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On Positive Earnings Revisions, Japan’s Challenges & Valuing AI IPOs
Joe reports that newly released July data on industry analysts’ earnings estimate revisions show that for all 11 S&P 500 sectors, the net direction was up. That sign of rising sights for earnings broadly across the economy is rare and last seen after the pandemic lockdowns ended. … Also: William reports that the Bank of Japan may pause its quantitative tightening given Japan’s flagging economy. That should reassure investors worried about the stock market repercussions of the BOJ’s selling its ETF holdings. … Also: Melissa examines prospective valuations of two AI providers planning IPOs, Anthropic and OpenAI.
War! What Is It Good For?
The 1970 song "War! What Is It Good For?" was performed by the Temptations on an album and by Edwin Starr as a single. The song's answer to the question is "Absolutely nothing!" The powerful lyrics include: "It ain't nothing but a heartbreaker / Friend only to the undertaker, woo!" Financial market history shows that geopolitical crises, including wars, often have been good buying opportunities for stocks (chart). That was true during Gulf War III, as the S&P 500 bottomed on March 30 and rose 18.3% through yesterday's close. The ceasefire in the war between Iran and the US ended abruptly today; will that present another buying opportunity? We think so. The numerous crises and wars in the Middle East since the 1970s have all been good for oil prices, at least initially. The end of the ceasefire today boosted the price of a barrel of Brent crude oil by $4.42 to $78.59 this morning. However, there was a significant bear market in oil before the current war started, which explains why the price didn't increase much more in March and April than it did and why it came tumbling down in May and June (chart). The S&P 500 Energy stock price index spiked during Gulf War III in March and fell during the ceasefire, finding support at its 200-day moving average (chart). It undoubtedly will bounce off that level today after President Donald Trump declared that the tentative ceasefire with Iran is over after Iran attacked ships transiting the Strait of Hormuz yesterday. At the NATO summit in Ankara, Trump blasted Iran, saying: “I don’t want to deal with them, but they’re scum. They’re sick people, they’re led by sick people, and they’re vicious, violent people, and if they had a nuclear weapon, they’d use it.” We continue to recommend overweighting the S&P 500 Energy sector as a hedge against increased geopolitical risk in the Middle East. That's easy to do since the sector accounts for just 2.9% of the market capitalization of the S&P 500 (chart). We view the recent weakness in semiconductor stocks as a buying opportunity. Their meltup over the past three years has been well supported by their earnings (chart). The S&P 500 Semiconductor industry's forward P/E was 17.4 yesterday. This morning, the 2-year US Treasury yield is up to 4.21%, reconfirming that the markets expect the Fed to raise the federal funds rate by a couple of 25-bps moves in the coming months (chart). The 10-year US Treasury bond yield is up to 4.57% this morning, retesting the yield's downward trend line (chart). We think it will hold. The gold price is retesting support (again) around $4,000 (chart). We expect that support level will hold. Weighing the gold price down currently is the resumption of the war, since it’s boosting the foreign exchange value of the dollar and bond yields.
Booming AI Imports Depressing US GDP, Though Not Final Sales
The Atlanta Fed's GDPNow model estimates Q2-2026 real GDP growth at just 1.4% (saar). That's because net exports (i.e., exports minus imports) dragged it down by 1.3 ppt. During the quarter, AI-related imports increased sharply, outpacing the large increase in US exports of crude oil and petroleum products. The picture is brighter below the headline number. Real final sales to private domestic purchasers, which strips out volatile trade and inventory swings, is tracking at 2.9%, up from 1.7% in Q1-2026 (chart). Consumer spending growth is projected at 2.0%, a sharp rebound from 0.5% in Q1, and business fixed investment is running at 8.2%, up from 6.5%. A closer look at the recent economic data reveals what is driving the Q2 GDP estimate and hiding the underlying strength of the economy: (1) US Merchandise Trade. The sum of US merchandise imports and exports is a good proxy for global economic activity because the US is the world's largest importer and a major exporter. At an increase of 15.6% y/y in May, our proxy is flashing a positive signal for the global economy (chart). US merchandise imports have been soaring in recent months, reflecting the AI-driven demand for technology capital goods (chart). They have outpaced surging US merchandise exports, which have been led by exports of crude oil and other petroleum products. The import surge is concentrated in the three Asian countries at the heart of the global AI supply chain. Taiwan supplies the advanced semiconductors that power AI chips, South Korea dominates memory chip production, and Vietnam has emerged as a critical assembly hub for AI servers, computers, and smartphones as US tech companies have diversified supply chains away from China (chart). US high-tech imports have more than doubled since early 2024 (chart). US crude oil and petroleum exports hit a record $27.8 billion in May as Middle East supply disruptions pushed global buyers toward reliable US oil exporters, providing a recent offset to the AI-driven import surge. (2) US Consumer. Consumer spending remains remarkably robust. The Redbook Same-Store Retail Sales Index rose 10.1% y/y for the week of June 26, the highest growth rate since September 2022 (chart). June and July retail sales reports are likely to be very strong! The World Cup might have contributed to this strength. Sales at discount stores rose 11.9% y/y (chart). These retailers should report very strong sales for both Q2 and Q3. A key support for consumer spending is the labor market. ADP data show US private-sector employers added an average of 21,000 jobs per week in the four weeks ending June 20, slightly below the prior period’s 24,250 but consistent with a solid monthly pace of around 84,000 (chart). June's preliminary NFIB small business survey corroborates this. Hiring demand rebounded after a soft patch in May, with 32% of owners reporting unfilled openings (up 3 percentage points) and a net 11% planning to add jobs over the next three months, in line with the long-term average. (3) PMIs. The NM-PMI eased slightly to 54.0 in June but remained firmly in expansion territory, with every subcomponent above 50, including employment, new orders, and production (chart). Meanwhile, the employment component of the M-PMI is on an upward trend, rising to 49.7 in June (chart). The measure historically has correlated well with manufacturing payroll growth, which has also improved this year. The AI buildout should keep that trend intact, as data center construction, semiconductor reshoring, and surging demand for power infrastructure require a growing manufacturing workforce. The employment component of the NM-PMI has been less directionally clear but was above 50.0 in June, consistent with gains in services sector payrolls (chart). (4) Inflation. Price pressures in both manufacturing and services have moderated as oil prices retreated to pre-conflict levels. Even so, June's prices paid components of both PMIs remain elevated, confirming that pipeline price pressures are far from over (chart). The New York Fed's June Survey of Consumer Expectations showed one-year inflation expectations rising to 3.7%, the highest since September 2023, while three-year expectations climbed to 3.3%, the highest since June 2022 (chart). The drift higher at both time horizons reinforces our conviction that the Fed must maintain a hawkish policy stance, as the upside risks to inflation continue to outweigh the downside risks to the labor market.
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