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On Challenges Facing Europe & Canada
The Eurozone is grappling with stagflation, and the ECB is determined to subdue inflation with rate hikes, which it failed to do aggressively enough in 2022. But the stakes are higher today, the decision complicated by trade/geopolitical pressures and uncertainties, and tightening more than the struggling economy can take is a risk. William discusses the challenge facing the ECB and the potential fallout from rate hikes. … Also: Canada is determined to wean itself off exports to the US, but that’s easier said than done. The vast US market absorbs the majority of Canada’s exports, and the resilient American consumer has been lifting Canada out of an economic morass.
MATERIALS: Small Weight, Big Growth
We recommend overweighting the S&P 500 Materials sector. The sector accounts for just 1.9% of the S&P 500's market capitalization, so an overweight is cheap to implement, the same logic we applied to our Energy sector recommendation on April 20. S&P 500 Materials is up 9.9% ytd, fifth behind Energy, Information Technology, Industrials, and Real Estate. The stock price index is near a record high. Forward operating earnings per share continues to climb back toward its 2022 peak (chart). Materials’ 2026 EPS growth forecast is 39.7%, the third-highest among sectors (chart). Here's more: (1) Concentration. Materials is the second smallest S&P 500 sector by weight, ahead of only Real Estate. The S&P 400 MidCap and S&P 600 SmallCap counterparts carry larger weights of 5.6% and 4.8%, respectively (chart). The S&P 600 Materials is up 21.7% ytd, more than double the S&P 500 Materials gain of 9.9%. The S&P 400 Materials is up 4.8%, reflecting the operating leverage in smaller-cap commodity producers during cyclical recoveries. (2) Bifurcation. Within the Materials sector, strength is uneven. Steel and Copper lead the charge, up 56.9% and 24.8% ytd, respectively, while Construction Materials lags at -10.4% (chart). The 67-point spread between the former and the latter defines a split between hard-asset producers and housing-sensitive cyclicals. The performance map mirrors the earnings map, with Steel and Copper carrying 2026 EPS growth forecasts of 88.3% and 48.0%, both well above the sector's 39.7%. Industrial Gases is the exception. The 18.1% ytd gain rests on only 9.0% expected 2026 EPS growth, reflecting a multiple re-rating on semiconductor fab exposure rather than an earnings story. (3) Margin recovery. The Materials sector's forward profit margin is 12.7%, the sixth-lowest among the 11 sectors. Margins are on a steep recovery from the 9.7% trough in Q4-2025 to forecasts of 13.0% in Q2-2026, 13.1% in Q3, and 12.4% in Q4 (chart). (5) Gold. Hawkish Fed expectations have pushed the gold spot price below its 200-dma for the first time since 2023, with bullion at $4,353.60 against the 200-dma of $4,446.60 (chart). The key area of support is $4,000. The structural setup remains intact. International gold reserves are at a record $3.5 trillion, driven by continued central bank buying (chart). Central bank accumulation has paused owing to the war, but the reserve-diversification thesis remains intact. (6) Fertilizers. The S&P 500 Fertilizers & Agricultural Chemicals industry (CF, CTVA, MOS) is up 19.9% ytd, with 2026 EPS growth forecast at 20.2% and revenue growth at 8.0% (chart). The forward profit margin has recovered to 13.3% from below 10.7% in early 2025, with room to run back toward the 20% peak last seen during the 2022 Russia-Ukraine supply shock (chart). The Iran/Hormuz shock has added a fresh risk premium to stocks in the nitrogen fertilizers industry. The less obvious investment angle is semiconductors: Ultra-high-purity ammonia is used not just to make fertilizer but also in chipmaking processes tied to AI hardware. US producers remain structurally advantaged given the high Henry Hub gas costs that producers elsewhere have to pay, with CF Industries as the cleanest expression of this trade. A small, cheap sector with the third-highest 2026 EPS growth forecast and a forward P/E trending down, rather than up, is one to overweight. Gold may be correcting, and the fertilizer war premium could fade if the Strait reopens, but the broader case for our overweight on Materials stands.
The Hires-Exceed-Fires Economy
The strength of May’s employment report surprised many, debunking the notion that the US labor market is mired in “low-hire, low-fire” stagnation. But it confirmed the views of Ed and Elias. They expect demand for labor to continue to improve and supply to remain structurally constrained. This should keep unemployment low, boost productivity, and sustain wage growth. That shouldn’t cause an inflationary wage-price spiral over the long term; the AI-sparked productivity boom should keep unit labor costs in check, in line with our longer-term Roaring 2020s hypothesis. But near-term risks remain: The AI buildout is inflationary, and higher wage growth could add price pressure before offsetting productivity gains materialize. … Also: Elias discusses five economic impacts of AI.
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TARGET: FORWARD OPERATING EARNINGS PER SHARE
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