Investors have lifted global stock markets above pre-conflict levels by unwinding geopolitical hedges and chasing an artificial intelligence-driven rally, according to market observers. Sentiment has shifted from fears of severe disruption to expectations of normalized energy shipments and diplomatic negotiations.

The MSCI World Index, which tracks over 1,000 mid- and large-cap stocks across developed markets, fell 3.29% in the first week following the outbreak of Middle East hostilities. However, the index recently reached a record high and now stands nearly 2% above its level on the first trading day after the conflict began.

The strong rebound has surprised some analysts, given that the conflict remains unresolved and a fragile ceasefire is under pressure. Billy Leung, Investment Strategist at Global X ETFs, noted that the rally was driven by a rapid unwinding of war-risk premiums previously priced into equities, crude oil, and the U.S. dollar, rather than a fundamental change in economic conditions.

He added that as prospects for a ceasefire emerged, "weeks of defensive positioning were quickly reversed, and this shift in positioning has been a key driver of the rebound." Indeed, markets appear to have moved swiftly from pricing worst-case scenarios—such as a prolonged closure of the Strait of Hormuz—toward more optimistic outcomes involving resumed energy flows and diplomatic progress.

Zavier Wong, Market Analyst at eToro, said investors "fairly quickly judged that the conflict would remain confined to U.S.-Iran bilateral tensions," allowing equities to reprice rapidly. "Once that view took hold, the earlier sell-off appeared largely overdone," he noted, adding that short-covering by hedge funds after the ceasefire announcement further amplified gains.

However, the recovery has not been entirely smooth. Wong pointed out that markets have given back some gains as tensions reemerged during negotiations, suggesting "the rebound may be more conditional than it initially appeared."

On Monday, the U.S. President again threatened overwhelming military action against Iran, warning that if no deal is reached before the fragile truce expires this week, "massive bombs will fall from the sky."

Beyond positioning dynamics, a more favorable macroeconomic backdrop has also reassured investors. Industry veterans noted that U.S. labor market indicators show little deterioration, and expectations for Federal Reserve rate cuts later this year remain intact. Meanwhile, enthusiasm around artificial intelligence continues to provide strong momentum, particularly in tech-heavy markets.

Yap Fook Hien, Senior Investment Strategist at Standard Chartered, stated that progress in AI—from surging demand for computing power to eased funding concerns—has bolstered confidence in equities, adding that "earnings growth remains a very strong explanatory factor for stock market performance."

The combination of improved sentiment and robust growth drivers has led some to declare the return of market "animal spirits." Leung exclaimed, "Animal spirits are back!" pointing to strong inflows into cyclical and small-cap stocks, alongside sustained momentum in AI-related sectors.

Veteran market strategist Ed Yardeni echoed this view, describing the rally as a bet that the conflict will be temporary, despite recent escalations. "I think the market is right—the U.S. President intends to end the conflict quickly, and the global economy, which has shown remarkable resilience in recent years, will continue to hold up," Yardeni said.

He added that investors appear more willing to "look past this Middle East confrontation" and focus instead on technological innovations such as AI, robotics, and autonomous driving.

Still, not all market signals are aligned. Analysts warn that despite the equity surge, other asset classes reflect a more cautious outlook. Wong highlighted a growing divergence between stock and bond markets, with fixed-income markets still pricing in potential economic stress.

"Real yields and breakeven inflation rates suggest markets haven’t fully ruled out stagflation risks stemming from a prolonged energy shock," he said. "Equities, by contrast, have largely ignored this."