It’s a Good Recipe For Markets…
Executive Summary:
Earnings, earnings, and more earnings: The equity market continues to perform exceptionally well due to a combination of resilient economic factors and massive corporate earnings growth that is overshadowing broader economic concerns.
A struggling labor market: Beneath the surface of a seemingly low unemployment rate, the labor market is flashing significant warning signs, including plunging wage growth, massive negative revisions, and a troubling surge in part-time and multiple-job holders.
Back to the ‘bad news is good news’ market: Investors interpreted the weak employment data as a signal that the Federal Reserve will back away from peak hawkishness, leading to a broad rally across stocks, bonds, and commodities.
Full Commentary:
Recently, when I’ve written a note or made a presentation, I’ve been greeted with a blank stare or a dumbfounded look of disbelief – Corey, with all the craziness, how is it that the equity market is performing so well? My simplified response is that there are variables at play that at this moment are more important and impactful to markets, which overwhelms what one would describe as chaos. It’s the right recipe where economic growth, labor market resilience (more on this below), sticky inflation, fiscal policy, and monetary policy are not too hot or too cold, yet corporate earnings are hitting it out of the park. According to data from FactSet, Q2 revenue growth for the S&P 500 is running at +15% (that’s revenue growth) while earnings growth is +50.4%. This will be the second consecutive quarter of earnings growth above +25% and the seventh consecutive quarter of double-digit earnings growth for the index.
The bear argument is that corporate America is over-earning and that a big chunk of the EPS growth is a factor of marking to market the price appreciation for the investments made in private companies (Anthropic, SpaceX, and OpenAI) by the MegaCap Tech companies. If you exclude Alphabet and Amazon’s non-operating earnings gains, the blended earnings growth rate for Q2 would fall to +32% from +50.4%. That’s a delta worth being mindful of, but making a bearish case on +32% organic operating earnings growth is a tough sell. Another bear argument, and I’d submit it has more validity, is the upcoming rate of change deceleration we’re going to see in corporate earnings going forward. First quarter S&P 500 EPS growth was +28.6% and is tracking close to +50% in the second quarter, with Q2 looking like the peak rate of growth on both an operating and total earnings basis. Below are FactSet's estimates for the last two quarters of the year, and calendar year (CY) estimates for 2026 and 2027:
For Q3 2026, analysts are projecting earnings growth of 27.4% and revenue growth of 11.3%.
For Q4 2026, analysts are projecting earnings growth of 25.2% and revenue growth of 10.9%.
For CY 2026, analysts are projecting earnings growth of 30.0% and revenue growth of 11.5%.
For CY 2027, analysts are projecting earnings growth of 13.6% and revenue growth of 8.4%
Rate-of-change accelerations and decelerations matter to markets, so this will be something to monitor as to when it starts to matter. For now, we have an S&P 500 that has appreciated roughly 13% year-to-date while earnings are estimated to grow at more than double that pace (+30%). This is the textbook definition of equities growing into an above-average P/E multiple, which is what we’ve seen this year with the S&P 500 starting the year at a 22x P/E multiple on forward earnings that has now compressed to 20x.
As for last week, it was a case of ‘bad news was good news’ when the surprisingly weak non-farm payrolls number sparked an all-out melt-up, pushing the S&P to a new all-time high (the 26th of the year) as September rate hike odds tumbled from a near certainty to just 40%. The dismal economic news proved to be a relief for investors, with technical pressure already on the mend after the momentum unwind bottomed on the news of Citadel taking out the Situational Awareness portfolio on the morning of July 30, and confirmation that Treasury Secretary Bessant was working with the Japanese Minister of Finance (MOF) to step in and halt the relentless pressure on the Yen.
Investors holding practically anything liked what they saw last week as everything rallied: stocks, bonds, commodities, and precious metals. Lower 10-year Treasury yields (down to 4.66% from a recent peak of 4.75%) and sliding oil prices acted as powerful tailwinds. The Dow shot up +3.0%, the S&P 500 leapt +3.6%, and the Nasdaq surged +5.2%. The small-cap Russell 2000 gained +3.5%, resting just below all-time highs. It was the best week for major averages since mid-April, though gold rallied the sharpest at +7.2%, alongside massive rips in gold miners at +21%, silver miners at +22%, and uranium miners at +15%. The debasement trade appears to be seeing a revival.
We still have this tug-of-war in Iran to contend with, where rumors are that a bilateral deal between Iran and Oman on the Strait of Hormuz is near. Tehran is stating that the U.S. must meet a slew of hard-line demands for a re-opening (seeking billions of dollars in payments, the removal of American troops from the region, an end to the naval blockade, and more…). All the while, the U.A.E. has reported that Iran just launched a missile attack on one of its ships, only to then have President Trump move to tamp things down by claiming that he will simply let economic pressures do the job on the regime as opposed to any further major U.S. strikes: “We are low keying it,” he told Axios on Sunday (the mullahs obviously see this as a further sign that Mr. Trump wants out). That’s one way to prevent any further oil-induced run-up in gasoline prices, with the midterms now less than 80 days away.
The biggest market-moving event last week was the surprisingly weak employment report released on Friday showing the U.S. economy lost -23k jobs vs. expectations for a +70k print. And the official headline print of losing 23,000 jobs only tells half the story. The negative revisions of 103,000 jobs to the prior two months, slashing May's gain down to +63k and June's down to a meager +20k, speak to the lack of robustness in job creation. Furthermore, temporary layoffs spiked to 921,000 in July, a classic historical precursor to permanent job destruction.
If there is one glaring takeaway from Friday's July jobs report, it is that the headline U-3 unemployment rate, which ticked down to 4.1%, is not accurately capturing the state of the labor market. If the labor market were truly tight, wage growth would not be rolling over this aggressively. Average hourly earnings rose by a microscopic +0.1% month-over-month in July. That dragged the year-over-year trend down to +3.2%, severely missing the +3.5% consensus. To put that in perspective, this is the slowest wage growth trajectory in over five years. It is a steep drop from the +4.0% we saw a year ago in 2025, and a far cry from the +6.0% inflation-era peak of 2021-2022. More importantly, wage growth is now completely round-tripped back to its per-pandemic pace. Yet, the last time wages were growing at 3.2%, the Federal Reserve was busy pinning the funds rate at 1.75%. The disconnect between today's restrictive policy and the actual wage data is staggering.
The critical measure of labor market slack actually resides in the broad U-6 unemployment rate, which remains stubbornly stuck at 7.9%. Keep in mind, U-6 was sitting at 7.0% pre-COVID, a period devoid of wage pressure and accompanied by Fed rate cuts. Why policymakers remain solely consumed with inflation when the broad unemployment rate is nearly a full percentage point higher today is inconsistent with their dual mandate. Look, I’m not sure it's fair to levy too harsh a judgment on the Fed at this juncture; they appear to be between a rock and a hard place – missing on both their inflation and full employment mandate (a misleadingly low unemployment rate notwithstanding) with a solution toolkit that may not match up well with the problem set.
When you look past the top-line numbers, the structural composition of the labor market is flashing warning signals. The headline establishment figure was boosted by +66k from the Birth-Death model. Meanwhile, the Household Survey suggests we’re seeing a measurable deterioration in job quality. A staggering +138k of the newly minted positions were strictly part-time, dragging full-time employment down to nearly a two-year low. We also have a non-trivial double-counting problem: the number of multiple job holders (a reliable, historically contra-cyclical indicator of financial distress) jumped by +139k in July, hot on the heels of a +126k run-up in June. We aren't creating a robust labor market; we are creating an economy where workers need two jobs just to tread water. Even the labor force participation rate is throwing in the towel, sliding to 61.4%, which is down 0.7 percentage points since January.
Because the data can fluctuate wildly from month to month, it is always best to garner a bird's-eye view of the labor market. Assessing the data on a year-over-year basis is the most effective retort to those who say to ignore one month's data. Looking at the wider lens, the year-over-year trend in non-farm payrolls is microscopic at +0.2%, the Household Survey is down -0.6%, and full-time employment is off -1.0%. Going back 70 years, these specific metrics have been sure-fire recession impulses from the labor market. Maybe it will be different this time, but even so, it is best not to paint lipstick on this pig of a jobs report.
Surely, the data-dependent folks at the Fed are seeing these numbers. The question is whether they will acknowledge them before the slack turns into a spiral. Indeed, the “build in” now for the index of aggregate hours worked for Q3 is basically 0.0%. That means another quarter where there is no labor input into the economy — it is all about productivity, as we saw in spades in the second quarter when non-farm business productivity expanded at a +1.4% annual rate in Q2, which more than doubled the +0.6% consensus forecast. We had 82% of the growth in the economy being driven by productivity last quarter. Over the past year, productivity has come to represent nearly 90% of U.S. economic activity. In normal times, the split between productivity and labor input into the economy is even at 50-50. Over the past four quarters, try 90-10. Not even during the wild Internet boom of the late 1990s were the inputs into the economy this imbalanced. Such metrics, if accurate, are not inflationary, but it does go a long way in explaining why corporate earnings are hitting it out of the park. See the following charts, delineating ‘profit share of gross domestic income’ going to corporate America (up and to the right) vs. the ratio of ‘personal income to corporate income’ (down and to the right).
The reality, both in theory and practice, is that there is no such thing as any sustainable inflation if the labor market doesn’t play ball. Every single inflationary episode we can find, usually triggered by an oil/commodity shock, persisted only if that shock got transmitted into wages. That is clearly not occurring. Nothing is more important than inflation, and nothing is more important to inflation than wages adjusted for productivity. Full stop.
This is what had asset prices ripping on what was a very weak jobs report – expectations resetting that peak Fed hawkishness is in the rearview mirror. I know, I know, Corey…it doesn’t make sense to say the labor market is weak (my kids, grandkids, nieces, and nephews are struggling) yet stocks are jubilant, bonds are rallying, and commodities are ripping. Well, investors own a stake in a profit stream, and right now the backdrop is Goldilocks for the forward outlook of that profit stream: earnings up, inflation high but not too high, interest rates in check with a Fed that talks tough but seems unwilling to act, and an administration that is motivated and measures itself on the performance of the stock market. You don’t have to like it, and you’re not crazy to think it doesn’t make sense, but it is what it is. Sure, there are storm clouds out there on the horizon, and it's likely at some point those clouds will turn into a destructive storm, but my advice is to make those preparations when there are reliable indications that such a storm is upon us. Until then, don’t fight the forces and trends that are keeping that storm at bay.
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