By Paul R. La Monica

Higher earnings drive up stocks. But what if oil prices, on a nosebleed climb since the Iran war started a month ago, drags down corporate profits?

That's a very real possibility -- and a big problem for Wall Street, Morgan Stanley's Lisa Shalett forewarned on Monday.

The argument for a broadening of the rally -- more participation from the so-called other 493 of the S&P 500 -- hinges on the notion that earnings growth for non-tech companies -- will begin to catch up to the levels of the Magnificent Seven, wrote Shalett, chief investment officer of Morgan Stanley Asset Management. But that may not be feasible because of record-setting oil prices.

"The bulk of earnings revisions gains is coming from a small group of energy, materials and tech stocks, with tech's share expected to be even higher than last year," she wrote.

Plus, the Federal Reserve now seems less likely to cut interest rates later this year, Shalett said. The market is even starting to price in the possibility of interest rate hikes if oil prices remain high and lead to concern about inflation.

"Even an end to Mideast hostilities might not be enough to catalyze S&P 500 recovery if high oil prices, and thus inflation threats, are persistent and lengthy enough to keep the Fed on the sideline through year-end," she wrote.

Another investment strategut, Mona Mahajan of Edward Jones, agrees that oil needs to remain Wall Street's focus.

"Markets are almost directly correlated with moves in oil right now," she wrote in a report on Friday. "Markets are still pricing in oil returning to the mid-$70 range by year-end. If the conflict remains contained, the spillover effects should remain contained as well -- but there are tail risks on both sides."

Even before the Iran war, Shalett noted, there were signs that pointed to the tamping down of earnings growth: tariffs that foster inflation, an economic slowdown from waning consumer confidence, and slower-than-expected productivity gains from gen AI.

And there's more. The flip side to GenAI's disappointing pace is the lightning speed that newer and more advanced AI models, particularly from Anthropic's Claude, are having -- perhaps most notably on software and services companies.

Then there are the problems with private credit, which have also led to big selloffs for various financial services companies, including many big banks, brokerages and asset management firms.

Those worries aren't going away overnight, and credit woes could wind up hampering economic growth. That would ultimately hurt valuations too, a problem given the concerns that price-to-earnings ratios are already higher than normal, even with the S&P 500 tumbling nearly 7% this year.

"P/E multiples follow credit spreads," said market strategists at Stifel in a report Sunday. "We see credit tightening as optimistic GDP expectations fade."

Add all that up and investors might want to play defense. That could even include some of the hard-hit Big Tech stocks. The AI growth story isn't over just yet and techs should be able to thrive even if oil prices remain high and the Fed doesn't cut rates.

"These companies have strong balance sheets and can act as relative havens in periods of uncertainty," Mahajan said. "We still see the AI and technology theme as an important part of a diversified portfolio, particularly in volatile environments."

So, the big takeaway? You already know it. Hang on tight, but don't close your eyes.

Write to Paul R. La Monica at paul.lamonica@barrons.com

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March 30, 2026 15:23 ET (19:23 GMT)

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