bond prices would have increased instead. Economic growth, of course, could still take a hit. The latest economic growth forecasts from the Organisation for Economic Co-operation and Development (OECD)2 and the International Monetary Fund3 (IMF), published respectively in March and April, have not been significantly revised downward but do take into account the possibility of a slowdown. For now, however, in the eyes of the bond market, Iran remains primarily an inflation shock.
Why do US stocks seem to keep rising?
Now that one mystery seems to have been solved, it is time to move on to the bigger one, namely why US stocks have managed to register net gains since the start of the war in Iran. In particular, large-cap US stocks represented by the S&P 500 index, which make up well over 60% of the MSCI World All Country index, have recorded an increase of +4.9%* from February 27 to May 4. Behind this relative resilience are key factors worth considering.
Optimism about AI and corporate earnings provide support
The first is the prospect of continued progress in the field of AI. As of May 4, Wall Street consensus estimates for 2026 earnings growth of the Nasdaq 100 index, heavily oriented towards the technology sector, now indicate an increase of more than 37%* compared to the previous year. While it is inevitable that US energy stocks benefit from oil supply constraints, for the broader S&P 500 index, which includes numerous “potential victims” of an energy shock, including stocks in consumer goods and transportation sectors, earnings growth of over 20%* is still expected. Contrary to what one might think, these estimates for 2026 have in fact increased since the start of the war.
Wars are a scourge, but not always for stocks
The other supporting factor is historical in nature, namely the fact that wars have never systematically and exclusively caused stock market crashes or recessions in the United States. Perhaps this reflects America’s privileged geographic position, which allows it to undertake “adventures” abroad and then withdraw without significant consequences for the domestic economy. It is true that World War II contributed to delaying the S&P’s recovery from the 1929 crash until the early 1950s. But it cannot be said that the Vietnam War, the first Gulf War, the war in Afghanistan, and the second Gulf War deeply damaged either the stock market or the economy itself. The impetus for innovation and natural economic growth deriving from the enormous American domestic market has proven difficult to hinder over time.
Retail investors and buy the dip
But perhaps the most important factor supporting the market right now is the army of American retail investors. Research by JPMorgan Chase4 has revealed a historic structural shift in this market segment. For example, the percentage of twenty-five-year-olds using investment accounts was 6% in 2015, but had risen to 37% by 2024. This in turn has introduced a “buy-the-dip” mentality, in which many investors now see bad news as an opportunity to buy “cheap” rather than sell or simply stay put.
Consumers may soon feel the squeeze
For investors, the implications of all this are manifold. First of all, market reactions to the war in Iran should not be a reason to completely overhaul existing portfolios. US Treasuries are currently focusing more on inflation and could be a source of portfolio volatility. But if the war drags on, persistent inflation will begin to impact economic growth as consumers are forced to spend more on energy (which generally cannot be substituted) and less on other goods, such as discretionary goods and services (for example, new car purchases and dining out). On both sides of the Atlantic, there are many public interest stories about families beginning to consider difficult trade-offs between transport and heating on one hand and future holidays and outings on the other. Therefore, a carefully constructed and sized exposure to government bonds could still prove useful.
As for the stock market, much depends on how the changes described above are interpreted, namely whether as expressions of euphoria or deeper structural shifts. Although there is an element of exuberance in recent earnings increases and retail investor behavior, the change in the investor landscape – facilitated by trading apps and certainly hyperactive online forums – suggests a lasting cultural shift that, if anything, probably supports the traditional “buy-and-hold” approach that has been so historically successful.
Staying invested: long-term resilience does not mean short-term invincibility
That said, a strong increase in US equity allocations and a frenzied market influx on bad news days could mean tempting fate at this point. Yes, the US stock market is proving resilient, but with rising valuations, bumps along the way are likely to become more frequent. And for some investors, the regularity of the trajectory is almost as important as the destination itself. On this basis, reassessing suitability and risk appetite rather than making reactive portfolio changes could be a sensible course of action. If done well, this could ensure that investors continue to manage surprises, pleasant or otherwise.
