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Worry List Is Growing More Worrisome
We’re still strong believers in our Roaring 2020s scenario, hinging on a productivity boom that strengthens economic growth even as it contains inflation. However, we’ve shaved the subjective odds that we ascribe to that scenario from 80% to 70% and now see a 30% chance that rising geopolitical and other risks could derail it. Today, Ed and Elias update our deepened worry list, detailing the concerning prospects, as well as reiterate the reasons that we remain bullish. We still believe that strong earnings growth will lift the S&P 500 to our 8400 price target by year-end.
US SECTORS CALL: Energy, Information Technology & Health Care
Rising bond yields and oil prices weighed on stocks last week, though a mostly in-line CPI report on Friday sparked a rebound. The S&P 500 still fell 0.8%, with nine of the 11 sectors declining. Energy (OW) led, rising 2.0%, and it tops the sector derby at 44.5% ytd. Communication Services (MW) was the only other gainer, up 1.1%. Health Care (OW) fell the most at 3.6%. Information Technology (MW) was nearly flat at -0.2% and is up 23.2% ytd, with fundamentals that continue to improve. Let's take a closer look at Energy, Information Technology, and Health Care: (1) Energy. We have recommended overweighting Energy as a hedge against geopolitical risk. Brent fell below $90 a barrel in late August as diplomacy briefly eased tensions in the Persian Gulf. Last week, the US and Iran exchanged strikes, and Houthi attacks set Saudi oil facilities on fire. Brent futures rose to $104.61 on Friday (chart). The S&P 500 Energy index is at a record high. Leading the S&P 500 Energy sector's 44.5% gain so far this year is the Oil & Gas Refining & Marketing industry, up 127.5% (chart). The S&P 500 Energy sector remains cheap and under-owned. It currently accounts for just 3.5% of the S&P 500 market capitalization and 4.7% of the index's forward earnings share (chart). It's easy to overweight it. Earnings have driven the Energy sector's rally. Forward earnings is up 57.0% ytd, while the forward P/E is down 7.9%. The sector trades at 14.5 times forward earnings against 19.1 for the S&P 500 (chart). If the war continues into the November midterm elections, as President Trump said on Wednesday, Energy should continue to outperform. We are retaining our overweight rating on Energy. (2) Information Technology. The AI spending boom is showing up in revenues, not just backlogs. Oracle beat estimates on Thursday. Total revenues rose 30% y/y, up from 21% last quarter, as the company's backlog boosts revenue. Cloud infrastructure revenue rose 121% to $7.4 billion. The stock opened 7.3% higher on Friday, then gave it all back to close down 1.7%. Investors initially liked the revenue numbers. They are still deciding what to pay for them. The Information Technology sector's revenue outlook continues to improve. Estimates call for IT revenues to grow 33.1% this year and 31.1% next year. Yet the sector trades at 20.2 times forward earnings, down from 26.5 at the end of 2025. As of last week, the sector's forward revenues and forward earnings were up 88.0% and 54.0% y/y, respectively. The AI buildout needs more than chips. It needs hardware and equipment to process and store information and also to build more capacity. Technology Hardware, Storage & Peripherals led the IT sector this week, rising 3.3%, and is up 35.5% ytd (chart). Samsung said in July that the memory shortage should run into 2028. Chipmakers can close that gap only by building capacity, and that means buying equipment. Consensus estimates call for revenue growth of 22.4% this year and 36.6% in 2027. Earnings growth follows, from 35.1% to 48.5% (chart). The industry is the sector's best performer ytd, up 69.4%, yet its forward P/E has fallen to 29.4 from 52.3 on June 30. Earnings are rising faster than stock prices in this industry. (3) Health Care. Health Care was the worst-performing sector last week, falling 3.6%. Every industry declined. Equipment dropped 5.3%, Biotechnology 4.5%, Pharmaceuticals 3.4%, and Managed Health Care 2.5%. Health Care Services held up best, down 1.8% (chart). The selloff obscures a sector where earnings are improving. Managed Care is the clearest case. Its earnings fell 35.0% in 2025. Analysts have marked up this year's estimate to 11.7% growth, from -1.6% as recently as March (chart). They see 14.9% next year. Forward earnings has climbed to $186.00 per share from a low of $152.44, and the forward profit margin has risen to 3.0% from 2.5% in March. The industry is up 21.0% ytd, the best in the sector. Pharmaceuticals are on the same path, a year behind. Consensus shows earnings falling 3.6% this year, then growing 26.9% in 2027 (chart). The industry's forward earnings is at a record high. The S&P 600 Health Care index is up 20.2% ytd, and the S&P 400 is up 17.7%, against 6.6% for the S&P 500 sector (chart). We are retaining our overweight rating on Health Care.
GLOBAL MARKETS CALL: Will The Bull Market Survive Higher Oil Prices & Bond Yields?
The price of Brent crude is back above $100 a barrel. Government bond yields are rising nearly everywhere, with the 10-year yields of Australia and the UK both above 5.00% and the US’s at 4.97%. Either development would normally be enough to break a global bull market in stocks. Neither has so far. That's because corporate earnings keep climbing. The Fed, the Bank of England (BOE), and the Bank of Japan (BOJ) all meet this week. The Fed's decision matters the most to investors’ appetite for global risk. The BOJ's decision matters the most for the yen carry trade, which seems to be unwinding now that the yen is back up to 153.47 per dollar and short-term interest rates are rising in Japan. That unwinding might partly explain the global bond market selloff. Here's more: I. Stay Home vs Go Global The Go Global investment strategy is still working, and September has done nothing to change that so far. Brazil leads the country ETF rankings mtd at 6.0% in dollar terms, with South Korea at 4.3% and Poland at 3.3% (chart). The US ETF is down 0.4% mtd. The ytd performance derby shows similar leadership, with a much wider spread. The South Korea and Taiwan ETFs are in the lead, up 94.1% and 74.6% ytd, respectively (chart). The US ETF is up 12.1%, behind both the All Country World (ACW) ex-US ETF at 15.1% and ACW ETF at 13.3%. Within emerging markets, the Emerging Markets ex China ETF has pulled decisively ahead of the broader Emerging Markets one. The ratio of the two is just short of the record set earlier this year (chart). We have preferred the former to the latter for some time. II. Earnings & Valuation Overseas earnings are soaring, while overseas valuations have dropped. The ACW ex-US MSCI’s forward earnings is up 40.4% y/y, while its forward revenue is up 10.5% y/y (chart). This is reflected in the index's forward profit margin, which is at a record-high 12.6%. The US MSCI accounts for 54.0% of the ACW MSCI’s forward earnings but a heftier 63.8% of its market capitalization (chart). The Emerging Markets MSCI holds mirror-image shares: 20.1% of forward earnings but just 12.0% of market cap. Its earnings share is up sharply from 15.4% at the end of 2025, while Europe’s and Japan's earnings shares have fallen. Meanwhile, the ACW ex-US MSCI trades at a 13.0 forward P/E, well below its 2021 peak of 17.2 (chart). Investors have resisted paying more for stocks that are delivering better earnings. III. Global Bonds Bond yields are rising nearly everywhere, and equities seem to be reading this development as mostly reflecting resilient economic and earnings growth. Australia's 10-year government bond yield is 5.37%, and the UK's is 5.35%, both above 5.00% (chart). The US’s, at 4.97%, is at the top end of the 4.00%-5.00% range we call the "old normal." Over in Asia, South Korea's 10-year yield has climbed to 4.57%, the highest since 2022, while China's is 1.69% and still falling (chart). China remains the world's exception to the rising trend, reflecting that economy’s deflation. IV. Commodities With the war's re-escalation, the price of Brent crude is back up to $104.61 a barrel. But that hasn’t stopped the Emerging Markets ETF from rising as well, to $67.8 as of September 11 (chart). So far, higher energy prices have not derailed the emerging markets trade the way they did in 2022. The FIBER Metals Spot Price Index is at 377, up sharply since late 2024, and the Emerging Markets ex China ETF is tracking it closely (chart). Industrial metals demand is holding up, a sign that the global economy is absorbing the shock oil and bond shocks. V. Japan Japan has been at the epicenter of the global yield rout, with the BOJ set to hike rates this week. The Japanese government bond yield curve has steepened dramatically. The 40-year yield is 4.11%, the 30-year 4.06%, and the 10-year 2.99%, all against a policy rate of just 1.00% (chart). The long end has priced in considerably more tightening than the BOJ has delivered. In recent years, the rising Nikkei and the weakening yen have been closely correlated (chart). This can be explained by exporters. A weaker yen lifts the translated earnings of Japan's large overseas revenue base, and the equity market rally has traded off the weakening currency for three years. That relationship has reversed over the past month. The yen is up 3.72%, and the Nikkei is down 4.75%. Investors are now pricing in action by the BOJ, not the exporters. Despite concerns about rising interest rates and a strengthening currency, Japanese earnings keep climbing. Forward earnings per share is 160.34 yen, a record high (chart). Record earnings against a 15.5 forward P/E is not what a market looks like when monetary policy is about to break it.
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