I’m not actually nervous about a correction but, it’s one of the most common questions that I field from clients and in casual conversations.  While I don’t try to predict what markets will do in the short term, we are aware that historically markets have a number of pullbacks (-5%; every year), corrections (-10%; most years) and bear markets (-20%; every few years) so we try to invest with an all-weather portfolio that weather these persistent storms. Rather than reflect on all the monsters under the bed, we’ll spend a few moments trying to put this market in context.

War

In War, What is it Good For we highlighted that while war is terrible from a social, political and humanitarian perspective, markets tend to bounce back quickly unless we have a protracted global conflict.  There are more details in the linked note, but so far, the war in Iran has fit the script.  The average market drawdown following the start of a war is 5% and the market makes a new high 47-days later. The Iran war saw markets drawdown 7.8% and recover to prewar levels 46-days later. 

It’s All About (Spectacular) Earnings Growth

In our 2026 Year Ahead Note we highlighted that the most consensus sell-side call heading into the year was for 13-14% earnings growth in the S&P 500. We argued that market would likely do well if earnings growth accelerated. If there is a bubble in 2026 it’s in earnings. 

With 90% of S&P500 companies having reported 2Q earnings, earnings growth is up 30% year-over-year, and this excludes the gains on private investments by Alphabet and Amazon. No one had 30%+ earnings growth on their bingo card for 2026. 

As result of this spectacular earnings growth, the S&P500 has become less expensive. The S&P 500 started 2025 and 2026 at 22.0x forward price to earnings ratio.  Since earning have been growing faster than the market has appreciated, this ratio has compressed to 19.1x today; right in line with the five-year average for the index.

S&P 500 Forward Price to Earnings

Source: Bloomberg

Josh Brown, from the Compound & Friends had an excellent summary of reasons to be bullish during a guest appearance on the Prof G Markets podcast.  Josh commented (and I’m paraphrasing for brevity):

• earnings beats in almost every sector,
• rotation where the market rallies despite previous leadership underperforming,
• defensives rallying with cyclicals,
• growth rallying with value,
• large caps rallying with small cap,
• revenue growth ahead of expectations,
• analysts raising expectations for the back half of the year,
• international stocks rallying,
• lots of IPOs but not too many IPOs, and
• the market it is taking out its own trash, like the margin calls and rapid deleveraging of the hedge fund Situational Awareness earlier this month.

There are always reasons to be concerned, and we need to see a significant increase in the return on investment in AI to keep this rally chugging along, but the setup for both the market and the economy looks relatively constructive through the end of the year.

The Risk for 2027

A slowdown in earnings growth may create a challenge for the market in 2027. While we expect earnings growth to be very solid in 2027, investors may be disappointed since earnings will likely decelerate from the 30%-ish growth experienced in 2026.  The silver lining is that the market’s valuation has been compressed by earnings growth.

Positively, the sell side is effective at forecasting earnings outside of recessions and pandemics.

 

 

Other risk that investors remain focused on the wars in Iran, Palestine and Ukraine, debt levels and fiscal spending in many countries, circular AI spending, global logistics including the Straight of Hormuz.

The chart below does an excellent job of showing some of the circular financing that we’re currently seeing in AI.  I couldn’t find the sister chart that I was looking for that would show the circular financing in the automotive industry where OEMs will often finance their suppliers, dealer networks, and the purchase of their finished automobiles.

 

Equites vs Cash

The ride in equites can be bumpy.

But equities do a much better job of protecting purchasing power than cash over the long term.

What's an investor to do?

The key for investors is often to stay invested and diversified. There are always reasons to sell, but you will not find many investors happy about selling in 2018, 2020, 2022, or in early 2025, when the market was down 19%. In 2025, and early 2026, the key (again) was to stay invested. 

As investors, the ‘price’ we pay for returns is gut churning volatility. The table below shows the probability of 5% to 40% pullbacks for the S&P 500 each year.  The volatility we are currently experiencing is normal. It could get worse and still be normal. 

While action helps alleviate anxiety, timing markets is extremely difficult. Investors will benefit from saving and investing consistently across market cycles. This process allows investors to buy more securities when the market is inexpensive and fewer securities when the market is expensive. Consistently investing across market cycles also provides investors with fresh capital to exploit emerging structural changes.

Some investors may find value in a barbell strategy, where high-quality companies exposed to secular themes provide equity market exposure. The other side of the barbell is cash, actively managed fixed income and alternative investments that may reduce volatility and provide ballast for portfolios. For investors in the distribution phase of their lives, the focus expands to optimize the tax efficiency of distributions.

Don't hesitate to get in touch with me for a more detailed discussion.

Delli (delli@cibc.com)

 

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