It’s All Riding On Asset Prices Staying Elevated
The equity market is taking on a Teflon persona with the S&P 500 climbing a wall of worry over the past six months, regardless of weak economic data: sub-50 ISM manufacturing readings for seven consecutive months, downtrodden housing data, and massive downward revisions in employment. I'll dig into more of this below, but first, let's hit on last week's price action. The S&P 500 turned in its fifth weekly increase in the last six and is defying seasonality with a +1.9% gain for the month, while up +12.0% year-to-date. Nothing is performing better these days than the tech-heavy Nasdaq, which notched a new record high on Friday, up +2.0% for the week and nearly +15.0% for the year.
It's not just U.S. equities that are performing well; Asian equities have been red hot, with markets in Japan, South Korea, and Taiwan closing out last week at record highs. The Hang Seng in Hong Kong is this year's leader, with a huge +32.0% year-to-date advance. China's economy may be deflating, but its stock market sure isn't — the Shanghai Composite has recorded a +15.5% year-to-date gain. Asia has been a region of the global equity market we've liked all year long and remains one of our preferred areas to allocate capital to with respect to the global equity market— the MSCI Asia-Pacific index is not just at an all-time high, but is outperforming the MSCI World gauge by the widest margin in eight years.
Beyond equities, we have gold prices notching record-highs with each passing day, closing the week at $3,643 per ounce with a +4.8% month-to-date run-up. There is a case for taking some profits in both the metal and gold miners, but seeing as we view this as a multi-year cycle, we intend to just sit on our position. The same can be said for the nuclear energy space as well as uranium miners, an area we've been steadfast long-term bulls on, but like gold, we still think there is more juice left in this theme, albeit being extended on a near-term basis.
Another metal we're constructive on, but I haven't spilled much ink on in this missive, is copper, a metal facing a future of supply deficiency and rising prices. This is a derivative of three megatrends: green energy (at least outside the U.S.), sharply expanding military expenditures globally, and the AI spending craze, which doesn't show any sign of stopping. Last week, we learned of a proposed $53 billion merger between Anglo American and Teck Resources (representing the mining sector's biggest deal for a decade), which, in my view, signals a maneuver to position the combined entity in the pole position to take advantage of the future demand potential for the reddish metal. For investors in the commodity space, there is tremendous visibility — copper demand has been climbing for some time, but now is far surpassing new supplies. And it will take years before production begins to keep pace with demand.
We have held the view for some time that one of the "cheapest" ways to play AI is to invest downstream in the energy and materials space, both areas that are absolute necessities to fulfill AI ambitions. Within the Basic Materials space, the same can be said for copper, where the rapid expansion of AI is triggering a secular wave of incremental demand for the metal, which data centers require in vast amounts — as in, a single AI data center typically absorbs as much electricity in a year as hundreds of thousands of electric cars. Estimates we have seen show that data centers will require more than 4.3 million metric tons of the metal, which corresponds to nearly a year's supply from Chile – the world's top supplier.
Then there is the global need to crank up military spending from current levels of 2.5% of GDP to 4.0% — where it was before the end of the Cold War: the numbers we see suggest that this alone will translate into 170,000 tons of extra copper demand — and into a finely balanced market at the current time. Keep in mind that copper is highly correlated to global economic activity, so investors need to be cognizant that a business cycle downturn will, without question, intermittently disrupt strong structural tailwinds.
Back to the equity markets and this relentless rise that we're seeing. It's not as though there aren't positive fundamental drivers behind it. Sure, there are variables to be concerned about, which I'll hit on below, but let's start with variables that on the margin have pivoted in constructive fashion. Let's start with interest rates, which have moved down dramatically in anticipation of the Fed restarting its rate-cutting cycle later this week. All the heavy lifting from the maligned Treasury market has taken the 30-year fixed-rate mortgage down to 6.35% — nearly 50 basis points lower than where they were at the start of July. Against this backdrop, we are seeing more than just a pulse emerge in the moribund housing market, with mortgage applications for new purchases shooting up +23% in the year to September 2nd and refinancing activity up +34%.
Lower rates have also triggered a four-month winning streak in the KBW bank index (on track for a fifth), and the highly-leveraged Russell 2000 is on track to beat the large-cap S&P 500 for the second month running. This is a sure sign that hopes for a Goldilocks economy and a soft-landing are alive and well in the mindset of the marginal investor — perceptions that are proving to be extremely difficult to break, even with the squishy soft labor market data of late.
Besides lower interest rates, what equity investors are also feasting on is the weakness in oil prices, with WTI down -7.0% from year-ago levels (a support for profit margins) and the weak U.S. dollar (down more than -2.0%) — the latter being a boon for export-oriented S&P 500 Capital Goods, which are up +25.0% on a YoY basis. Add to this the fact that Wall St. analysts continue to hold firm on their quarterly earnings estimates with Q3 and Q4 numbers being lifted by +0.6% and +0.9% respectively, while lifting Q1 2026 by +1.1% and Q2 2026 by +3.5%. As a result, analysts now expect the S&P 500 to post record earnings every quarter over the next year. Keep in mind the norm is that you typically see analysts walk back estimates as we near reporting quarters, but that's not the case at the moment.
As an investor, it's important to be constantly mapping and measuring what may be priced in and where your blind spots are. It's fair to conclude that a lot of good news is already reflected in an S&P 500 trading at a 22x P/E on next year's earnings. Not to mention off-the-chart investor sentiment with the AI trade getting another boost last week on the back of Oracle's ballooning order book. Portfolio manager cash positions are at record lows, and every Wall Street strategist is now lifting their S&P 500 price targets. The consensus view on the economy is that it's on the verge of a reacceleration, or doing just fine with +3.0% or more real GDP growth in Q2. Add to this the revival we're experiencing in the IPO market, which is at its busiest level of activity in four years, and elevated sentiment indicators like we're seeing with the number of bulls three times higher than bears in the latest Investors' Intelligence survey. None of this is an imminent sign that the good times are about to end, but they are confirmation signals from investors that the good times are broadly being embraced – hence in the price.
Now indulge me as I dig into some of the data points that don't comport with the 'everything is awesome' message being suggested by equities at all-time highs. Let's start with earnings, where we all tend to gaze at the S&P 500, but this index is dominated by mega-cap tech companies with monopolistic characteristics that are seeing a profit boom. However, when you take a broader look at corporate earnings, as can be found in the National Accounts series that includes small-caps, mid-caps, and non-listed companies, the YoY trend in earnings throttled back to +4.3% in the second quarter, from +6.3% in Q1, and +10.9% a year ago. This is the weakest pace of NIPA profit growth since the second quarter of 2023 (yet, total equity valuation has risen at nearly triple the pace of aggregate corporate profits, which underscores the extreme nature of today's valuations). This is likely one reason why hiring activity is slumping so badly — it is economy-wide profits that drive the job market, not merely the S&P 500, which represents just a slice.
Don’t get me wrong – profit margins remain strong, but as I’ll illustrate below with an example from Sherwin-Williams, while corporate America focusing on its bottom-line and profit margins might good for investors, its not good Main St. Earlier this month Cleveland.com obtained an internal communication from Sherwin-Williams announcing it plans to temporarily suspend the company’s matching contributions to employee 401(k) plans, citing weak sales amid economic and tariff headwinds. CEO Heidi Petz attributed the decisions to several factors: high mortgage rates that have pushed housing demand to near-historic lows and inflation that has reduced DIY demand for three consecutive years. Tariff policies have also decreased industrial demand and increased costs for the paint and coatings manufacturer, Petz’s letter stated.
“Sherwin-Williams is not immune from these conditions, which have lasted longer and been more impactful than anticipated…Unfortunately, customer demand remains soft, and in some areas, it’s getting worse,” Petz stated.
The letter goes on to state that Sherwin-Williams has already undertaken what Petz described as “disciplined, responsible, and aggressive” cost-saving measures, including reducing third-party spending, simplifying operations, delaying new hires, and restructuring global assets.
What's your point Corey? Are you just cherry-picking a negative story that's highly sensitive to a housing sector that, based on activity levels (not prices), has been in recession for the better part of the last 24 months? Here's the point: For the past 20-25 years, Sherwin-Williams has been virtually unsinkable. They could always raise price 3-4% per year, come hell or high water. They outcompeted Home Depot and Lowe's with their own store base. They had a loyal pro painter clientele. Their robust repaint and remodel business sheltered them from the worst effects of the housing crash relative to consumer goods peers. China couldn't undercut them because paint is too heavy relative to its price to source from China economically…and yet things are bad enough for this Fortune 500 company that for just the third time in the past 25 years, they have suspended their 401(k) matching program.
For me, this is a significant development in how I view markets, given the structural dynamics of passive flows constantly bidding for equities. Maybe this is a one-off, and there is no 'THERE' there. Keep in mind they took this measure after already "undertaking disciplined, responsible, and aggressive cost-savings measures, including reducing third-party spending, simplifying operations, delaying new hires, and restructuring global assets." Now, couple this with what we are seeing playing out in the labor market, where temp employment is now worse than the drawdown during the early 2000’s recession. Both Sherwin-Williams and temp employment are historically leading indicators of the business cycle.
Perhaps this provides some tangible evidence to explain why consumer sentiment remains so depressed. In the latest Conference Board Consumer Sentiment report, pessimism about the job market increased, with more people surveyed saying they expect their income to decline. A similar message can be garnered from the University of Michigan Consumer Sentiment Index, which is at its lowest levels since 2008 as highlighted in the Larry McDonald post below:
That consumer sentiment is below 2008 GFC levels is troubling in its own right, but what makes it particularly troubling is that historically, U.S. consumer sentiment has tracked quite closely over time with US equity markets, and yet, as the 5-year chart below shows, US consumer sentiment has completely diverged from the S&P 500 and Nasdaq (green dotted arrow below):
This divergence brings to mind a couple of unsettling realities:
That the “stock market is not representative of the U.S. economy” has never been more true. Those who own assets and are able to participate in the levitation of asset price inflation are feeling a lot less pain than those solely reliant on income to keep up their standard of living.
The U.S. equity market has been a major driver of U.S. consumer spending and, therefore, also a major driver of U.S. GDP (consumption is 70% of GDP) and federal tax receipts. Said plainly, the stock market is driving the economy, not the other way around, and if the U.S. stock market were to undergo a significant and sustained correction, it will likely push the U.S. economy into recession while blowing out the federal deficits to unmanageable levels without the Fed having to step in to intervene (YCC, QE, Interest rate cuts…)
Retirees or those approaching retirement (55+ age group) now make up more than 50% of the share of U.S. consumption with the 65+ age group carrying the load.
The U.S. economy and federal government can’t afford for the stock market to undergo a significant and sustained correction. I know, I know, this sounds like blasphemy, but play out the scenarios yourself and see what conclusions you come to. Stocks go down: executive comp dries up as stock options expire worthless, job losses increase, retiree spending shrivels, generational gifting decreases, tax revenue declines…and the dominoes continue to fall.
For those still not buying into the importance of the U.S. equity market, have a look at the recent Flow of Funds report released by the Federal Reserve. The boom in the stock market from April through June helped take U.S. household net worth up $7.1 trillion in the second quarter to a record $176.3 trillion. This was the largest increase since the bull market was just getting going in the fourth quarter of 2020 and the second biggest on record. The ratio of net worth to disposable income rose from 760% to 782% — the 1999 bubble peak was 616%, and the 2007 bubble peak was 674%. This occurred over a period where we’ve recently learned the labor market was virtually frozen with roughly +20k jobs being created per month over this period. So, it wasn’t income or job growth driving the consumer.
I’m going to close up this week’s missive with a few words on last week’s benchmark payroll revision from the BLS. These revisions have nothing to do with sloppy work by the Bureau and more to do with updated tax collection data, and we go through this process every single year. There’s nothing new here except for the information being provided, which is the big -910k downward adjustment to employment over the year to March 2025 (and this follows on the heels of the -818k negative revision in the twelve months to March 2024). That means that the U.S. economy got a reality check, where we have 1.7 million fewer jobs than initially reported over the prior two years ending in March 2025. As for the past twelve months, this means that the average pace of employment gains has gone from +147k per month to around +70k — cut by more than half.
So, yes, the Fed has grounds to pivot its policy focus from its inflation mandate to its labor mandate, given this "data-dependent" Fed has been pursuing a policy that has been too tight for too long, and on this score, President Trump is not wrong. The central bank now has a long way to go, especially since tariff shocks will come and go. What is key is this message: in level terms, this was the steepest revision since the records go back (to 2000) and the largest percent decline since 2009. Revisions of this size represent "regime change" when it comes to shifts in the economic cycle. For those who believe the economy is headed to recession or has been in one, they received a big shot in the arm from the revised data (not to mention the news from the Census Bureau that there was practically no real personal income growth last year).
As for this week's Fed meeting, the markets are fully expecting a rate cut on Wednesday — 93% for a 25-basis point move and 7% for a 50-basis point move. I strongly doubt the Fed is going to cut fifty. The real key is going to be (i) the tone of the press statement, (ii) Jay Powell's post-meeting press conference and (iii), while generally useless, the dot plots and SEP forecasts — keeping in mind that futures are discounting a funds rate of 2.75%-3.0% by the end of 2026, whereas the last set of FOMC projections showed a 3.6% median rate.
Once we get past the FOMC meeting and the array of economic data this week, market attention is going to turn to the strong possibility that we see a federal government shutdown by the end of the month. While more often than not we see a last-minute agreement to kick the can down the road, the Democrats do not seem willing to play ball this time around, and their votes will be needed to avert a disruption (the GOP only has a 53-47 majority in the Senate and needs 60 votes to keep the lights on). Something tells me the VIX, at 15, is nothing short of a bargain.
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