Patiently constructive…
Executive Summary:
Market Divergence & Underlying Weakness: Although the S&P 500 remains within striking distance of all-time highs, market breadth has deteriorated significantly, with fewer than 30% of constituents in the S&P 500, MidCap 400, and SmallCap 600 trading above their 50-day moving averages.
A Less Forgiving Macro Backdrop: Beyond isolated energy shocks, the overall economic landscape is tightening; rising capital costs, flattening yield curves, and a projected slowdown in the rate of economic growth demand active risk management despite continued dip-buying in the tech sector.
Monetary Policy Risks & Portfolio Discipline: The Federal Reserve is actively attempting to suppress supply-driven inflation through demand destruction, raising the probability of a growth slowdown. With household equity exposure sitting at a record 53.3% and interest rates offering viable alternatives, prioritizing long-term financial security over chasing outsized risks is paramount.
Full commentary:
While the S&P 500 sits within 2% of its mid-August all-time high—giving casual passive investors the illusion that all is well—the bigger story lies beneath the surface, where a lot more pain is being experienced. The small-cap Russell 2000 closed last week at three-month lows, and the Dow is hovering near its own multi-month low. The S&P 500 continues to grind sideways to modestly lower, but market breadth has deteriorated markedly: fewer than 30% of S&P 500 stocks are currently trading above their 50-day moving averages.
It is a similar story further down the market-cap spectrum, with less than 30% of constituents in both the S&P 400 MidCap and S&P 600 SmallCap indexes trading above their 50-day moving averages. While key sectors still exhibit enough relative strength to lure buyers on pullbacks, this type of fragmented, choppy market environment can prove treacherous for active investors.
That being said, it would be disingenuous not to acknowledge the remarkable resilience displayed by both the broader economy and risk assets in the face of an aggressive barrage of macroeconomic headwinds:
Monetary Tightening: The Fed recently hiked rates for the first time in three years, with expectations for further hikes building as global central banks also shift to a tightening stance.
Geopolitical Escalation: The U.S. and Iran have yet to find a viable off-ramp to de-escalate Middle East tensions, broadening the negative global economic consequences well beyond energy markets.
Energy Prices: Both Brent and WTI crude closed above $100/bbl every day but Friday last week.
Tech Sector Pushback: Intensifying backlash against the AI trade and data center buildouts threatens the primary engine of U.S. economic growth this year.
Surging Yields: Global interest rates have moved relentlessly higher over the past five months. The 2-year Treasury yield has surged from 3.70% in mid-April to 4.75%, while the 10-year yield has climbed from 4.25% to 5.00%.
Political Uncertainty: We are just over six weeks away from a highly consequential midterm election, with odds suggesting congressional power is set to change hands.
If not for corporate earnings surging nearly 30% in 2026 to $370/share for the S&P 500—and consensus estimates projecting another 12% growth in 2027 to $415/share—equity prices would likely be significantly lower given these considerable uncertainties.
So far, September is living up to its historical reputation as a challenging month for equities. As of Friday’s close, the S&P 500 is down -0.5% for the month, the MSCI All-Country World Index (ACWI) is down -0.9% (-1.4% excluding the U.S.), and U.S. small caps are struggling, down -3.2%. However, zooming out to the third quarter paints a moderately brighter picture. The S&P 500 (+2.0%) and Nasdaq Composite (+1.2%) are posting solid gains, while Rest-of-World (ROW) equities are modestly positive at +0.2%. Yet, market leadership continues to narrow; the equal-weight S&P 500 is down -0.2% quarter-to-date, and the Russell 2000 is lower by more than -2% over the same period.
Reviewing the data across September, Q3, and year-to-date, one would be hard-pressed to see how $100 oil or a renewed Fed hiking cycle have meaningfully dented aggregate equity returns. While we are seeing the usual ebbs and flows of capital rotation, there are few signs of wholesale panic regarding U.S. or global growth. As I noted earlier in this missive, it is a testament to the market’s continuing faith in an exceptionally resilient American economy.
Bottom line: Next week, the calendar flips to the fourth quarter of what has been a highly productive year for stocks. Despite September’s churn, there is still underlying momentum. Furthermore, a contingent of investors remains wrongly positioned in the bearish camp and may be forced to chase performance into year-end, potentially driving equities higher than they are today. While stocks have thus far ignored catalysts that historically trigger deeper corrections—and I may have to reassess this thesis if resilience ultimately gives way to weakness—I am letting corporate earnings and economic strength anchor my perspective. For now, I am looking past the short-term noise and remaining constructively bullish on equities into year-end.
After a week dominated by central bank policy, investor attention shifts back to geopolitics as Trump and Xi are scheduled to meet in Washington on Thursday. Discussions will likely center on trade, AI technology restrictions, and the broader mechanics of how the globe’s two superpowers can coexist as the world transitions from a U.S.-centric unipolar order to a multipolar one. For now, markets remain optimistic that this summit can build upon the tentatively improving sentiment between Washington and Beijing.
Yet, the most pressing near-term variable for markets remains the energy complex. Brent crude is down for a fourth consecutive session as Saudi Arabia moves closer to restoring capacity on its East-West pipeline, alleviating some pressure on a market unusually sensitive to energy volatility. However, beneath the headline crude numbers, a worldwide shortage of Group III base oil—a critical input for full-synthetic motor oils used by modern vehicles—has pushed U.S. prices to a record $12.45 per gallon, nearly four times their February level. Major retailers like Costco have already begun rationing supplies. Independent garages are struggling to source product, and oil-change chains are passing higher lubricant costs directly to consumers.
According to FT’s reporting, industry executives warn that even after global shipping routes fully reopen, it could take four to six months for supply to normalize. This illustrates how an energy shock works its way through the economic system: first crude, then diesel, then lubricants, and finally transportation and maintenance costs. Eventually, the end consumer has to pay the bill.
Despite this, it is noteworthy that when investors are given even the slightest excuse to buy the dip (oil is down over 4% in today’s trading), capital flows straight back into semiconductors. The SMH ETF is up 3.5% today and 6.5% in September, shrugging off a steep 23% correction in July. Earnings growth in this sector remains exceptional, and the ‘picks and shovels’ trade continues to command the market’s reflexive enthusiasm.
While I remain constructive on risk assets, serving as a fiduciary requires me to continuously put on the skeptic’s hat and analyze the risks lurking around the corner. Admittedly, the macroeconomic backdrop is becoming considerably less forgiving. Yield curves are flattening, capital costs are rising, energy remains expensive, and the global growth outlook continues to soften.
While backward-looking metrics appear robust, our forward-looking modeling suggests a high probability that the Fed will be hiking interest rates directly into an economic slowdown. Our work indicates that Q3 will likely mark the peak of U.S. economic growth on a rate-of-change basis over the next twelve months. To be clear, this does not mean the economy is contracting. Rather, the rate of growth is set to decelerate—stepping down from a +4% pace in Q3 to sequentially lower prints in the ensuing quarters.
This second-derivative slowdown will matter. Even the most profitable segments of the equity market—hyperscalers, semiconductors, and mega-cap tech—will eventually have to contend with a higher hurdle rate. Therefore, my constructive tone warrants a dose of pragmatism: a move to the 8,000 level for the S&P 500 by year-end represents less than a 3% increase from current levels. In a slowing growth environment with constrained index-level upside, careful allocation and active risk management are more important than ever.
Let me close out this week’s missive with some thoughts on the Federal Reserve and its decision to hike interest rates last week, particularly regarding what policymakers are trying to achieve.
Before going further, it is important to lay out the nuance in how I view the forward policy path. From a market-signaling perspective, hiking was arguably the right move in the near term to demonstrate a willingness to defend inflation credibility with decisive action. However, this same move may well be viewed as a policy error 12 months from now, forcing the Fed to reverse course and cut rates this time next year.
The Fed is attempting to suppress inflation at a moment when a meaningful share of pricing pressure stems from structural supply disruptions rather than an unhinged wage-price spiral. Simultaneously, rate-sensitive segments of the real economy are already buckling under materially tighter financial conditions. Housing activity remains stuck near post-GFC lows. Consumers face a dual squeeze from elevated energy prices and surging borrowing costs. Corporate debt service is climbing, and even Big Tech is increasingly turning to structured finance vehicles to fund capital-intensive data center builds.
To top it off, last week's 25-basis-point hike will add an estimated $50 billion to federal outlays over the coming year solely through higher debt-servicing costs on maturing Treasuries. As Luke Gromen recently highlighted in his FFTT weekend report:
“All else equal, higher interest rates plus time (as debt reprices) will send Treasury (interest outlays) from being the third biggest line item in the Federal budget (after Social Security) to the second and then to the single biggest outlay… Warsh may not want to get involved in fiscal discussions, but he is the most important swing factor in the size of the US fiscal deficit!”
The data from the Treasury Borrowing Advisory Committee (TBAC) confirms this fiscal reality: Treasury debt service surged by +$120 billion (+10% YoY) through Q3 FY2026, easily outpacing spending growth in Health & Human Services (+7%) and Social Security (+5%).
So, what exactly is monetary policy trying to accomplish beyond signaling and posturing? That question has become harder to answer following the Fed’s latest communications. For the bond market, the core issue is no longer just runaway fiscal deficits, massive AI capex, or noisy prints in headline data; it is deep uncertainty surrounding the Fed’s underlying reaction function. Chairman Warsh continues to strike a hawkish tone without clarifying how the central bank plans to balance supply-driven inflation against the collateral damage being inflicted on interest-sensitive sectors.
Durinis press conference, Chair Warsh made it abundantly clear that restoring inflation to the 2.0% target remains priority number one:
“What we can do and will do is ensure that any change in relative prices don't broaden out, don't have second and third order effects on the economy. That's what we're tasked to do and that's what we will do.”
“Some months ago, I said we will deliver stable prices. Today's action is consistent with that.”
“We removed a dose of accommodation so that financial and credit conditions would be more consistent with our ultimate objectives. That was the decision that was our judgment, and we'll continue to evaluate that prospectively.”
Markets can efficiently price bad news, and they can price good news. What they struggle to discount is an opaque reaction function. That lack of clarity is an increasingly heavy driver of the term premium now embedded across the yield curve. The fact that 10-year Treasury yields jumped 7 basis points back to 5.00% on Friday—even as WTI crude tumbled 2.6% back below $100/bbl—signals that fixed income is trading on monetary policy confusion as much as it is on commodity volatility.
Fed funds futures now price a 50% probability of a follow-up hike in October, fully discount another hike by December (with a 33% chance of two), and imply up to three additional moves next year. As history shows with rookie Fed Chairs dating back to Marriner Eccles in the 1930s, markets will aggressively test their resolve. Warsh is facing that test right now.
While markets have priced in a substantial portion of this hawkish trajectory, the lagged effects of cumulative tightening have yet to fully play out. The unvarnished truth behind the Fed's rhetoric is that demand destruction is the primary transmission channel available to achieve a 2% target when price spikes are supply-driven. Higher interest rates do not produce more oil or resolve petrochemical logistics bottlenecks; they work by eroding aggregate demand until it matches constrained supply.
In other words: the Fed is targeting growth. That presents an undeniable headwind for forward corporate earnings and compresses fair-value P/E multiples—the former of which we haven’t experienced yet, while the latter we already have.
“Don’t fight the Fed” remains an indispensable market maxim. As long as the AI capex cycle powers ahead at its current clip, overall economic resilience should stay intact. But when that investment wave eventually matures and plateaus—as every major capital cycle does—other economic engines must be ready to step in. Historical precedent is unambiguous: whenever the Federal Reserve has tightened policy directly into a growth deceleration, recession has followed 100% of the time.
Today, that margin for error is razor-thin. As shown in the Ned Davis Research chart above, equities as a share of household financial assets (adjusted for pension entitlements) stand at an all-time high of 53.3%—eclipsing both the dot-com bubble peak of 45.2% and the 2021 post-pandemic peak of 46.2%, against a historical mean of just 29.2%. With private wealth so heavily tied to Wall Street and federal fiscal deficits at record non-recessionary levels, the U.S. financial system is in no position to comfortably withstand a sustained, equity-led recession.
Until those growth fissures crack open, strong earnings and structural tailwinds will likely carry the market into year-end. But make no mistake: the cross-currents are building beneath the surface. All of which suggests that now is not the time for prudent long-term investors to abandon patience, discipline, and realistic expectations of what they need to achieve their financial objectives. With equity valuations at all-time highs and interest rates moving up to a two-decade-high level that suggests investors have a viable investment alternative, what incentive is there to be overweight risk if you are already ahead of where you need to be with your long-term financial security? No, this isn’t an invitation to be ultra-conservative, but rather a reminder that investing involves risk, even if it seems those risks have been brief and infrequent over the past 15 years.
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