How to Make Sense of Equities at Record Highs and Oil on the Rise
FERNANDO DE FRUTOS, CFA, PhD | MAY 2026
• Equity markets are not ignoring geopolitical risk; they are weighing it against a powerful offset from earnings and AI-led investment. The apparent disconnect between higher oil prices and resilient stocks may reflect a hidden correction: without the conflict and energy shock, equities might have been materially higher.
• The key question is whether the energy shock remains reversible or becomes structural. Markets can look through temporary disruptions, but physical bottlenecks, constrained shipping routes or damage to energy infrastructure can turn a geopolitical episode into a macroeconomic shock through margins, inflation and central-bank policy.
• This tension argues for neutral equity positioning after a recent overweight. Tail risks have increased, but prudence cuts both ways: becoming too defensive too early may carry a high opportunity cost if the shock remains contained and the AI-led earnings cycle continues.
History does not repeat, but it does rhyme. Poetry usually rhymes, although it does not always make sense. Markets can do the same.
Equity markets are close to record highs, while oil prices have moved sharply higher. This combination is not unprecedented, but the verse feels awkward. In 2007, oil was rising because a booming, energy-hungry global economy — led by China — was pulling resources into an expansion. Today, oil has risen because of a conflict in the Middle East that could threaten the expansion itself.
That is the dissonance investors are trying to interpret. If geopolitical risks are increasing, why are equity markets not falling? Are markets complacent? Are they looking through the conflict? Or is another force offsetting the risk?
We think markets are not ignoring the risk. They are weighing it against a very powerful tailwind.
Tail Risk Is Not Volatility
Focusing on geopolitical risk is rarely a sound investment strategy by itself. These risks are usually low probability, high impact and difficult to estimate. They can distort our perception because imagination is often more vivid than the statistical base rate.
But once these risks materialize, they cannot be neglected. Conflicts matter for markets through two channels: escalation and transmission. Escalation asks whether the conflict remains contained or expands. Transmission asks how it reaches the global economy — usually through energy prices, commodities, shipping routes, confidence and, eventually, inflation.
The current conflict is especially relevant because the transmission channel is physical. The Strait of Hormuz is one of the world’s most important energy corridors. Under normal conditions, a large share of seaborne oil moves through it, while the capacity of alternative routes through Saudi Arabia and the UAE is meaningfully smaller. Inventories can help. Strategic reserves can help. Shipping can adjust. Producers can try to redirect flows. But a physical bottleneck is not the same as a tariff announcement or a central-bank press conference. It cannot be reversed with a sentence.
Escalation is not only geographic. It can also be vertical: a conflict can become more damaging within the same geography. For energy markets, that may be the more important risk. The worst scenario is not necessarily a broader conflict, but one in which pipelines, ports, refineries, storage facilities or export terminals are impaired for long enough to make the shock persistent.
That is where tail risk becomes more than volatility.
Reversible Shocks and Structural Shocks
This is not the first oil shock in the region. The 1970s embargo, the Iran-Iraq war and the Gulf Wars all tested markets. Equity reaction was shaped less by the initial price move than by one question: did the shock look reversible, or did it look structural?
The 1970s were structural. The embargo itself was not the only issue. The deeper issue was that oil pricing power had shifted. Producer states became more central, oil prices rose dramatically, inflation became entrenched and equity markets entered one of the most difficult environments of the post-war period. That was not a temporary disruption. It was a regime change.
The later Gulf crises were different. They were severe, but they did not permanently alter the structure of the oil market. Supply routes were restored, production normalized and investors learned to look through the shock. Markets sold off, but then recovered.
Trade disputes illustrate the same mechanism. Tariffs can be disruptive, but they are reversible. They are a policy choice: they can be delayed, diluted, negotiated or removed. Supply chains also have buffers — inventories, margins, pricing power, rerouting and substitution.
Energy markets have buffers too, but they are less forgiving. Oil can be stored, reserves can be released and production can be adjusted. Yet if a major shipping route is constrained, if storage fills, if wells must be shut in, or if infrastructure is damaged, the shock begins to move from financial markets into the real economy.
Oil wells are not faucets. They are pressure-managed systems connected to rock, water, gas, pumps, pipes, terminals and ships. If flows are interrupted for long enough, some production capacity may not restart cleanly. Physical systems can be resilient, but they are not infinitely elastic.
This is the “boiling frog” problem. Markets are good at reacting to discrete events. They are less good at pricing a gradual deterioration that becomes structural only after a sequence of small steps. As long as investors believe the disruption is temporary, equities can look through it. But if weeks become months, energy prices stay high, shipping remains constrained, or inflation expectations begin to move, the shock changes character.
At that point, the market is no longer pricing a geopolitical episode. It is pricing a macroeconomic shock: weaker growth, higher inflation and a more difficult central-bank trade-off.
The Market Has Corrected — From Where It Could Have Been
One could argue that equity markets should have fallen more. That view is understandable. The risk has deteriorated, and some of the possible outcomes are uncomfortable.
But perhaps the market has corrected in a less visible way. Without the conflict, and without the energy shock, equities might have been materially higher. The correction may not be obvious in index levels because it has been offset by another force: earnings and AI.
Before the conflict became the dominant source of concern, the global economy was improving. Corporate earnings were rising. The economy was proving more resilient than expected. The investment cycle was strengthening. More importantly, AI was moving from a market narrative into an economic variable.
That is why the current market is difficult to read. Higher energy prices are a tax on consumption, margins and confidence. AI-related investment supports revenues, capital expenditure and productivity expectations. One force shortens the investment horizon; the other extends it. One says “protect capital.” The other says “do not abandon the structural opportunity.” Both can be true.
Markets may not be saying that the conflict does not matter. They may be saying that, even after discounting the conflict, the long-term AI and earnings tailwind remains powerful enough to prevent a larger equity correction.
Prudence Cuts Both Ways
Prudence does not mean focusing only on what can go wrong. It also means not ignoring what can go right.
That is the uncomfortable part of the current environment. If the investment horizon is short, the conflict matters enormously. Near-term returns may depend on whether energy flows normalize or whether the disruption becomes more persistent. If the investment horizon is long, the AI investment cycle may matter more. A regional conflict, however serious, may not be enough to derail a technological transition that is already influencing capital expenditure, productivity and corporate strategy.
Most portfolios sit between those two horizons. That is where the dilemma lies. For that medium-term horizon, we believe neutral equity positioning strikes the right balance. It recognizes that geopolitical and energy risks have deteriorated. It also recognizes that the opportunity cost of becoming too defensive may be high if the shock remains reversible and the AI-led earnings cycle continues.
Markets are not giving us a clean signal. They are giving us an uncomfortable rhyme: tail risks are rising, but so are tailwinds.
In that environment, neutrality is not indecision. It is discipline.
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