Key Takeaways
- The AI supercycle dominated first-quarter earnings, masking underlying uncertainty, according to Mattioli Woods fund manager Lauren Hyslop.
- UK large caps look compelling amid stagflationary risks in Europe.
- BP and Rolls-Royce stand amid wider opportunities in energy and aerospace stocks.
Karen Gilchrist: With a strong earnings season almost complete, markets have been gaining momentum from solid corporate results, even as questions remain over continued geopolitical tensions, inflation risks and the AI rally. To unpack what this means for asset allocation, macro strategy and stock opportunities, I’m joined by Lauren Hyslop, fund manager at Mattioli Woods.
Tech and AI Dominate Q1 Earnings
Lauren, let’s get started with a look at earnings. What are some of your key takeaways, as we’ve seen a slew of companies beat expectations so far this reporting season. And how do you think it should inform how investors think about the year ahead?
Lauren Hyslop: On the surface, Q1 ’26 looks pretty extraordinary. So you’ve got S&P 500 earnings tracking at 27% year on year growth. 84% of companies have beaten EPS [earnings per share] estimates, that’s well above historical average. And net profit margins have hit a 15-year record. So if you were just to read the headline, you’d think corporate America was having a vintage year. And, in one corner of it, it genuinely is. You’ve got the four hyperscalers—Amazon AMZN, Microsoft MSFT, Meta META and Alphabet GOOG—collectively announced capex plans that could hit $725 billion just this year, up 77% from last year’s already record figures. So the AI infrastructure supercycle isn’t slowing down: It’s accelerating.
But those results, I think, are doing a lot of the heavy lifting for everything else. So technology is almost entirely responsible for the upside. Energy sector margins have fallen to 6.6%, against a five-year average of 9.6%. Consumer companies are being squeezed from both ends: higher input costs and a consumer spending more at the pump. Since the Iran war began, more than two dozen companies have withdrawn or cut guidance and several have refused to give any guidance at all, citing the conflict as making forecasting genuinely unreliable. When management teams can’t model their own cost structures two quarters out, the earnings revision cycle loses a lot of its information content.
I think the broader lesson is this: The bifurcation between sectors isn’t going away. Energy, defense and big tech are being upgraded; consumer, industrials and materials are being cut. In that environment, passive exposure to cap-weighted indexes increasingly just means owning the AI capex story and not much else. The scorecard looks good; the field conditions for the next few quarters are considerably less forgiving.
Opportunities in UK Stocks—Especially Large Caps
Karen Gilchrist: Interesting. Does that mirror with what you’re seeing in Europe and would the same apply that it’s really tech names, energy names that seem to be the outperformers here?
Lauren Hyslop: Yeah, I would really say that. On Europe we’ve actually gone, within our asset allocation, we’ve taken the underweight [position] because it is structurally vulnerable to oil and gas disruption. With inflation reaccelerating and growth under real pressure, we don’t really see a compelling reason to add any exposure there. Plus, it is quite light on those tech names, as you’ve mentioned. So we’ve become a lot more cautious on the European story.
UK equities, on the other hand, is I think an interesting one. We’re actually keeping them overweight. And I think it’s one of the more interesting calls. Yes, domestic growth is challenged, we don’t dispute that, and the Iran conflict is making that worse. But the valuation discount relative to other regions is still significant. And that combined dividend and buyback yield is genuinely still attractive, in our view. If you think about the FTSE 100, it’s one of the most naturally stagflation-resilient indices in the world. So it’s heavily weighted towards the exact sectors that benefit from the conditions that we’ve just been chatting about.
Energy majors like BP BP and Shell SHEL, global mining companies, defense contractors, international banks, consumer staples, all with genuine global pricing power. So these are, in our view, businesses whose revenues are largely resilient, dollar-denominated, and whose profits go up when commodity prices rise. And whose dividends are funded by the kind of cash generation that inflation actually enhances, rather than erodes. So I think there’s an important distinction there, both between Europe and the UK, and within the UK, between large cap and small cap, more domestically-exposed companies.
Top Picks in Energy and Aerospace
Karen Gilchrist: Understood. You mentioned a few sectors there and indeed a few names. Are there any other particular stocks that are really jumping out to you at the moment within those sectors that you flagged?
Lauren Hyslop: Energy is the kind of obvious trade. And I would say BP is probably the clearest individual expression of it. So, it doubled its Q1 profits on exceptional oil trading, which is obvious. But the really interesting angle isn’t actually the windfall quarter, it’s the deleveraging story. BP is the most leveraged of the oil majors, which makes it uniquely sensitive to higher-for-longer energy prices. And actually, the management at BP has said explicitly the excess cash goes to balance sheet repair first. So at $100 per barrel plus oil, that story accelerates dramatically. And something I think is really crucial is even if a peace deal lands tomorrow, the energy equity case doesn’t collapse. Around 2 million barrels a day of refining capacity has been physically destroyed. Refining margins stay tight for two or three years, regardless of what happens with diplomacy. So the supply shock is structural, not cyclical.
I also think there’s a few structural themes that are quietly building conviction. So the aerospace cycle still has momentum in my view. There just simply aren’t enough planes. Rolls-Royce RR has reaffirmed its 16% profit growth guidance, despite the conflict. And near-shoring and energy security are themes that the Iran war has forced from theory into actual capital allocation decisions. We saw a similar effect around the Russia-Ukraine war in 2022 as well. So industrials with exposure to that shift, I think are really well placed on a multi-year view. And I think there’s probably a kind of simple through line there: balance sheet strength and durable pricing power. Those two things are really separating winners from the field, and the evidence just keeps coming back to that.
There Are Risks in Fixed Income
Karen Gilchrist: Right. You mentioned that you’re underweight European equities, largely. You also touched on the risks associated with the war. Are there any other areas that you’re looking to avoid, or you think that are undervalued market risks at the moment that you’re steering clear of?
Lauren Hyslop: I would say, thinking about specifically where we’re underweight and where we see risks: on the fixed income side. I think this is where inflation and rates really come into play. So we’re running underweight duration. We’ve seen gilt yields in the UK have risen over 5%. And US Treasuries, too, around 4.3%. And we think the risks are still skewed to the upside from here. So the market is still pricing in a world where inflation gradually comes back to target. And we’re less sure about that, particularly with oil staying elevated and second-order energy effects feeding through into goods and services pricing. So we really remain neutral to gilts, but with a short duration tilt skewed towards obviously the shorter end.
Another area where we see some risks: investment grade credit. So we remain underweight there. The spreads have widened this year—a combination of AI disruption, uncertainty, private credit concerns, and now the Iran conflict. We just don’t think that that widening has been enough to compensate for the risk. So the risk-reward just isn’t there. On a high yield, actually, we’re more neutral. We think the asymmetry in unfavorable, and when the cycle turns, passive exposure looks particularly vulnerable. So we’ve gone for active selection there because we do think there’s some value in that space, but we want our exposure to be deliberate.
Markets Are Looking Through the Iran Shock—for Now
Karen Gilchrist: You mentioned higher oil prices there and the associated inflationary risks. We’ve seen that markets are seemingly looking through some of these elevated oil prices and indeed some of the sort of second-order impacts of the war, the impacts on supply chains. How are you thinking about that? Do you think that the market’s response is in line, or are you thinking differently about that?
Lauren Hyslop: Yeah, it’s a really strange one, isn’t it? Because on the surface you could accuse the markets of complacency. Six weeks after the US and Israeli forces have struck in Iran, we’ve got the S&P 500 sitting at an all-time high. That just seems really peculiar. The VIX has gone back to sleep. You’d be forgiven for thinking that one of the largest energy supply disruptions in modern history is just apparently a major inconvenience.
But if you look at it on a deeper level, the resilience isn’t entirely irrational. The strike was telegraphed for weeks. Investors did have time to pre-position. And history is pretty clear that geopolitical shocks, which don’t trigger recessions, tend to be fairly good buying opportunities. And we talked about Q1 earnings: They have been genuinely extraordinary. So the AI trade seems very much alive.
I’ve mentioned already that is a headline number of companies just doing the work. And if you take a look at it, the number of stocks actually driving S&P 500 performance hit a record low of just 42 last week. The typical figure is closer to 100. So what looks like kind of broad market confidence is actually just a really small group of these mega-cap tech names pulling the index higher, while the rest of the market quietly struggles. Investors are essentially backing the certainty of big tech earnings over the uncertainty of everything else. And I think that’s a rational short-term call. But it’s also a fragile one. If sentiment around AI turns, there’s just not much underneath at all. And I think that is a bit of a worry.
Karen Gilchrist: Absolutely. Lauren Hyslop, thank you. For Morningstar, I’m Karen Gilchrist.
