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US MARKET CALL: Roaring Decades
Last week, we raised our year-end S&P 500 target from 8,250 to 8,400. We are sticking with our 10,000 target by the end of the decade, though we might raise it. Our Roaring 2020s scenario is delivering even better S&P 500 earnings than we expected. FEMO (fabulous earnings momentum) is driving the stock market higher! The S&P 500 is up 141.0% so far this decade, making it the sixth-best decade since the Roaring 1920s already (chart). If it rises to 10,000 by the end of the decade, it will be up 209.5%, the fifth-best decade. In other words, roaring decades are not exceptional for the stock market. (The S&P 500 fell during the 1930s and 2000s, and edged up slightly during the 1940s, 1960s, and 2000s.) To reach 10,000 by the end of the decade requires an additional 28.5% (or 2,201 points) gain in the S&P 500. That's roughly 7.5%-8.0% annualized price growth over the remaining 3.4 years of the decade. If the S&P 500 hits 8,400 by the end of this year, that would make 2026 the fourth consecutive year of 15% or more annual gains (chart). The only previous streak of five consecutive gains occurred during the second half of the 1990s. Let’s look a bit deeper: (1) Performance. Both the market-weight and equal-weight S&P 500 are at record highs (chart). The latter has been rising to new highs with less volatility than the former after both bottomed at the end of March. We expected the bull market to broaden this year. So far, so good. The Impressive-493 continues to outperform the Magnificent-7, up 17.6% ytd versus 3.8% (chart). The S&P 500 as a whole is up 13.9%. The Russell 2000 is also at a record high (chart). SmallCaps, which are the most economically sensitive corner of the stock market, suggest that investors are bullish on the economic outlook. (2) Earnings. S&P 500 forward earnings always converges to the coming year's consensus analysts' earnings estimate by definition (forward earnings is the time-weighted average of the consensus estimates for this year and next). The 2027 consensus estimate is still rising. It is up to $410.25 (chart). We estimate that both forward earnings and the 2027 estimate will rise to $415.00 by year-end. That should take the S&P 500 up to 8,400, implying a forward P/E of about 20.2. Q2 earnings rose 47.3% y/y, up from 19.0% for Q1. Industry analysts’ consensus earnings estimates imply that they expect 23.1% growth in Q3 and 27.3% in Q4 (chart). The Q2 number was inflated by the mark-to-market gains at Alphabet and Amazon that we have flagged. Without them, Q2 earnings growth slips to 25.7%. The Q3 and Q4 estimates carry no such distortion. The forward profit margin is 16.5%, and the 2027 margin estimate is 16.6% (chart). This is unprecedented. (We impute margin estimates from analysts’ estimates for earnings and revenues.) During the week of August 13, S&P 500 companies had positive 12-month percent changes in forward revenues and forward earnings of 88.5% and 86.1% (chart). Forward earnings are rising to record highs across the S&P 500 LargeCaps, S&P 400 MidCaps, and S&P 600 SmallCaps (chart). FEMO is broad-based. (3) Sentiment. The Investors Intelligence bull/bear ratio has climbed to 3.88 against its 2.60 average, while the AAII bull/bear ratio is at 0.92 versus its average of 1.18 (chart). Institutional bullishness is getting extended. (4) Bonds. The Citigroup Economic Surprise Index has dropped sharply to 15.0, with the 10-year Treasury yield up just 7bps over 13 weeks (chart). Weaker retail sales and employment data drove the CESI down. Bond yields may ease from here, according to the CESI, even though most investors expect them to go higher.
ECONOMIC WEEK AHEAD: August 17-21
Last week brought mixed inflation news in the US: July’s core CPI inflation rate cooled to 2.5% y/y, its lowest since March 2021 (chart). However, July's comparable PPI rose 4.4%. Wednesday’s release of the July 28-29 FOMC meeting minutes should provide some insights on how Fed officials were assessing the outlook for inflation before these numbers were available. Weekly unemployment claims (Thu), industrial production (Tue), and regional business surveys round out this week’s docket of domestic economic news, with flash PMIs closing out the week on Friday. Earnings season is quiet, with Walmart and Alibaba the only notable June-quarter reports scheduled for this week. We will also get some key economic data from overseas. Here’s more: (1) FOMC meeting minutes. July's FOMC minutes (Wed) should reveal how split the committee was heading into last week’s inflation releases. The financial markets’ expectations for the committee’s next moves have shifted. The odds of a September hike in the federal funds rate has dropped to roughly a third from over 50% before the latest CPI and PPI prints. Federal funds rate futures as of August 14 implied 1.5 rate hikes over the next 12 months (chart). (2) Unemployment insurance claims. Initial jobless claims climbed to 209,000 in the week ended August 7, snapping the streak of sub-200,000 readings, though the four-week average of 199,000 still points to a tight labor market (chart). Continuing claims for the week ending July 31 eased to 1,777,000, with the four-week average at 1,790,000. This week's report should show that layoffs remain low. (3) Business surveys. July's regional business surveys from the NY and Philly Federal Reserve banks showed a sharp pickup in activity. The August surveys should confirm that business activity has picked up. (4) Industrial production. Aggregate weekly hours in manufacturing edged up in July, suggesting that manufacturing output did the same (chart). July's industrial production (Tue) follows June's report showing total output up just 1.1% y/y, even as real GDP goods growth ran much hotter at 4.8% in Q2 (chart). The two measures have diverged repeatedly since 2010, with GDP goods consistently outpacing industrial output. (5) Global data dump. Overseas economic growth data lead the week ahead, with Japan's preliminary Q2 GDP and China's latest retail sales and industrial production both due Monday. Inflation readings follow, with Canada's CPI Monday and the UK's CPI/PPI and euro area CPI both Wednesday. Global 10-year government yields have climbed broadly this year, with Australia’s and the UK’s near 5.00% and the US at 4.69%, against Germany’s 3.20% and Japan’s 2.88% (chart). This week's data will test how much further that repricing has to run. The Bank of Japan and the European Central Bank are expected to raise their respective policy rates in September.
The Fed's Divide: Will Core PCED Settle The Debate?
The FOMC is divided between a hawkish and an owlish camp. The hawks include Dallas Fed President Lorie Logan, Cleveland Fed President Beth Hammack, and Minneapolis Fed President Neel Kashkari, all of whom dissented at the July FOMC meeting in favor of a rate hike. Logan argues that policy is no longer restraining the economy. Hammack recently said that "now is the time to act" and that the latest inflation data are "not enough to convince me the tide has turned." Kashkari has warned that delaying action could eventually require more aggressive rate hikes. The owlish camp includes the likes of New York Fed President John Williams and Richmond Fed President Tom Barkin. Barkin recently argued that much of today's inflation reflects tariffs, higher oil prices, and AI-related demand shocks. He believes that current interest rates may still be restrictive enough to bring inflation down. Williams's framework contends that core PCED inflation near 0.2% m/m would be consistent with continued disinflation over the rest of the year. Readings closer to 0.3% would suggest more persistent inflation and could warrant a policy response, in his view. Following this week's July CPI and PPI reports, which camp has gained the upper hand? Consider the following: (1) PPI for final demand. Final-demand PPI was unchanged in July as a 3.1% m/m drop in energy and food prices offset inflation elsewhere in the producer pipeline (chart). Lower fuel costs lowered transportation and warehousing services, which fell 1.8%. On the other hand, the PPI excluding food, energy, and trade services rose 0.4% m/m. On a yearly basis, final-demand PPI moderated but remained elevated at 4.7%, with services up 3.9% and goods up 6.5% (chart). (2) PPI for consumption. The PPI for personal consumption, a key input into the Fed’s preferred PCED inflation gauge, rose 0.1% m/m in July (chart). Excluding food and energy, it was up 0.4%. That's a hot number, though the PPI excludes shelter costs, which have been cooling. Core PPI for personal consumption moderated slightly to 4.4% y/y, but remained above both core PCED and core CPI inflation, suggesting that upside risks to consumer inflation remain elevated (chart). (3) Supercore inflation. The PPI supercore inflation rate has moderated recently but remained elevated at 4.2% y/y in July, more than double its pre-pandemic trend (chart). (4) Core PCED. With July CPI and PPI now in hand, most forecasters expect core PCED inflation to rise 0.2%-0.3% m/m in July. The median Wall Street estimate is 0.22%, while the Cleveland Fed’s Inflation Nowcasting model projects 0.25%. The framework recently outlined by New York Fed President John Williams suggests a reading closer to 0.2% would likely reinforce the case for a hold in September, while one closer to 0.3% would strengthen the case for a September hike. Markets leaned toward the former after the PPI was released, as the probability of a September hike declined to 34.8%, down from more than 40% before the release. (5) Jobless claims. Initial jobless claims edged up to 209,000 in the week ended August 7 but remained historically low (chart). The four-week average held at its lowest since October 2022, while continuing claims declined. (6) GDP. Growth also looks solid. The Weekly Economic Index rose 2.7% y/y in the week ended August 7, consistent with roughly 3% real GDP growth (chart). The Atlanta Fed’s GDPNow model currently projects 5.8% real GDP growth in Q3, supported by consumer spending and business fixed investment (chart). (7) Federal budget deficit. The federal budget deficit widened to $432 billion in July, the largest monthly shortfall since March 2021, bringing the 12-month deficit up to $2.0 trillion (chart). Long-term US Treasury yields have been rising partly in response to increased government debt supply (chart). Recent Treasury auctions showed the pressure: The 10-year Treasury yield rose to its highest level since 2007, while the 30-year rose to its highest level since 2001. Of course, higher long-term yields reflect several additional factors besides the federal budget deficit. One is a higher neutral interest rate, driven by strong AI-related demand for capital at a time when structural forces such as population aging and immigration restrictions are weighing on national saving. Long-term yields have also been supported by economic resilience and increased debt issuance by hyperscalers to finance AI-related investments. We view a 10-year Treasury yield between 4.00% and 5.00% as broadly consistent with these fundamentals. The Bond Vigilantes are not revolting yet.
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