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Fed Rate Hike Still On The Table
Neither the Fed’s dual mandate nor its official 2% inflation target have changed. But from what Kevin Warsh has said since assuming the role of Fed chief in May, his priority appears to be the inflation side of the dual mandate and his target may be underlying inflation rather the PCED inflation rate. Today, Ed and Elias look at the ramifications of such a potential shift in the Fed’s focus and discuss the best measure of underlying inflation. They also assess the latest economic data and explain why they think a rate hike this year is still likely. … Also: Dr Ed reviews “I Swear” (+ +).
GLOBAL MARKET CALL: Downgrading Emerging Markets To Market Weight
We are downgrading emerging markets to market weight, not because the Go Global thesis is broken but because four separate short-term headwinds are converging at once: (1) The price of oil is back above $80 a barrel as the IRGC keeps the Strait of Hormuz contested. (2) The FOMC is hawkish. With inflation still sticky and a solid labor market, financial markets are currently pricing in one rate hike before the end of this year. (3) That's boosting the dollar. (4) AI fatigue is showing up in South Korea and Taiwan. None of these reverse the multi-year case for international equities. Valuations abroad are cheaper than in the US, and the structural rotation away from decades of US stock market leadership is intact. Let's look further: (1) Stay Home vs Go Global. The price ratios between these two long-run investment styles representing the US stock market (Stay Home) and the rest of the world’s stock markets (Go Global) remain below their early 2025 peaks in both dollar and local currency terms (chart). They are also still below their long-term uptrends from 2010 through early 2025, and on short-term downtrends since then. Since early 2025, stock markets in the US and other developed economies have kept pace with each other (chart). From 2010 through early 2025, the US market outperformed. The ratios of the US versus emerging markets show the latter outperforming the former since early 2025 after underperforming since 2010 (chart). The downturn in the ratios since early 2025 was largely attributable to the AI-fueled booms in South Korea and Taiwan. There has been quite a bit of rotation in leadership so far in July. The countries that led the broader 2026 rally, South Korea and Taiwan, are the worst performers this month to date, down 19.5% and 10.4% respectively (chart). China and Indonesia are at the top of the leaderboard this month, with gains of 8.0% and 9.8%, respectively. The US is in the middle of the pack. (2) South Korea & Taiwan. South Korea's KOSPI is concentrated in two companies: Samsung Electronics and SK Hynix. Leveraged ETFs tied to each stock launched only in May and attracted a flood of retail money, sending the KOSPI soaring (chart). When these stocks turned down, margin calls cascaded, forcing brokerages to liquidate roughly 426 billion won in positions over the first 10 trading days of July alone. The minimum margin deposit was tripled, and purchases per trade were capped. The Bank of Korea hiked to 2.75%, its first move since January 2023, targeting a won near 17-year lows and inflation above 3% y/y. Taiwan has been a calmer version of the same AI trade. Its MSCI index is about 24% above its 200-day moving average, elevated but without the leveraged retail mania or the sharp reversal that hit South Korea (chart). The move remains orderly, a reminder that concentration risk and leverage, not AI exposure itself, drove South Korea's whipsaw. The South Korea and Taiwan ETFs are still up the most of any country ytd, at 67.2% and 53.2% in US dollar terms, respectively, significantly ahead of any other nation's ETF (chart). (3) ETFs. PBUS and ACWX, our US versus ex-US proxies, remain locked together near record highs, confirming that the broad Go Global trade is intact (chart). EMXC has been hit hard recently, unsurprisingly given its heavy exposure to South Korea and Taiwan. XC, which strips out those two markets entirely, trades at levels seen two years ago and continues to lag (chart). CQQQ has bounced off its 2026 low but remains a fraction of QQQ on any long horizon, a reminder that China tech hasn't joined the AI rally in the US or the ones in South Korea and Taiwan (chart).
US MARKET CALL: Hanging Out At 7,500 And 4.50%
The S&P 500 first hit 7,500 on May 14 and has remained stuck around that level. The index continues to cruise along its 50-day moving average. A 6.0% drop would send it back to its 200-day moving average (chart). We have seen this movie before, recently, during late 2024 into early 2025 and again during late 2025 into early 2026. Both saw similar bouts of sideways consolidation, followed by pullbacks that attracted dip buyers. That's a plausible scenario through September, in our opinion. We are still aiming for 8,250 by the end of this year. Consider the following: (1) Stock Market Performance. So far this year, the S&P 500's bull market leadership has rotated from the Magnificent-7 to the Impressive 493 (chart). The Mag-7 had a June swoon and has recovered somewhat so far in July. However, the S&P 493 collectively has outperformed the S&P 500's Mag-7 so far this year. Recently, S&P 500 Value has been outperforming S&P 500 Growth (chart). Fabulous earnings momentum (FEMO) has bolstered Growth's earnings expectations to such a high level that simply meeting them this earnings season could read as a letdown. Value carries no such burden. The rotation in market leadership shows up clearly across the S&P 1500 sectors. Cheaper, more defensive corners of the market have outperformed since May 14, led by the S&P 600 Health Care, up 18.7%, and the S&P 600 Consumer Discretionary, up 14.4% (chart). The S&P 500 itself is down just 0.6% over that span, a modest headline number that masks a wide spread between winners and losers. The Magnificent-7 is at the other end of that dispersion, down 5.7%. Information Technology looks tired. New catalysts are scarce, and a bit of AI fatigue has set in. Semiconductor momentum has faded as one of the market's most crowded trades corrects. SOXX is down 20.3% since it peaked at a record high on June 22. (2) Current Earnings Season. The analysts' consensus Q2 EPS growth estimate rose to 22.9% y/y on an apples-to-oranges basis, up 1.3% on the week (chart). Great expectations are held for Q3 and Q4, as well. On a pro forma basis (apples-to-apples), Q2 earnings growth is running at 26.0% (chart). Energy accounts for a large share of that figure given the war's impact on energy prices. Technology earnings growth has held steady. Health Care continues to lag on an earnings basis despite decent sector stock performance. Financials drove much of last week's improvement. Goldman Sachs beat EPS estimates by 46%, and JPMorgan beat by about 10%. (3) Revenues, Earnings, And Profit Margin. Analysts' consensus EPS estimate for S&P 500 companies this year has flattened recently, while the 2027 estimate has continued to climb above $400 (chart). Forward earnings, the time-weighted average of the two, rose to a record high last week, buoyed by the fact it converges toward the 2027 estimate as 2026 wears on. S&P 500 forward revenues per share also reached a new all-time high, climbing even faster recently (chart). The forward earnings series has been a reliable predictor of actual earnings during economic expansions but fails during recessions. Given the economy's resilience, the current run of record forward estimates is a realistic read on where earnings are headed over the next 12 months (chart). If a bubble exists anywhere in this market, it is not in valuation and not in revenues. It is in profit margins. The forward profit margin rose to a record 16.1% last week (chart). The percentage of S&P 500 companies with positive three-month forward earnings growth is at 89.4%, a level associated with past cyclical earnings peaks (chart). That's a harbinger of more rotation in a broadening bull market, in our opinion. (4) Credit. The 10-year Treasury yield is consolidating around 4.50%, squarely within the 4.00%-5.00% range we consider to be the "old normal" (chart). Corporate high-yield credit spreads remain tight despite ongoing worries about private credit (chart). That's helped to keep a lid on the S&P 500 VIX.
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