• Market Recap

   Markets moved higher last week with gains almost across the board.  The NASDAQ led markets as it finished up 0.9% for the week with the Dow Jones Industrial Average gaining 0.6%, the S&P 500 better by 0.5% and the MSCI EAFE Index eking out a slight gain.  The Cboe Volatility Index fell 4.6% down to 14.4 which is below average for volatility.  Bond prices rose slightly in aggregate with most of the action on the front end.  Spreads are starting to compress.  The spread on the 2 year Treasury and 10 year Treasury is down to 0.37% or 37 basis points (bps) while the spread on the 10 year Treasury and 30 year Treasury is down to 48 bps.  Both started the year at 0.68%.  I think the message from the bond market is that uncertainty is high as is inflation.  The 2 year Treasury’s yield started the year at 3.48% and has now risen to 4.35% further reflecting that dynamic.  Broad commodities fell slightly with oil down 3.8% and gold off 3.2%.  The U.S. Dollar was stronger as it gained against most major currencies other than the Aussie Dollar (AUD) which has continued its move higher against USD.  AUD is up 7.8% against USD so far this year.  This week will be a busy one for data releases with Job Openings and Labor Turnover Survey, ISM’s manufacturing and nonmanufacturing indexes, Construction Spending, Factory Orders, ADP’s National Employment report, Trade Balance, and on Friday, the Jobs Report.  Earnings are mostly done for the quarter, so I expect some of this data will attract attention from markets.

    Q2 Earnings Finish Strong

   97% of the S&P 500 have reported their 2^nd quarter results and the results have been unusually strong in my opinion.  Of those reporting, 86% have beaten expectations which is above the 5 year average (78%) and 10 year average (76%).  This is the highest beat rate since Q2 of 2021 (87%).  Companies are reporting results 26.5% above their expectations.  This surprise rate would mark the highest rate since FactSet began tracking this back in 2008.  With earnings coming in at 52% growth, we are well above analysts expectations of 23.1% growth back on June 30.  This is the highest growth rate since Q2 of 2021 at 91.6% earnings growth.  This will mark the second consecutive quarter of 25% growth.  9 of 11 sectors are reporting at least double digit earnings growth.  Health Care is the only sector to report a year over year decline.  Revenue growth has come in at 15.5%.  77% of companies are beating expectations on revenue growth that is above the 5 year average (70%) and 10 year average (68%).  Companies are beating revenue expectations by 3.2% which is tied with Q2 of 2022 for FactSet’s best result since they have been tracking it.  Revenue growth is the highest since Q4 of 2021 with 16.1% revenue growth.  All 11 sectors have reported revenue growth with 5 sectors reporting double digit revenue growth.  This is the second consecutive quarter with double digit revenue growth for the S&P 500.  Net profit margins have increased to 17.0% which is nicely above last quarter’s net margin of 14.8%.  This will mark back to back quarters where profit margins are the highest since FactSet began tracking in 2009.  The high bar won’t be lowered any time soon with Q3 expectations of 28.2% and Q4 at 25.8%.  Full year growth is expected at 31.2%.  Next year is expected to see earnings growth of 14.4% with revenue growth of 8.9%.  The result of this strong earnings growth is that the Price to Earnings Ratio (P/E) has dropped almost a full handle during the reporting period.  The P/E ratio stood at 20.4 back on June 30 and it is now down to 19.6.  That is now below the 5 year average of 19.9 but above the 10 year average of 19.0.  The trailing P/E has dropped to 26.4 which is well above the 5 year average (24.4) and 10 year average (23.5), but is also much lower than the extreme levels we’ve seen in past bubbles.  I’m not saying this market is cheap, rather that it doesn’t look as extreme to me given the current earnings growth and near term expectations.  (Source: Butters, J., Earnings Insight August 28, 2026, FactSet)    

    Inflation and Income Continue Higher

   Personal Consumption Expenditures (PCE) rose 0.2% in July and are up 3.7% in the past year.  Core PCE, excluding food and energy, rose 0.2% for the month and is up 3.3% in the past year.  Personal income rose 0.4% in July and is up 3.7% in the past year.  Personal consumption increased 0.2% (0.3% including prior revisions) and is up 5.9% in the past year.  Adjusting for inflation, we see personal consumption was unchanged in July and up 2.1% in the past year.  Spending on goods fell 0.7% for the month while spending on services rose 0.6%.  The big spending categories have remained Insurance, Health Care and Housing.  Consumer spending increased by $36.3 billion, but those top 3 categories contributed $63.9 billion.  Housing costs are slowing a little bit with the 12 month increase to Housing and Utilities at a 3.2% annual increase, but Health Care is still at 4.2% inflation while insurance comes in at 2.9%.  One category jumped off the page to me: Final Consumption Expenditures of Nonprofit Institutions Serving Households.  That category is up 6.9% annually, and what the heck is it?  This is basically a catch all category for religious charities and relief organizations, trade unions and professional associations, political parties, and social, cultural and recreational clubs.  This category accounts for about 3% of total GDP and most of that money is spent on welfare, education and medical care.  So we are seeing that nonprofits are being squeezed by inflation more because education and health care have seen higher rates of inflation than the broader economy.  Personal Savings finally rose after declining for 5 months.  The Personal Savings rate went from 2.6% in June up to 3.0% in July.  It remains at a very low level similar to 2022 and 2008 so we can see the impact on consumers.  Wages are going up, but it isn’t really translating into more disposable income.  I think that there are some signs that parts of inflation are coming down, but the game of whack-a-mole continues in other parts of the market.  Health Care and Housing are the two biggest categories keeping inflation from moving lower and those appear to be structural problems, so we need everything else to get cheaper to overcome those two.  I’m not sure how much the Fed can contribute here since they don’t build houses or run doctors offices or hospitals.  (Source: Bureau of Economic Analysis, Personal Income and Outlays, July 2026, U.S. Department of Commerce)

   

  • Still No Guidance From Warsh

   Fed Chair, Kevin Warsh, gave his first speech at the annual Jackson Hole Wyoming meeting sponsored by the St. Louis Federal Reserve.  Warsh’s speech was short again, and light on details again.  He set expectations right from the get go “Here is a quick overview of what I’ll cover in my remarks this morning.  You can call it an outline… you can call it a trail map… just don’t call it forward guidance.”  Warsh then spoke about AI where he asked 9 questions and delivered no answers or even speculation “Will the application of AI cause a significant, sustained rise in productivity across the economy?  And if so, when?”  These are important questions for sure, but I’m not sure why Warsh would ask and then provide nothing.  I guess we’re supposed to take from this that the Fed understands the game on the ground with AI?  And now, I’m asking questions!  I did think that Warsh made a good point about forward guidance “If markets rely materially on the Fed’s guidance and the Fed relies on market prices, we are all more likely to be blinded to new developments… more likely to be caught unprepared for a turn of events… and more likely to commit errors in policymaking.”  Warsh goes on to bring up former chair Ben Bernanke’s Hall of Mirrors analogy about the self-reinforcing nature of the Fed’s future guidance.  I did like this point that Warsh made about potential policy mistakes from the Fed “Perversely, market participants are unlikely to bear the biggest cost of the hall-of-mirrors problem.  The most serious harm is likely to befall those without financial assets.  If the Fed gets inflation wrong and judges the economy wrong, who get the worst of it?  Not the financial high fliers.  Hard-working Americans are the ones left to deal with inflation that is too high or jobs that suddenly appear less secure.”  His final point on the future guidance subject was “a quieter Fed, more purposeful in its communications, is better able to meet its objectives.  And we can be held accountable for delivering on our remit – the only true test of our credibility.  To borrow a line from General Chuck Yeager, “At the moment of truth, there are either reasons or results.””  Finally, Warsh did comment on the current state of the American economy.  “For my part, today I am impressed by the overall performance of the economy, which appears to have strengthened.  One indicator of strength is how well an economy holds up to shocks.  On that score, both Main Street and Wall Street have been remarkably resilient.  Business capital expenditures – the seed corn of future economic growth – are rising rapidly.  The four-quarter change in investment in equipment and intangibles has been around 9%, its highest growth rate since 2021.  More than half of the cap-ex growth this year can likely be ascribed to the buildout related to AI.  For firms in the S&P 500, profits have grown by more than 20% over the past year.  Profit margins are quite elevated, relative to history.  Overall equity market volatility is low.  Certain sectors – like housing and agriculture – are showing strains.  But, on balance, I would be hard pressed to describe broad financial conditions as restrictive.  Combining consumption with the brisk investment we’ve observed, private domestic final purchases (PDFP) has also risen.  PDFP has increased at a pace of nearly 3% so far this calendar year.  That’s a measure that typically carries more signal than GDP, and the trend here is positive.”  Warsh closed with concerns on inflation “But on the price-stability side of our mandate, the numbers are more concerning.  The Fed’s preferred measure of inflation, the 12-month change in the PCE price index, stands at 3.7%, while the six-month change is 4.1%.  The comparable measures from the CPI are also elevated, as are the core measures of both PCE and CPI inflation.  None of these measures are perfect, but they all tell a similar story: Inflation is running above our 2% target.  So the Fed’s predominant focus right now should be on prices.  There is one signal nobody can miss: The responsibility for 65 months of sustained, elevated inflation sits squarely with the central bank.  And that is where it belongs.”  Many have taken his comments as hawkish, and I would have to agree that the comments do signal that rate hikes are on the table.  I’m curious if Warsh is trying to jawbone rates here, or will the Fed literally put its money where its mouth is and actually begin to raise rates again in the face of 5 plus years of above trend inflation.  (Source: Federal Reserve Bank of Kansas City, In Our Time, Remarks by Kevin Warsh, Federal Reserve)

   U.S. Strikes Oil Deal with Venezuela

   Venezuela has the largest proven oil reserves in the world with over 300 billion barrels of crude oil that accounts for around 20% of all know oil on planet earth.  The U.S. just made an agreement to extract and export 65 billion barrels of that oil.  Interim President of Venezuela, Delcy Rodriguez, made an address on state outlet VTV to comment.  “This 25 year bilateral project envisages the development of 17 strategic oilfields with a production target of more than 1.5 million barrels per day.  That figure relates solely to the bilateral agreement between Venezuela and the United States.  The agreement is based on a very simple premise.  Each party contributes what it does best.  Venezuela contributes oil, its industry and the experience of its workers accumulated over more than 100 years.  The United States contributes the capital and technology needed to recover and develop those assets.  Venezuela receives productions, jobs, investment in infrastructure, increased revenue for the government and productive linkages for domestic industry.”  $19 per barrel will go to Venezuela for each barrel of oil produced and sold to the U.S., generating an estimated $209 billion per year for the government.  The benchmark price is based on $65/barrel oil, but Rodriguez said that price could fluctuate based on global prices.  Rodriguez went on to note that Venezuela is not giving up ownership of the assets “But there is something that must be absolutely clear, Venezuela retains ownership and sovereignty over its resources, while utilizing capital, technology, and operational capacity to leverage the recovery of a strategic industry that has been severely hit by sanctions.”  Chevron is nearing a deal to make investments in Venezuela.  So far, other major oil companies have cited security concerns, but I think this deal will go a long way to allay those concerns.  It is interesting that the U.S. made this deal a short time after a trade deal with Canada fell through.  Some Venezuelan oil is heavy sour crude that is somewhat similar to the heavy sour crude coming from Canadian tar sands.  U.S. oil refineries are tooled to handle heavy sour crude and Venezuelan oil is an easy substitute for Canadian oil.  While this is a big story today, we shouldn’t expect Venezuelan oil to ride to the rescue of high prices today.  Much of the new acreage is greenfield and is likely to take at least 5-7 years before production comes online.  Other acreage is brownfield that degraded over the past 25 years under Chavez and Maduro, so significant work and capital is needed to get those assets up and running as well.  This does call back the National Defense Strategy rolled out in January.  At the time, it was called the Trump corollary to the Monroe Doctrine.  But the actual strategy is now being implemented.  Venezuela will no longer supply much oil to China, and its defense ties to Russia are gone.  The United States is clearly the dominant force in both North and South America.  The U.S. is using its military, capital and technology to kick out any challengers and also marshal natural resources to the mutual benefit of the U.S. and the countries in its sphere of influence.  We can also see that Iran specifically, and OPEC in general are becoming less important to American interests by the day.   We should remember that Guyana, right next door to Venezuela, also has massive reserves and American companies are already doing business there.  I think Venezuela is about to return to its former glory and become one of the richest nations on the planet.  That is good news for American consumers as well as broader American interests.  (Sources: Mancini, R., Venezuelan interim president offers details on US oil deal, The Hill; Eaton, C., U.S. to Take Control of Much of Venezuela’s Proven Oil Reserves, The Wall Street Journal)    

  We’re over 2500 words so far, so let’s keep it short and cut to the chase.  I still want to own more stocks.  Valuations have come down considerably and that is happening with markets near all time highs.  That is strong signal to me that we shouldn’t get too cute here.  I would encourage investors holding cash to consider continuing with a monthly dollar cost averaging program.  I would encourage them to consider investments in large, U.S. dividend payers, select U.S. technology companies, long dated bonds for investors seeking income, and currencies and commodities for diversification.  Give the skepticism around markets, excellent earnings growth, and a generally healthy U.S. economy, I have a hard time seeing how market won’t move higher.  Of course, this is the 2020s, so there might be something else right around the bend, but things look pretty good to me these days. 

  All the best,

Gary