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Fed Turning Hawkish
Today, Dr Ed and Elias set out the case for the Fed to tighten sooner rather than later. Unlike the consensus, which doesn’t expect a rate hike until late this year at the earliest, we see the FOMC raising the federal funds rate in July, after pivoting to a tightening bias at its meeting this month. That would be appropriate given the resilient economy, stable labor market, and rising inflation. Indeed, recent statements by various Fed officials suggest that a hawkish recalibration is underway. … Also: A sanguine take on recent consumer debt and credit statistics. They’re not cause for alarm, initial appearances to the contrary. … And Dr Ed reviews “Pressure” (+ +).
CONSUMER STAPLES: High P/E With Low Earnings Growth
We recommend an underweight position in the S&P 500 Consumer Staples sector. At first glance, the sector looks fine. Its stock price index is near a record high (chart). Consumer Staples could turn out to be a haven if AI exuberance is fueling a tech bubble that bursts. On the other hand, Consumer Staples is up 6.5% ytd, ranking 7th among the 11 S&P 500 sectors and trailing the S&P 500's 10.7%. Since the current bull market began on October 12, 2022, the sector is up 30.7%, second-worst of the 11 sectors, ahead of only Health Care (chart). The defensive rotation that some have called has not come to fruition. A sector trading at a market-plus multiple on muted earnings and revenue growth is one to underweight, not to chase, in our opinion. Here's more: (1) Concentration. S&P 500 Consumer Staples accounts for just 4.9% of the index's market capitalization, down from above 13% in the late 1990s, and is marginally above its 2025 multi-decade low (chart). Its MidCap and SmallCap counterparts tell the same story, at 3.0% and 2.8%, respectively. The structural decline largely reflects the sector's slower growth profile, especially compared to Information Technology. Walmart, Costco, Procter & Gamble, Coca-Cola, and Philip Morris together account for 75% of the S&P 500 sector's market capitalization. (2) Weak Breadth. The sector's 6.5% ytd gain rests on three industries. Tobacco (13.4%), Soft Drinks (8.4%), and Consumer Staples Merchandise Retail (7.0%) are doing the work, while Brewers is the laggard at -15.3% (chart). The defensive bid is evident for tobacco, soda, and big-box retail. But it isn't a sector-wide rotation. (3) Fundamentals. The analysts' consensus for the sector's long-term earnings growth (LTEG) is 8.4%, the lowest among all S&P 500 sectors (chart). At 7.1%, the sector's forward profit margin is the lowest of the 11 S&P 500 sectors and roughly half the S&P 500's 15.6% (chart). Staples have always operated on thin margins, but it has gone nowhere for over a decade and remains below the pre-GFC peak. The structural weakness is slow revenue growth with low, stagnant margins. The sector's forward earnings is on an uptrend (chart). But the 2026 and 2027 EPS estimates have been falling for a while (chart). The trajectory of analysts' consensus earnings revisions is negative. (4) Valuation. S&P 500 Consumer Staples currently trades at a 22.2 forward P/E, above the S&P 500's 21.2 (chart). The more telling comparison is to Information Technology, which trades at 24.4. The gap is just 2.2 points. Yet Information Technology's 2026 EPS growth is forecast at 47.2%, compared with Staples' 6.8%. The sector's Consumer Staples Merchandise Retail industry trades at a 35.6 forward P/E, near its recent record high and more than double the level it carried as recently as 2018 (chart). Walmart and Costco account for 92% of the industry’s market capitalization. Walmart’s forward P/E of 39 is at a premium to Amazon’s 29. The market is pricing the world's largest grocer as a tech company. The sector could outperform briefly on a sharp risk-off move, but the structural case for our underweight remains intact.
GLOBAL MARKET CALL: 'Go Global' Should Outperform When Strait Reopens
Our call to Go Global rather than Stay Home has paid off so far this year, despite the latest war in the Middle East, which boosted Stay Home, especially in March. However, Go Global was mostly driven by the AI trade in South Korea and Taiwan. The Emerging Markets MSCI ETF (EEM) is up 25.4% ytd against 10.9% for the S&P 500. Moreover, we recommended staying out of China. The EM ex-China ETF (EMXC) is up 39.0% ytd. Europe, Japan, and many EMs that are net petroleum importers should outperform when the Strait of Hormuz reopens, at least on a short-term basis. Here's more: (1) Go Global vs Stay Home. The ratio of the US MSCI to the All Country World (ACW) ex-US MSCI stock price index had been on a solid upward trend since 2010, peaking at a record high in early 2025 (chart). It fell below this trend in late 2025. It rebounded during the war because the US is a net petroleum exporter. The ratio remains below the trendline. The forward earnings per share of the ACW ex-US MSCI has been rising rapidly, along with the comparable series for the US (chart). The strength is broad-based across regions, with India a notable upside surprise. This is a bit surprising, though the AI-led boom in South Korea and Taiwan certainly explains much of the strength in the overseas measure of forward earnings. The US MSCI’s forward P/E is currently 21.5 versus 14.2 for the ACW ex-US MSCI, and the gap has widened recently (chart). There's clearly room for multiple expansion overseas, though that's been true for a long time. At the country level, the AI-driven cohort continues to dominate. On a ytd basis, South Korea and Taiwan closed up 28.0% and 14.4% in May, respectively, with EM ex-China up 11.0%, while the US gained 5.3% during the month (chart). The Korea Institute for Industrial Economics and Trade just lifted its 2026 export forecast to $924.4 billion, up 30.3% y/y, led by semiconductor exports. Looking further down the pecking order, several laggards are oil importers positioned to benefit from a reopening of the Strait. (2) Emerging markets. The EM rally's extraordinary concentration is the catch. EMXC is up 39.0% ytd, EEM is up 25.4% ytd, and WisdomTree True EM is down 2.5% ytd (chart). The gap between EMXC and EEM reflects the China drag. The gaps between both and True EM reflect the South Korea and Taiwan tailwind. The Emerging Markets MSCI tracks the FIBER industrial materials price index closely (chart). FIBER captures aluminum, copper, oil, and other listed commodities. Both continue to rise, suggesting that this time the AI trade is the source of global reflation. The classic inverse correlation between EM equities and the DXY dollar index isn't evident this time, as the former soars while the latter remains firm (chart). The AI trade, not currency tailwinds, is doing the work for EM right now. The EM MSCI Currency Ratio has been declining since 2011 (chart). It looked set to break out of its downtrend in early 2025. Last year's tariffs and this year's war pushed the ratio back down. We watch this ratio as an EM stress indicator, recalling the EM currency crises during the 1990s. (3) Global inflation. US CPI goods inflation rate has been tracking the FRBNY Global Supply Chain Pressure Index closely, especially in recent months (chart). Goods inflation is a global supply-chain story, not just a US one. The chart suggests inflation may prove to be a more troublesome global issue than the markets are currently discounting.
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S&P 500 TRANSACTION & PAYMENT PROCESSING SERVICES: FORWARD STEG & LTEG
SOUTHERN COMPANY: FORWARD LTEG, STRG & STEG
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