How can the S&P 500 be hitting fresh record highs amid a fragile ceasefire in the Middle East? The longer the Strait of Hormuz remains closed, the higher oil prices — and the greater the stagflation risk, an extremely adverse backdrop for equities. So why is the broad equity index rising? In fact, investors are asking the wrong questions.

Since the outbreak of the Middle East conflict, 118 S&P 500 stocks have entered correction territory — down 10% or more. Those include companies exposed to commodity prices, whether energy or aluminum. Conversely, 82 stocks are up 10% or more, and most of them are tied to artificial intelligence. Exclude the Magnificent Seven from the index's market cap and the broad index's value would effectively fall.

Performance of US equity indices

The equal-weighted version of the S&P 500 is moving roughly as slowly as the global MSCI ex-US. Yet, in absolute terms, the broad index has gained about 4% since the conflict began, and the Nasdaq Composite is up about 8%.

Thus, US exceptionalism is the product of a handful of companies tied to AI. The relevant question is whether an AI bubble is forming — not why equities are rising during a fragile ceasefire.

Bank of America warns that bubble risks are material. We are seeing a pattern that has echoes of the dot?com crisis. The Nasdaq 100 has risen in 14 of the last 16 trading days alongside rising realized volatility — an anomaly. Volatility usually falls during a bullish market.

Dynamics of forward P/E

Investors have embraced sharply lower fundamental valuations in the tech sector recently, including lower forward P/Es, and impressive corporate earnings. Blockbuster profit and revenue guidance from Intel, for example, sent not only its shares up 24% but helped lift the entire market.

The week to May 1 will be decisive. Alphabet, Microsoft, Amazon, and Meta Platforms will report. Together these companies are worth about $16 trillion, roughly a quarter of the S&P 500's market cap. If the tech giants' results fail to justify the index's record highs, the market could face a wave of selling.

Technically, the daily chart shows that the S&P 500 has broken out of a congestion zone and consolidated above fair value at 7,110, which now serves as key support. A confident break above the pivot at 7,165 would increase the odds of a continued rally and justify adding to existing long positions in the broad index.