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Thanks For The Memories
I. Micron and the AI Trade Memory has become one of the biggest beneficiaries of the AI spending boom. Micron’s stock, for example, is up 273.2% ytd, second only to SanDisk among the semiconductor companies. We have been bullish on memory, and Micron’s fiscal Q4-2026 results reinforced our view. Revenue surged 379% y/y to a record $54.2 billion, above the $50.8 billion consensus. Adjusted EPS of $33.42 topped management’s guidance range. Gross margins widened to 87% as DRAM and NAND prices surged. The outlook was even stronger. Micron guided fiscal Q1-2027 revenue to $61.5 billion, well above the roughly $57 billion analysts expected. Management expects memory supply-demand conditions to tighten further in 2027 and 2028, with more than 75% of fiscal 2027 output already committed. The company now has 26 long-term agreements (LTAs), up from 16 last quarter. Many investors still view memory as a classic boom-bust commodity. Before the latest earnings report, Micron’s forward P/E was 6.8. The stock barely budged today following the company's gangbusters results (chart). Micron’s results reinforce the case that the AI buildout still has plenty of runway. Hyperscalers continue to increase infrastructure spending. Indeed, Goldman Sachs recently raised its 2027 hyperscaler capex forecast to $1.2 trillion, roughly 50% above $750 billion this year. II. "Growthflation" With the AI buildout continuing to act as a powerful private-sector stimulus program, it is hardly surprising that the latest indicators continue to point to a strong economy. At the same time, inflation remains stuck around 3.0%. Today, the 10-year Treasury yield briefly hit 5.33% and the 30-year reached 5.68%, both marking fresh 24-year highs, before easing back a bit (chart). The message is clear: robust growth and persistent inflation are putting upward pressure on long-term yields. We think the bond yield is reflecting the strength of nominal GDP, which rose 6.3% y/y during Q2 (chart). We don't expect the bond yield to depress the economy unless it surges above the growth rate of nominal GDP, which we don't expect to happen. In fact, Dr Ed visited our institutional accounts in Toronto over the past two days and found that all of them expressed interest in buying bonds at these attractive yields. Now, consider the latest evidence of the "growthflation" driving nominal GDP: (1) Labor market. Initial jobless claims fell to 197,000 during the week of September 25, the lowest level since July 18 (chart). They have been below 200,000 for seven weeks this year, the most in any year since 1969. Additionally, the latest reading is near a 57-year low. Continuing claims dropped to 1,701,000, the lowest reading since March 2023. Challenger job-cut announcements fell 18% m/m and 20% y/y to 43,281 in September, the lowest total for the month since 2022 (chart). Layoff activity remains subdued across the US economy. Private payroll growth also appears to be firming. ADP employment rose by 90,000 in September, while Revelio Labs estimates that private payrolls increased by 56,900 last month (chart). We expect tomorrow’s BLS report to show roughly 100,000 nonfarm payroll gains in September, more than enough to keep the unemployment rate near its current low of 4.1%. (2) Construction spending. Construction spending jumped 0.9% m/m in August to a $2.20 trillion annual rate (chart). Private nonresidential construction rose 1.0% to $773 billion, while residential construction increased 1.1% to $882 billion (chart). Office construction, which includes data centers, surged 4.6% m/m, while power construction rose 0.9%. Both categories continue to benefit from the massive AI infrastructure buildout. (3) Manufacturing. The ISM M-PMI remained firmly in expansion territory at 54.5 in September, marking the ninth consecutive month above 50.0 and the longest expansion streak since 2022. Major components, including new orders, production, and employment, also remained in expansion territory. The upswing is being fueled by the AI capex boom, reshoring, and stronger incentives for domestic investment, including immediate expensing under the OBBBA. Meanwhile, input cost pressures remained elevated in September. The ISM prices-paid index rose to 77.9, near its highest level since 2022, while regional Fed price surveys also remained high (chart). Respondent comments in the ISM survey noted that demand remains strong in semiconductors, electronics, machinery, and AI/data-center-related markets, but that strength is increasingly running up against worker shortages, stretched steel capacity, longer lead times, and rising input costs.
On Stock Market Churn, Corporate Debt & AI Agents
The S&P 500 Equal Weight index is up less ytd than the S&P 500, so the average company’s stock isn’t faring as well as the overall index’s performance would suggest. That’s a reversal from mid-August, Joe points out. Today, Jackie looks under the S&P 500’s hood, identifying industries that have toppled the most from their summer peaks. … Also: Corporate bonds have had a tough year, with rising Treasury yields and lots of new supply. But their declines don’t reflect credit-quality concerns. … And: The AI agents Big Tech has been launching are likely to squeeze entrepreneurs’ niche offerings out of the market.
Optimistic Spin: Bond Market Pricing Better-Than-Expected Economic Growth
Bond yields rose yet again today even though September's PCED inflation report showed some improvement, which was due mostly to new measurement procedures. Inflation remains about a percentage point above the Fed's 2.0% target. Other economic indicators today confirmed that the economy and the labor market are doing very well and strengthened the case for more Fed rate hikes. Yesterday's dovish suggestion by NY Fed President John Williams that a pause in rate hikes might make sense was all but forgotten today. The most optimistic explanation for the backup in bond yields is that it reflects better-than-expected economic growth, suggesting the economy's R-Star (i.e., the neutral interest rate) is higher than Fed officials thought at the beginning of the year. Back then, they mostly agreed that the federal funds rate was still slightly restrictive, i.e., above the neutral rate. Now, they agree with Fed Chair Kevin Warsh that September's 25bps rate hike "removed a dose of accommodation." That implies that the federal funds rate is below neutral. No wonder the 2-year Treasury yield remained 100bps above the federal funds rate today (chart). Federal funds futures are pricing in three to four 25bps rate hikes over the next 12 months, including roughly two over the next six months (chart). Let's review the latest data: (1) Inflation. Today’s August PCED report confirmed that the strong US economy still has an inflation problem. Headline PCED rose 0.3% m/m and 3.4% y/y, while core PCED increased 0.2% m/m and 3.0% y/y. Both remain well above the Fed’s 2% target. The August PCED report incorporated the annual revisions and methodological changes implemented by the Bureau of Economic Analysis. July's headline PCED inflation rate was revised down 37bps, to 2.98% y/y from 3.35%, while core PCED was cut 34bps, to 3.36% from 3.70%. The key point is that much of the recent decline in core PCED inflation reflects revised measurement procedures rather than a genuine improvement in underlying inflation. Indeed, despite the methodological changes, the report's details point to sticky underlying inflation. Goods PCED inflation rose to 3.6% y/y in August from 3.3% in July, partly reflecting a 4.1% m/m jump in gasoline prices (chart). Tariffs and the AI buildout added further pressure: prices for computers and peripherals surged 3.8% m/m, while toy prices rose 2.0%. Looking ahead, tariff pass-through and AI-related demand should keep goods inflation elevated, while the renewed rise in oil and refined-product prices in September adds another source of upward pressure. The PCED services inflation rate eased to 3.4% y/y in August (chart). However, the “supercore” PCED services, which excludes both energy and housing, rose 0.4% m/m in August. That was the strongest monthly increase since May 2026 and pushed the y/y rate up to 3.5%. The supercore inflation rate isolates some of the stickiest and most wage-sensitive parts of the inflation basket. The measure remains well above a pace consistent with the Fed’s 2% target. More importantly, it has been moving higher since October 2025. (2) Consumer spending and income. Consumer spending remains remarkably strong. Inflation-adjusted consumption rose to another record high in August (chart). By contrast, real disposable personal income was unchanged m/m and has been essentially flat for more than a year. That trend is likely to persist as more Baby Boomers retire, slowing wage income growth. Real consumer spending rose 0.6% m/m in August, the strongest monthly gain since March 2025. The increase was broad-based, with especially strong spending on discretionary categories including restaurants and hotels, recreation, and apparel (chart). The surge in household net worth relative to disposable income is causing consumers, especially Baby Boomers, to reduce their savings rate (chart). August’s saving rate was revised meaningfully higher, but still fell to 4.1%, the lowest since November 2022. We expect it to decline further as more Boomers retire. Their labor income drops to zero when they do so, but their sizable accumulated wealth lets them keep spending. (3) Labor market. Another key driver of consumer spending is the strong labor market. ADP private payrolls rose by 90,000 in September, with healthy gains across both goods-producing and service industries (chart). We expect Friday’s employment report to confirm that strength, with nonfarm payrolls likely to show a 100,000 increase in September. (4) GDP. Q2's real GDP growth was revised today from 1.5% saar to 2.2%. On the other hand, Q3's growth rate was revised down from 5.0% to 3.7% by the Atlanta Fed's GDPNow tracking model (chart). That was mostly attributable to the widening trade deficit. Final sales to private domestic purchasers was strong with a 4.5% gain.
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