We are in the middle of the largest oil supply shock in history. A war is still raging. Consumer confidence is at record lows. But somehow, the S&P 500 is at an all-time high. Seems confusing.
In April alone, the S&P 500 is up more than 8%. Most investors are cheering, while others are confused and claiming that markets are irrational.
Here is what is actually happening and why it is more dangerous than the headlines suggest.
The plumbing nobody talks about
A significant share of this rally had nothing to do with any human being making a rational judgment about Iran, oil, or corporate earnings. It was, to a large degree, mechanical.
When volatility spiked in March, systematic trading funds — known as CTAs — were automatically forced to sell. When volatility compressed after a tentative ceasefire, their models triggered re-entry just as automatically.
Simultaneously, options markets created a self-reinforcing loop.
As prices climbed back toward all-time highs, market makers were compelled to buy into the rally to hedge their books, pushing prices higher still.
On top of this, a large number of investors had positioned bearishly through March and were forced to cover losing short positions — not because they changed their minds, but because the financial pain became unsustainable.
Much of the green on trading screens this past fortnight was not conviction but plumbing.
The rational core inside the irrational rally
Not everything driving this move is detached from reality. Two components have genuine logic behind them.
First, the market trimmed its estimate of worst-case outcomes.
When the war began, investors had to price in extreme scenarios: a sunken US carrier, nuclear escalation, and a five-year conflict.
As weeks passed without any of those materialising, the catastrophic tail of possible futures got smaller. That is legitimate re-pricing — not denial of the war, but a reduction in the probability of its worst expressions.
Second, the companies that dominate the S&P 500 are genuinely insulated from oil prices in the near term. Microsoft, Alphabet, Meta, Amazon, Nvidia, or the Magnificent Seven collectively drive a disproportionate share of the index’s earnings, and their inputs are electricity and engineers, not petroleum.
Forward earnings multiples on several of these names remain defensible.
The market is not entirely wrong about these specific companies. What it is doing is allowing their strength to obscure the damage being done to the broader economy that surrounds them.
Pavlov’s investors
Markets learn from patterns, and over the past two years, investors have been repeatedly conditioned by the same sequence.
A crisis emerges, the market sells off sharply, and then the threat is softened or reversed.
This happened with Liberation Day tariffs in 2025. It appears to be happening again here.
The moment President Trump signalled openness to renewed talks with Iran, the market did not wait for confirmation of a deal.
It front-ran the anticipated resolution with extraordinary conviction, having been burned enough times for maintaining bearish positions through previous Trump-driven crises.
This behaviour is rational given the pattern that has been observed, but also dangerous.
Pavlovian conditioning works precisely until the moment it doesn’t — and when the pattern finally breaks, the learned behavior amplifies the crash rather than cushioning it.
Nominal gains, real losses
There is a subtler dynamic at work that most commentary misses entirely. An oil shock is, by definition, inflationary. Inflation erodes the purchasing power of cash.
When cash loses value, investors flood into nominal assets — stocks, gold, real estate — as a store of value.
The stock market hitting new highs in dollar terms does not necessarily mean real wealth is being created. It may partly reflect the fact that the dollar itself is worth less.
Gold has been rising alongside equities. The S&P 500 measured in gold has been trending sideways to down.
Investors celebrating all-time-high portfolio values in dollars may be experiencing a nominal illusion — their brokerage account shows a bigger number while the purchasing power behind that number quietly erodes.
The word ‘yet’ is doing all the work
Here is the central problem with the bull case. Oil supply shocks do not hit corporate earnings immediately. They move through the economy like a slow wave, arriving with a lag of two to four quarters.
Higher energy costs raise input costs for manufacturers. They raise shipping costs. They raise food costs, because petroleum touches fertiliser, packaging, and transport. Those costs erode consumer spending. That erodes revenue and earnings.
None of this has appeared yet in quarterly results — the Hormuz closure only took effect in early March.
Citadel CEO Ken Griffin stated plainly that if the Strait stays closed for six to twelve months, a global recession becomes unavoidable.
The market’s implicit response is that it won’t stay closed that long. That may be correct. But it is a bet, not an analysis.
As of today, the Strait remains effectively closed. Shipping traffic sits at a fraction of pre-war levels. Iran has not capitulated. Diplomatic talks in Islamabad have collapsed.
The market is pricing a resolution that has not happened, while discounting a supply shock that already has.
What to watch?
Four signals will determine whether the market’s optimism is vindicated or exposed.
First, Q2 earnings guidance. When CFOs speak in July, any meaningful downward revision on margins or forward revenue will hit fast and hard.
Second, actual Strait traffic. If ship transits do not recover significantly by midsummer, the ‘it’s already over’ narrative collapses.
Third, the diplomatic pattern breaking. If Trump signals resolution, the market rips — and then talks fail again — the learned buy-the-dip reflex faces a crisis of faith.
Fourth, credit markets. If high-yield spreads begin to widen, it means the debt markets are pricing something the equity markets are choosing to ignore.
For now, the market has done what markets do in the face of ambiguity. It picked the most comfortable story available, assigned it maximum probability, and ran.
History suggests this can continue for longer than any rational observer expects. It also suggests it cannot continue indefinitely.
The question is not whether the reckoning comes. The question is how far above reality the market climbs before it does.
The post Is the S&P 500 surge built on conditioning, plumbing, and illusion? may be modified as updates unfold
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