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US MARKET CALL: Stocks Ignoring Bonds, For Now
The 10-year US Treasury bond yield has climbed above 5.25%, and the S&P 500 hasn’t flinched. The stock index is just 2.2% below our year-end target of 7,900. It could overshoot our target in the coming days now that crude oil shipments from the Persian Gulf producers reportedly are averaging around 98% of pre-war totals, excluding Iran. Producers and shippers have found workarounds to their usual Strait of Hormuz routes, including alternative pipeline routes, ship-to-ship transfers, and naval-escorted night transits. The question is: How long stocks can ignore bonds if yields keep rising despite lower oil prices? If yields are simply repricing to reflect stronger-than-expected economic growth, then earnings will remain strong. The downside risk is to the stock market's valuation multiple if bond yields are rising on concerns about mounting government debt, possibly exacerbated by the unwinding of the yen carry trade. For now, we are sticking with our S&P 500 targets of 7,900 by year-end and 8,400 by mid-year 2027. Here's more: I. Bonds The 10-year Treasury yield rose to 5.24% on Friday, and the 10-year TIPS yield rose to 2.91% (chart). Since the start of the year, the nominal yield is up 109bps, and the TIPS yield is up 95bps. Real yields account for nearly all of the increase, while inflation expectations have barely budged. We read that as a vote of confidence in the economy and a sign of strong demand for credit. Friday's employment report disappointed. Payrolls rose only 29,000 in September versus forecasts of 80,000-100,000, with 60,000 of additional downward revisions for July and August. The 10-year yield dipped on the news, then recovered, suggesting that more than the economy's strength or weakness is driving yields. The 2-year yield is 4.78%, well above the 3.88% federal funds rate and discounting more Fed rate hikes ahead (chart). We see the payroll miss as an outlier among otherwise solid labor market indicators. Credit markets are starting to show signs of stress as interest rates move higher. Credit default swap spreads have widened in recent weeks (chart). Private credit is also show some distress again. The Virtus Private Credit Strategy ETF and the VanEck BDC Income ETF have taken another leg down (chart). The slide coincides with another quarter of heavy redemption requests at nontraded private credit funds, many of which remain above their 5% quarterly withdrawal limits. The stress has remained within private credit. It hasn't spilled over into the broad stock market. II. Stocks The S&P 500 closed at 7,722.72 on Friday, 1.0% below its August 13 record high (chart). The S&P 500's summer stall has turned into a fall stall. The equal-weight S&P 500 is down 5.9% from its August 14 record high and is now only 2.0% above its 200-day moving average. Concentration worries have returned with the Magnificent-7's rebound since mid-August. XMAGS is up 13.6% ytd, versus 10.1% for MAGS and 12.8% for the S&P 500 (chart). The broad market's outperformance has shrunk considerably since August. The rebound in the stock prices of the hyperscalers since late July has been led by Meta (chart). The Russell 2000 is down 7.7% from its record high on August 14 and 1.8% above its 200-day moving average (chart). SmallCaps are very sensitive to interest rates. If high bond yields start to bite the economy, the SmallCaps will be the first to react. III. Earnings The fabulous earnings momentum (FEMO) story remains intact. S&P 500 forward earnings rose to a record $406.45 per share last week. The 2027 consensus estimate has flattened over the past few weeks around $419 (chart). We still expect both to climb to $425 by year-end on better-than-expected Q3 and Q4 earnings. JPMorgan kicks off the Q3 earnings reporting season on October 13. Industry analysts expect Q3 earnings to rise 23.4% y/y and Q4 earnings to rise 28.2% (chart). Both estimates have edged down ahead of reporting season, as they usually do. We expect companies to clear the lowered bar. IV. Valuation Since mid-August, the stock market's slippage has come entirely from a lower multiple. S&P 500 forward earnings is up 28.2% ytd, compared with 12.8% for the price index, while the forward P/E is down 12.8% (chart). The S&P 500’s forward P/E is 19.0, the Mag-7’s is 22.9, and the SMidCaps’ (i.e., SmallCaps and MidCaps collectively) is below 15 (chart). Our 7,900 S&P 500 target assumes an 18.6 multiple. With the 10-year yield above 5.00%, we see more downside than upside for valuations through year-end. V. Sentiment The two bull/bear ratios we follow are pointing in opposite directions. The Investors Intelligence ratio is 3.75, well above its 2.61 average, while the AAII ratio is 0.74, well below its 1.18 average (chart). Newsletter writers are too bullish. Individual investors are too bearish. Individual investors may seem to be bearish, but they are fully invested. Equities rose to a record 37.8% of household net worth and 48.2% of household financial assets in Q2 (chart). AAII members hold 71.7% of their portfolios in stocks, 14.8% in bonds, and only 13.3% in cash (chart). Retail investors are in this market with both feet.
Thanks For The Memories
I. Micron and the AI Trade Memory has become one of the biggest beneficiaries of the AI spending boom. Micron’s stock, for example, is up 273.2% ytd, second only to SanDisk among the semiconductor companies. We have been bullish on memory, and Micron’s fiscal Q4-2026 results reinforced our view. Revenue surged 379% y/y to a record $54.2 billion, above the $50.8 billion consensus. Adjusted EPS of $33.42 topped management’s guidance range. Gross margins widened to 87% as DRAM and NAND prices surged. The outlook was even stronger. Micron guided fiscal Q1-2027 revenue to $61.5 billion, well above the roughly $57 billion analysts expected. Management expects memory supply-demand conditions to tighten further in 2027 and 2028, with more than 75% of fiscal 2027 output already committed. The company now has 26 long-term agreements (LTAs), up from 16 last quarter. Many investors still view memory as a classic boom-bust commodity. Before the latest earnings report, Micron’s forward P/E was 6.8. The stock barely budged today following the company's gangbusters results (chart). Micron’s results reinforce the case that the AI buildout still has plenty of runway. Hyperscalers continue to increase infrastructure spending. Indeed, Goldman Sachs recently raised its 2027 hyperscaler capex forecast to $1.2 trillion, roughly 50% above $750 billion this year. II. "Growthflation" With the AI buildout continuing to act as a powerful private-sector stimulus program, it is hardly surprising that the latest indicators continue to point to a strong economy. At the same time, inflation remains stuck around 3.0%. Today, the 10-year Treasury yield briefly hit 5.33% and the 30-year reached 5.68%, both marking fresh 24-year highs, before easing back a bit (chart). The message is clear: robust growth and persistent inflation are putting upward pressure on long-term yields. We think the bond yield is reflecting the strength of nominal GDP, which rose 6.3% y/y during Q2 (chart). We don't expect the bond yield to depress the economy unless it surges above the growth rate of nominal GDP, which we don't expect to happen. In fact, Dr Ed visited our institutional accounts in Toronto over the past two days and found that all of them expressed interest in buying bonds at these attractive yields. Now, consider the latest evidence of the "growthflation" driving nominal GDP: (1) Labor market. Initial jobless claims fell to 197,000 during the week of September 25, the lowest level since July 18 (chart). They have been below 200,000 for seven weeks this year, the most in any year since 1969. Additionally, the latest reading is near a 57-year low. Continuing claims dropped to 1,701,000, the lowest reading since March 2023. Challenger job-cut announcements fell 18% m/m and 20% y/y to 43,281 in September, the lowest total for the month since 2022 (chart). Layoff activity remains subdued across the US economy. Private payroll growth also appears to be firming. ADP employment rose by 90,000 in September, while Revelio Labs estimates that private payrolls increased by 56,900 last month (chart). We expect tomorrow’s BLS report to show roughly 100,000 nonfarm payroll gains in September, more than enough to keep the unemployment rate near its current low of 4.1%. (2) Construction spending. Construction spending jumped 0.9% m/m in August to a $2.20 trillion annual rate (chart). Private nonresidential construction rose 1.0% to $773 billion, while residential construction increased 1.1% to $882 billion (chart). Office construction, which includes data centers, surged 4.6% m/m, while power construction rose 0.9%. Both categories continue to benefit from the massive AI infrastructure buildout. (3) Manufacturing. The ISM M-PMI remained firmly in expansion territory at 54.5 in September, marking the ninth consecutive month above 50.0 and the longest expansion streak since 2022. Major components, including new orders, production, and employment, also remained in expansion territory. The upswing is being fueled by the AI capex boom, reshoring, and stronger incentives for domestic investment, including immediate expensing under the OBBBA. Meanwhile, input cost pressures remained elevated in September. The ISM prices-paid index rose to 77.9, near its highest level since 2022, while regional Fed price surveys also remained high (chart). Respondent comments in the ISM survey noted that demand remains strong in semiconductors, electronics, machinery, and AI/data-center-related markets, but that strength is increasingly running up against worker shortages, stretched steel capacity, longer lead times, and rising input costs.
On Stock Market Churn, Corporate Debt & AI Agents
The S&P 500 Equal Weight index is up less ytd than the S&P 500, so the average company’s stock isn’t faring as well as the overall index’s performance would suggest. That’s a reversal from mid-August, Joe points out. Today, Jackie looks under the S&P 500’s hood, identifying industries that have toppled the most from their summer peaks. … Also: Corporate bonds have had a tough year, with rising Treasury yields and lots of new supply. But their declines don’t reflect credit-quality concerns. … And: The AI agents Big Tech has been launching are likely to squeeze entrepreneurs’ niche offerings out of the market.
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