Market Thoughts
Despite a modest slide on Friday, the S&P 500 added to its summer melt-up last week as it advanced +0.9%, ending the week essentially at an all-time high of 6,449. The world's most widely followed equity index is now up nearly +10% for the year and around +30% from its April low. While the technical picture is broadly supportive of equities continuing higher, I am observing some non-confirmations starting to set in – for instance the NYSE Composite Index (a broader representation of the US stock market than the S&P 500) is tagging the top end of a major trend line going back to 2010 (bottom panel on below chart) that has restrained further upside. It’s also worth noting that the recent new highs have coincided with a negative weekly RSI divergence (see top panel in red on the chart below)
While the fundamental backdrop remains supportive for risk assets in general on an intermediate to long-term time frame, I still think the near-term setup is ripe for a correction. The put/call ratio (investors buy puts for protection and calls for upside) is trending towards its lowest levels of the year, indicating investor complacency is elevated, which brings to mind the Wall St. adage – “buy protection when you can, not when you have to”.
Given what our research and models suggest, this would be a dip we’d use as an opportunity to buy things on our shopping list. However, without a pullback that resets some of the extremes we’re observing in positioning and sentiment, we’re inclined to remain patient and disciplined with our current exposure. After all, we have an S&P 500 trading at a record high price-to-book ratio of 5.3x and a forward P/E multiple of +22x – just under its highest level in the past four decades.
So, it’s not as if anyone buying the S&P 500 today is getting a bargain, and while that’s been the case for some time now, I think completely abandoning any valuation framework in one's investment philosophy is reckless for long-term investment success. It's worth pointing out that Q2 earnings for the S&P 500 were impressive in the aggregate (+11% versus expectations of +4% at the start of Q2). The outlook suggests more of the same, where more than 40% of companies providing guidance have raised their estimates – more than double the 17% share that did so in Q1. As such, consensus estimates for the S&P 500 over the next twelve months are now +6% higher than they were at the start of the year.
It should be added that the earnings upgrades have been heavily skewed toward three sectors: Tech, Communication Services (home to Meta and Alphabet), and Financials, and of the eleven sectors, four of them (Energy, Materials, Health Care, and Consumer Staples) have seen their EPS estimates downgraded this year, while another two are barely changed. I must say, the following chart from Blackrock was eye-opening, where it shows that even though Mag 7 names have been responsible for a large chunk of the S&P 500’s +10% ytd gain, this group has seen its valuation get cheaper relative to almost everything else. This is yet another reminder that investors cannot afford not to be exposed to this group of companies that dominate their respective industries. That being said, the Tech sector now accounts for almost 35% of the market cap of the S&P 500 and rises to 45% when you include Meta, Amazon, and Alphabet.
It’s not just equities that are priced for nirvana, but so too is the corporate credit market, where investment-grade credit spreads at +75 basis points and high-yield spreads at +264 basis points are near their tightest levels in the past three decades. All of which is a confirmation that things are pretty darn good, which is great for investors who have ridden the wave of the 30% rise over the past four months. However, additional gains from here require things to not just stay good, but incrementally improve – a tall ask in my estimation.
According to work from BofA’s Michael Hartnett and his team, the global economy has experienced 88 rate cuts year-to-date, the fastest cutting cycle since 2020, and investors are positioned for the Fed to join the party. But the ‘why’ for Fed cuts matters for investment purposes. Cuts on the basis of acquiescing to political pressure risk disrupting long-end treasury yields, breathe additional life into inflation that is already set to rise throughout the remainder of 2025, and undermine Fed independence and credibility. Cuts on the basis of slowing growth and a softening labor market need to be analyzed through the lens that the probability of recession is on the rise; therefore, are equities and credit deserving of trading at historically lofty valuations given a less rosy outlook?
Don’t get me wrong, the structural path for US fiscal and monetary policy has us on a course where currency debasement and inflation, presented under the guise of ‘we’ll grow our way out of it,’ is the most likely outcome. This implies that investors, over the long-term, need to position themselves with a heavy tilt towards real assets: equities correlated to nominal GDP, gold, commodities, crypto, and emerging markets. All of this reinforces what has become a broadening consensus view of ‘anything but bonds’ – Boomers have the wealth, but can’t bring themselves to swap stocks for bonds in the interest of preserving their nest egg and the Millennial and Gen Z demographic prefer to build wealth in the stock market rather than real estate while having no idea what a bond is. However, such an asset mix will experience periods of uncomfortable downside volatility that need to be navigated.
This brings me to the US dollar, which has been in the midst of its worst yearly performance since 1973, and the fraying of the ‘US exceptionalism’ investment theme, where foreign capital leaves US assets and goes home. So far, this thesis hasn’t played out as expected. Sure, foreign equity markets have outperformed US equities so far in 2025, but not because foreigners have been liquidating. The TICS data that came out on Friday showed that foreign investors bought $116.5 billion in US equities in June (the second-highest number on record) and a further $32 billion into corporate bonds. This followed a +318 billion net inflow in May. US security markets have experienced over $400 billion in net buying over the May-June period – more than doubling the +175 billion from May-June in 2024. I continue to think there is some validity to a global rotation trade where capital rotates out of the US to the rest of the world, but outside of a short stint at the start of the year, the data does not support this thesis.
Although what has flown under the radar, or at least I’m not seeing much ink spilled on the subject, is that China’s Shanghai Composite just hit its best level in a decade and is now up +11% for the year. It’s not as if the economic data coming out of China has been good (it hasn’t been) or that the PBOC has unleashed much in the way of monetary stimulus, but China has navigated trade tensions with the US quite well, with its export numbers continuing to hold firm. Furthermore, policymakers have been surgical in providing fiscal support where and when needed, with most investors who follow the region expecting additional fiscal support to come. China has a handful of tech companies capable of competing with the US; however, fear of capital controls, property rights, and the rule of law causes Chinese tech companies to trade at a heavy discount to US tech companies.
European equities have also been a standout on the ytd scoreboard this year, +28% as measured by the iShares MSCI Eurozone ETF (EZU). According to our work, the outperformance isn’t a fluke nor a flash in the pan: real rates near zero, strong currency, inflation well contained, possible end of the war in neighboring Ukraine, pro-growth fiscal stimulus aimed at supply-side capital spending, and a robust banking system.
At the same time, European equities trade at a forward P/E multiple of 15x (7-point discount to the U.S.) while offering near-3% dividend yields — more than double the S&P 500's comparable income stream. But this isn’t so much about valuation comparisons but rather a bona fide structural transformation happening. The region is in the process of ending years of undue fiscal policy tightness and returning to industrial competitiveness, ignited by a normalization in energy costs and a return to supply reliability.
Germany has blazed the trail here with its fiscal breakthrough, and Europe as a whole is embarking on what could be aptly described as a Marshall Plan on steroids. And believe it or not, European productivity (output per hour worked) already matches American levels in several countries – aided and abetted by accelerating infrastructure investments, digital transformation, and the green energy transition.
As for the Fed, this week will be key given the Jackson Hole symposium — the main topic is about the labor market (“Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy”), and while many see this is an opportunity for the Fed to sound dovish, it is clear that the central bank is divided. One hawkish surprise could come from any commentary about how the weakness in the labor market of late has come largely from the supply side, and the “break-even” for job growth to keep the unemployment rate steady is far lower than it used to be. In any event, what has changed is any talk of a -50-basis point rate cut at the next FOMC meeting on September 17th, and we are down to an 85% chance of any easing at this time from 100% in the middle of last week. Futures are not even fully priced for the two cuts that were in the latest set of Fed dot plots — discounting less than 85% odds of seeing two -25 basis point reductions by year-end (odds of three down to 40%).
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