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Hawks Versus Owls At The Fed
Today, Ed and Elias share bird’s eye views of the economy from the perches of the hawks and owls on the Fed. The hawks may favor tightening at the FOMC’s September meeting, unconvinced that inflation is on a steady flight path down to the Fed’s 2.0% target. The owls are more confident of inflation’s downward course. July’s subdued inflation readings support their case for holding rates steady in September. But recent labor demand and consumer spending data suggest that the economy is healthy enough for a rate hike, supporting the hawks. August’s data should help clarify whether inflation needs a nudge to return to target or can get there on its own.
US SECTORS CALL: Stories About Earnings, Margins & Multiples
Energy (OW) led the S&P 500 sectors last week, rising 7.3%. It is up 37.8% ytd, the best of all the sectors. Financials (OW) rose 0.9% and is on an 11-week winning streak. Health Care (OW) and Utilities (OW) also gained last week. Consumer Discretionary (UW) and Materials (OW) fell. Communication Services (MW) was down 1.0% for the week and is up just 1.2% ytd, the second worst of the 11 sectors. Now, let's look at recent developments in the Information Technology, Financials, Energy, and Communication Services sectors: (1) Information Technology. The semiconductors trade rebounded this month. SanDisk is up 35.1% mtd, along with Marvell (18.4%) and Micron (18.1%), all well ahead of the Mag-7 (chart). The y/y growth rates of the sector's forward revenues and forward earnings continue to soar in record-high territory (chart). So far this year, the sector's gains have been driven by forward earnings, while the valuation multiple fell (chart). (2) Financials. We turned constructive on Financials in April. Its ytd performance was the worst of the S&P 500 sectors’ at that time. Financials is now up 6.0% ytd and at a record high. Among its component industries, Life & Health Insurance (up 17.3%) and Investment Banking & Brokerage (14.7%) lead the ytd rally. Financial Exchanges & Data is down 7.9% ytd (chart). The sector's forward revenues and forward earnings are both at record highs. We think AI is a key contributor to the sector's significant increase in the forward profit margin, from around 18.0% in early 2024 to a record 22.1% currently (chart). Meanwhile, the AI trade has spread to Financials. Nvidia announced partnerships on August 10 with Apollo, BlackRock, Blackstone, Brookfield, Goldman Sachs, and KKR to mobilize over $500 billion of third-party capital to expand AI compute infrastructure. Five of the six are in the S&P 500 Financials sector. Analysts expect the Investment Banking & Brokerage industry’s earnings to grow 30.7% this year and Asset Management & Custody Banks’ earnings to grow 19.8%, compared with 14.7% for the sector as a whole (chart). (3) Energy. We have been recommending overweighting S&P 500 Energy sector as a hedge against geopolitical risks, and it continues to pay off. Oil & Gas Refining & Marketing is leading the way, up 102.6% ytd (chart). Equipment & Services is up 37.5%, Integrated Oil & Gas is up 32.7%, and Exploration & Production is up 26.7%. The sector's forward earnings is up 55.2% ytd, while its forward P/E is down 11.2% (chart). Analysts expect the sector's earnings to grow 78.4% this year, then fall 11.1% in 2027 (chart). Energy is the cheapest of the 11 sectors at a forward P/E of 13.8. It accounts for just a 3.1% share of the S&P 500 market cap versus 4.8% of forward earnings. (4) Communication Services. Communication Services has the second-best projected 2026 earnings growth of the 11 sectors and the second-worst share price performance ytd. Forward earnings is up 24.4% ytd, while the forward P/E is down 19.8% (chart).
US MARKET CALL: Roaring Decades
Last week, we raised our year-end S&P 500 target from 8,250 to 8,400. We are sticking with our 10,000 target by the end of the decade, though we might raise it. Our Roaring 2020s scenario is delivering even better S&P 500 earnings than we expected. FEMO (fabulous earnings momentum) is driving the stock market higher! The S&P 500 is up 141.0% so far this decade, making it the sixth-best decade since the Roaring 1920s already (chart). If it rises to 10,000 by the end of the decade, it will be up 209.5%, the fifth-best decade. In other words, roaring decades are not exceptional for the stock market. (The S&P 500 fell during the 1930s and 2000s, and edged up slightly during the 1940s, 1960s, and 2000s.) To reach 10,000 by the end of the decade requires an additional 28.5% (or 2,201 points) gain in the S&P 500. That's roughly 7.5%-8.0% annualized price growth over the remaining 3.4 years of the decade. If the S&P 500 hits 8,400 by the end of this year, that would make 2026 the fourth consecutive year of 15% or more annual gains (chart). The only previous streak of five consecutive gains occurred during the second half of the 1990s. Let’s look a bit deeper: (1) Performance. Both the market-weight and equal-weight S&P 500 are at record highs (chart). The latter has been rising to new highs with less volatility than the former after both bottomed at the end of March. We expected the bull market to broaden this year. So far, so good. The Impressive-493 continues to outperform the Magnificent-7, up 17.6% ytd versus 3.8% (chart). The S&P 500 as a whole is up 13.9%. The Russell 2000 is also at a record high (chart). SmallCaps, which are the most economically sensitive corner of the stock market, suggest that investors are bullish on the economic outlook. (2) Earnings. S&P 500 forward earnings always converges to the coming year's consensus analysts' earnings estimate by definition (forward earnings is the time-weighted average of the consensus estimates for this year and next). The 2027 consensus estimate is still rising. It is up to $410.25 (chart). We estimate that both forward earnings and the 2027 estimate will rise to $415.00 by year-end. That should take the S&P 500 up to 8,400, implying a forward P/E of about 20.2. Q2 earnings rose 47.3% y/y, up from 19.0% for Q1. Industry analysts’ consensus earnings estimates imply that they expect 23.1% growth in Q3 and 27.3% in Q4 (chart). The Q2 number was inflated by the mark-to-market gains at Alphabet and Amazon that we have flagged. Without them, Q2 earnings growth slips to 25.7%. The Q3 and Q4 estimates carry no such distortion. The forward profit margin is 16.5%, and the 2027 margin estimate is 16.6% (chart). This is unprecedented. (We impute margin estimates from analysts’ estimates for earnings and revenues.) During the week of August 13, S&P 500 companies had positive 12-month percent changes in forward revenues and forward earnings of 88.5% and 86.1% (chart). Forward earnings are rising to record highs across the S&P 500 LargeCaps, S&P 400 MidCaps, and S&P 600 SmallCaps (chart). FEMO is broad-based. (3) Sentiment. The Investors Intelligence bull/bear ratio has climbed to 3.88 against its 2.60 average, while the AAII bull/bear ratio is at 0.92 versus its average of 1.18 (chart). Institutional bullishness is getting extended. (4) Bonds. The Citigroup Economic Surprise Index has dropped sharply to 15.0, with the 10-year Treasury yield up just 7bps over 13 weeks (chart). Weaker retail sales and employment data drove the CESI down. Bond yields may ease from here, according to the CESI, even though most investors expect them to go higher.
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ORACLE: PRICE, FORWARD EARNINGS & VALUATION
S&P 500 COMMUNICATION SERVICES SECTOR & INDUSTRIES: ANNUAL EARNING GROWTH FORECAST
BNY MELLON: FORWARD REVENUES
NETFLIX: STOCK PRICE (NFLX)
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