The Week Ahead - 8/2/26

Next week is the first week of the month which also means it’s jobs week in the US, and we’ll get the normal first-week-of-the-month cadence of reports culminating in the July Nonfarm Payrolls Friday (technically the Employment Situation report) along with the NY Fed’s consumer survey and June consumer credit.

As usual before we get to jobs day we’ll get the July ADP monthly employment, Challenger job cuts, PMIs, and auto sales, June JOLTS, construction spending, factory orders, trade balance, as well as the standard weekly reports (jobless claims, mortgage applications, and US petroleum inventories (not ADP though with the monthly report this week)). We’ll also get the first read on Q2 productivity and unit labor costs as well as the Q2 Fed’s Senior Loan Officer Opinion Survey SLOOS).

While the Fed policy speaking blackout is over (and we did hear from the three dissenters as I mentioned we might in last night’s update) Fed speakers on the calendar are light with just Governor Cook and regional bank presidents Musalem and Barkin. I can assure you there will be more.

In terms of non-Bill (>1-yr in maturity) US Treasury auctions, we’re off next week. But more importantly, we’ll get the Q3 refunding announcement which will give us our auction sizes for every maturity for the upcoming quarter. It will come in two parts. On Monday we’ll get the aggregate expected borrowing amount for the quarter which is generally less market moving but can tip us to whether to expect anything Wednesday, which is where the action is when specific borrowing amounts by maturity are announced for the next three months as well as a forward looking statement on whether those might chang e. With 10-year yields the highest in 18 months and 30-years the highest since 2007, I’m sure Scott Bessent is loathe to add fuel to the fire by tipping a coming increase in long-end supply with the forward looking statement, but most expect that to come at some point. Probably something though at this point best left for another day.

While we’re now on the downslope (at least in terms of SPX earnings weight) for Q2 earnings season, the number of reporters actually increases with 140 SPX components (and 2,600 total companies according to WallStHorizon) reporting next week with 23 >$100bn market cap (BRK/B (Saturday), LLY, AMD, CAT, MRK, PLTR, ANET, AMGN, MCD, WDC, SNDK, DIS, GILD, BKNG, COP, PFE, UBER, CVS, APP, PH, VRTX, HWM, MCK in order of earnings weight). In addition, while not yet in the SPX, we’ll get the first earnings report from SpaceX which I’m sure will garner plenty of attention.

In terms of Iran, while we have seen threats of escalation come and go (the latest the latter as President Trump says in a social media post (below) he was holding off on further strikes on Iran on indications a deal may come together to reopen the Strait and deal with Iran’s nuclear program), as I said last week:

things remain very fluid. After two weeks of escalation, things seem to have de-escalated over the weekend. The Iranians know he needs to bring this to a close, but they also know that their hand gets weaker after the midterms. How far they want to push things, I’m not sure.

So as I said now eight weeks ago, “we’ll just have to see how things progress”. While odds on Kalshi that traffic through the Strait would normalize by Sept 1st had risen as high as 69% June 25th, that dropped to 7% two weeks ago and remains at 8%, although with only a month to go, I will shift to the Jan 1st contract which stands at 46%, little changed from last week’s 48% chance of normalization by that time.

The U.S.A. is locked and loaded and ready to go against the Islamic Republic of Iran, at levels of Military Terror, Strength, and Power not seen since World War II. Despite this, we have just been asked by Iran, and other Middle Eastern Countries, to hold off any attack in that the perimeters of a deal has been agreed to. This would include the Immediate, Complete, and Total OPENING OF THE HORMUZ STRAIT, and an end to Iran’s nuclear threat. Based on this request, I have agreed, for the future benefit of the WORLD and, likewise, the survival of a successful and prosperous Iran, to cancel the attack, subject to being able to rapidly make a DEAL. The Country of Israel joins me in this commitment. Get to work, everybody, and get it DONE. Thank you for your attention to this matter! President DONALD J. TRUMP

Ex-US highlights from DB:

Moving on to Europe, July CPI reports are due from Switzerland on Monday and Sweden on Thursday. There will also be plenty of June economic indicators for Germany throughout the week, including retail sales, factory orders, industrial production and trade data.

Over in Asia, the focus in China will be on private July PMI gauges, with the manufacturing one due Monday and services on Wednesday, and July trade data are out Friday. In Japan, June labour cash earnings and household spending will be amongst notable releases, due Wednesday and Friday respectively. Finally, The BoJ will publish the minutes of its June meeting on Wednesday. For more detail and forecasts, see DB’s week ahead for Japan here.

In corporate earnings, the Q2 season continues. The focus in Europe will be on Siemens, Novo Nordisk and Rheinmetall, amongst other large caps in the region. The list in Japan includes Toyota, SoftBank and Nintendo.

Here’s their one-pager:

BoA’s cheat sheets:

US: July jobs likely to show fading risks to labor market

We expect payrolls to rise by a below-consensus (but still firm) 80k in July (private: 95k). Benign claims data and steady labor market indicators point to continued job growth, though we see some downside risks from summer distortions, softer ADP data, and a potential reversal in local gov’t hiring. We expect the u-rate to round up to 4.3% as participation rebounds, though strong household employment could keep it at 4.2%. A report in line with our forecast would reinforce the view that downside risks to the labor market have largely faded, supporting our call for three hikes this year.

Europe: Watch out for signs of deteriorating sentiment

Keep an eye on potential revisions to “final” July PMIs in the Euro area and in the UK for signs of deterioration stemming from the renewed surge in energy prices (Mon/Wed). German factory orders should increase (Thu), with the by now standard risk from public defense orders. Industrial production, meanwhile, is likely to contract slightly again in Jun (Fri). We expect Swedish inflation to come in at 0.7% yoy in July.

Stable labor market data in Canada and New Zealand

In Canada, we expect employment to grow by 20.0k jobs in July, following a gain of 18.2k in June. The unemployment rate will likely stay at 6.5%. In New Zealand, we expect a mild uptick in the unemployment rate to 5.4%, up from 5.3% in the first quarter.

The week ahead in Emerging Markets

There are monetary policy meetings in India, Brazil, Mexico and Czech Republic. CPI in Indonesia, Korea, Mexico and Türkiye. Exports data in China.

US: Trade, ADP, S&P Global PMIs, jobless claims, unit labor costs, NFP, Fed speakers.

Euro area: PMIs (F), retail sales, Germany IP, factory orders.

Japan: BoJ minutes.

Canada: Jobs data.

Scandies: Sweden CPIF.

New Zealand: Unemployment rate.

In this week’s Week Ahead

• An update on the economy, including Q2 GDP and details including real final sales to private domestic purchasers and real disposable personal income, the Citi Economic Surprise Index, a review of how the Q2 GDP trackers performed, early Q3 GDP trackers, the Dallas Fed Weekly Economic Index, Goldman’s Current Activity Indicator, BoA card spending, and Yardeni on Redbook sales.
• A closer look at the consumer and underlying growth setup, including Yardeni on consumer spending, the rebound in BoA card spending and Redbook sales.
• A lengthy Q2 earnings season update, including beat rates, earnings and revenue surprises and current expectations for earnings, revenues, and profit margins, Amazon and Alphabet’s impact on headline earnings growth, sector-level earnings and revenue expectations, margins, and market reactions to beats and misses.
• A closer look at the earnings setup beyond Q2, including Q3, 2026, and 2027 earnings expectations, revisions, analyst price targets, ratings, and the impact of investment gains and “other income” on headline earnings.
• Goldman’s latest thoughts on earnings season, including AI infrastructure stocks, semiconductor price volatility versus earnings estimates, equal-weight S&P 500 earnings, mega-cap Tech “other income,” the contribution of AI infrastructure to earnings growth, revision breadth, and margin pressure.
• An update on valuations, including how rising earnings expectations and softer stock prices have affected forward P/Es for the Mag-7, large caps, mid caps, and small caps.
• A breadth update, including the McClellan Summation Index, stocks above 20- and 200-DMAs, new highs minus new lows, equal-weight vs. cap-weight, small caps vs. large caps, and growth vs. value.
• A detailed positioning and flows section, including Deutsche Bank’s composite positioning work, the divide between discretionary and systematic investors, large-cap Tech positioning, BoA’s systematic flow estimates, Deutsche Bank, and Goldman on CTAs, vol-control funds, risk parity, and options positioning.
• A closer look at BoA’s updated systematic flow work, including a more two-sided flow setup, the remaining downside risk in a weaker market, and the CTA levels to watch across Nasdaq, the S&P 500, and Russell 2000.
• An update on leveraged ETF positioning, including BoA’s SPX and Nasdaq-100 leveraged ETF work, ZeroHedge/Goldman on broader US leveraged ETF AUM and net exposure, Tier1Alpha on SOXL and leveraged-fund feedback loops, and the latest moves in single-stock leveraged ETF AUM.
• A look at retail positioning and options activity, including put/call ratios, Deutsche Bank on call/put buying and options skew, Vanda on retail selling in single stocks, Nvidia dip-buying, memory-stock flows, and BoA private-client allocations.
• An update on gamma and buybacks, including BoA and Tier1Alpha on dealer gamma, the potential impact of expiring options, Citadel’s buyback-window work, and BoA client buyback trends.
• A sentiment check, including AAII, NAAIM, Goldman’s US Equity Sentiment Indicator, CNN Fear & Greed, BoA’s Bull & Bear Indicator, and Helene Meisler’s weekend poll.
• A seasonality update, including early-August seasonality, BofA on August/September weakness and October/November reversal led by midterm years, Goldman’s deep dive on midterm-election uncertainty, volatility, fund flows, and sector relationships.
• An update on interest rates and Fed expectations, including the market reaction to Chair Warsh’s press conference, Yardeni on bond vigilantes, Bloomberg’s John Authers on the yield-curve message, BoA on Fed credibility and September hike risk, BlackRock’s Wei Li on the long end, St. Louis Fed President Alberto Musalem’s comments, the MOVE index, breakevens, and the Fed-favored 5-year, 5-year forward inflation rate.
• A wrap-up with some thoughts on the AI trade, earnings season, positioning, gamma, buybacks, long-end yields, Iran, and whether the market setup has improved.

Please note that I do sometimes add to or tweak items after first publishing, so it’s usually safest to read it from the website where it will have any updates.

Economy

Looking first at the economy, my intro has remained the same since the start of the Iran conflict: “we continue to see it weathering the various storms remarkably well due in large part to continued resilient consumption (fueled by huge increases in wealth over the past few years despite slowing incomes) and AI-spending… with data of late showing a stable (and perhaps accelerating) economy, but one that is also boosting inflation.”

As noted previously, while in June that parenthetical (a perhaps accelerating economy) had been doing a lot of work, things tailed off in July. We didn’t have as much hard data last week, outside of the normal weekly reports (which continued to show the “low fire” (jobless claims) and “slowing hire” (ADP weekly) labor market, but we did get the Q2 GDP numbers (which incorporated the June personal income and spending data) which were consistent with the very solid economic conditions I’ve discussed over the past three months.

Here was some commentary on that from me and others this week:

One big positive from the Q2 GDP report was "real final sales to private domestic purchasers,” a measure of underlying growth that combines consumer spending and gross private fixed investment," accelerated to +3.94% Q/Q SAAR in Q2, the strongest quarter since Q1 ‘23, from +1.74% in Q1. On a y/y basis it improved to +2.60% from +2.33%.

BofA with a similar takeaway of a strong core GDP print dragged lower by trade and inventories: 2Q GDP was in line with our tracking but below consensus at 1.5% q/q saar. However, underlying momentum was strong. Final private domestic demand (consumer spending + fixed investment) surged by 3.9%. Spending was up 3.2%, with broad-based gains across discretionary goods and services. This should reassure investors that the 1Q spending slowdown (+0.5%) was weather-related. There were also signs of broadening in capex. AI capex stayed firm, while industrial and transportation equipment picked up sharply.

Ed Yardeni: "The latest batch of economic data suggests that the US economy remains in remarkably good shape. Domestic demand is strong, and the labor market continues to show resilience. Underlying demand was quite strong. Final sales to private domestic purchasers, a key measure of underlying demand that excludes volatile trade and inventory swings, rose 3.9%, the strongest increase since Q1-2023 (chart)! "Consumer spending increased 3.2%, up from 0.5% in Q1. Nonresidential fixed investments jumped 8.4%.The weakness in headline GDP largely reflected trade, as an 11.5% surge in imports caused net exports to subtract 1.5 percentage points from growth. AI-related imports have been especially strong."

But as I noted in the GDP blogpost,

offsetting to some extent the positive takeaway from very strong real final sales to domestic purchasers was the fact that Real Disposable Personal Incomes (RDPI), which is aggregate national personal (non-corporate) incomes adjusted for inflation and taxes -1.50% Q/Q SAAR, the most since Q2 2022 after +0.93% in Q1.

Also, as expected, the PCE (consumer) prices in the June personal income and spending report were quite subdued with the first negative headline print since 2020 on the back of the largest drop in energy prices since August 2022, while core prices rose just 0.1%, although remained at 3.3% y/y for a fourth month, well off the 2% Fed target. The “supercore” services index that excludes energy and housing was also up just 0.1% but is still up 3.8% from a year ago

And while the hard data reports were light this week, they were enough to see our first material softening in the Citi economic surprise index in months, falling back to 38.3, the least since May 11th, from 57.1 the prior week and the highest sustained 7-week period since 2023.

Meanwhile GDP estimates are for now consistent with a solid economy (again though remembering GDP going into recessions generally doesn’t look like one is coming (it was up around 2% in Q2 & Q3 2008 well after the recession had started)).

With the first estimate of second quarter GDP in, we can take a look at how our trackers did, which was pretty good, coming in a little high with the Atlanta Fed basically on the money (after a midweek adjustment) and Morgan Stanley and BofA (who remains the most accurate tracker over the past 5 quarters) just two tenths too high. The NY Fed was the furthest off (but just by 1.32%, and they may end up being closer after revisions).

BoA (who has been the most accurate over the past year) was at 1.7%. Goldman +2.6% JPM +2.0% Morgan Stanley +1.7% Atlanta Fed +1.54% NY Fed +2.82% St Louis Fed +2.06% Avg = +2.07% Median = +2.00%

And we can now look to Q3, of which we only have a few:

BoA (who has been the most accurate over the past year) not released yet. Goldman +2.4% JPM +2.0% (+2.0%) Morgan Stanley (I don’t get until Monday) Atlanta Fed +4.95% (remembering they have been very high to start the last two quarters as well) NY Fed +2.52% St Louis Fed not released yet Avg = +2.97% Median = +2.46%

And as you know if you’re a regular reader, one of my favorite GDP trackers is the Weekly Economic Index from the Dallas Fed.*

In the week through July 25th it remained volatile for a sixth week back down to +2.46% from +2.87% the prior week (after +2.60%, +3.12%, +2.55%, and +3.06% the four weeks prior to that (that +3.12% reading the third highest since 2022 (after May 30th and November 23rd, 2024)).

More importantly, while the 13-wk avg edged down to 2.83% from 2.87% (which was the best since 2022), it continues to evidence economic momentum that is above trend.

* The WEI is scaled as a y/y rise for real GDP (so different than most GDP trackers which are Q/Q SAAR) and uses 10 daily and weekly economic series but runs a week behind other GDP trackers.

It has over time had one of the highest correlations with actual GDP of any tracker (see chart) although for Q2 it came in a little high predicting +2.80% y/y GDP growth vs the actual first estimate of +2.10%, while for Q1 it predicted +2.48 vs 2.66%. More importantly, it has consistently indicated no recession and relatively healthy growth since the pandemic (which is what we’ve experienced).

And Goldman’s July US Current Activity Indicator* eased back 0.3% to 3.9%, still though the best since November 2021. That comes after the strongest six-month period since 2022, as the manufacturing component is getting more help from other sectors.

*The CAI is their “real-time measure of inflation-adjusted economic momentum using 37 inputs.”

BofA card spending rebounded in the week ending July 25th, with spending on BofA cards (credit+debit):

• +4.1% y/y (+4.2% four-week moving average)
• Ex-gasoline spending up +3.3% (+3.6% four-week moving average), while
• Ex-autos and gasoline +4.8% (+3.7% four-week moving average).

Gasoline itself jumped to +18.0% y/y — its highest since June 13th, six weeks ago — from +14.2% the week before, rebounding after a one-week dip.

BofA noted that higher gas prices, following a re-escalation of the US-Iran conflict, contributed to the headline pickup. But the strength ran well beyond the pump: retail spending ex-autos and gasoline jumped to +4.8%, actually outpacing the gas-inclusive headline of +4.1%, which points to a genuine rebound rather than merely a gas-price bump. BofA also noted that higher- and lower-income spending growth were largely in line with each other this week, after lower-income growth had outpaced for the prior two weeks.

Gains were led by electronics, which accelerated to +21.9% from +19.8% and remains the strongest category on the board, running well above its +18.9% four-week average. Online retail (which overlaps with electronics) similarly jumped to +11.5% from +3.6% as the Prime Day base effect fully cleared, and general merchandise firmed to +5.2% from +4.0%. The week’s biggest single-week mover was department stores, which swung sharply to +8.5% from -9.4% — an 18-point jump, the largest weekly increase of any category — and at +8.5% it sits well above its depressed -2.7% four-week average.

The acceleration was concentrated in goods, however, rather than broad-based. On the services and travel side, airlines eased to +9.3% from +11.8%, lodging cooled to +0.8% from +3.8%, and restaurants & bars slipped to +2.3% from +3.4%. Several retail categories also fell, with clothing down to +2.2% from +5.8% and furniture deeper into the red. Three categories were negative y/y — home improvement (-2.2%), furniture (-1.9%) and grocery (-0.5%) — all only modestly below zero though.

And we also saw a rebound in Redbook sales in the week of July 24th as Ed Yardeni notes:

Redbook same-store retail sales rose 8.1% y/y in the week ending July 24, rebounding after a temporary pullback from the exceptionally strong gains during the World Cup this summer (chart). Sales growth remains well above the 2025 average of 5.8% y/ y.

Earnings

Through Thursday according to Factset we’ve had 61% of SPX components report by earnings weight, and while we came into the earnings season with a high bar the results continue to clear it, with 86% beating, slightly above the 84% beat rate in Q1 (which was the best since Q2 ‘21) and vs the 5yr average of 78% and the 10yr average of 76%.

And despite the high bar the magnitude of the beats has been a huge +31.4% (down some from the prior week though), almost double Q1’s +16.6%, and nearly five times the +6.5% in Q4 and +6.6% in Q3, and vs the 10-yr average of 7.4% and the 5-yr average of 7.0%, led by Consumer Discretionary’s +120.2% (boosted by Amazon’s massive 215% beat (on the back of a $53.4 billion gain in investments (primarily Anthropic) as well as Nike’s +479% beat, followed by Comm Services (+101.1%) similarly boosted by Alphabet’s +217% beat on the back of a $98 billion gain tied to its own investments.

Factset notes excluding Amazon and Alphabet, the surprise percentage for the S&P 500 for Q2 2026 would fall to 9.2% which would still be materially above the 5 and 10-year averages.

The beats have boosted Q2 earnings expectations to an eye-watering +47.4% up from 18.8% at the start of the quarter (April 1st). That would be the seventh consecutive quarter of double-digit earnings growth (and second above 20%) and the strongest since Q2 2021 (91.6%).

Factset notes if Alphabet and Amazon.com were excluded, “the blended earnings growth rate for the S&P 500 for Q2 2026 would fall to 28.8% from 47.4%,” still though it would be the “2nd consecutive quarter of year-over-year earnings growth above 20% and 7th consecutive quarter of double-digit earnings growth.”

Energy continues to lead on a percentage growth basis (although less so on an earnings weighted basis) +135.3%, but following Alphabet’s massive beat, Comm Services is not far behind (+109.8%) and Consumer Discretionary is +90.7%. Tech is +69.4%. Just incredible numbers.

As with Q1 Health Care is expected to be the only sector with negative growth -14.0% (down from +6.7% on March 31st).

In terms of Q2 revenues, 77% of SPX components have beat (vs the 10-year average of 68% and 5-year average of 70%). The beats are 2.9% above estimates, which would be the best since Q2 2022 (3.2%) and above the 5-year average of 1.9% and the 10-year average of 1.6%.

That has boosted Q2 revenue expectations to +14.1% (up from 9.5% at the start of the quarter (Apr 1st)) led by Tech (+35.6%), Energy (+31.7%) and Comm Services (+15.2%). No sector is expected to see a revenue decline y/y. Utilities are expected to see the least growth at +6.1%

If 14.1% is the actual revenue growth rate for the quarter, it will mark the highest revenue growth rate reported by the index since Q4 2021 (16.1%). It will also mark the second consecutive quarter of double-digit revenue growth for the index.

Profit margins were also boosted this week by Amazon’s income gains and are now forecast at 16.7%, easily a new record (beating the 14.8% in Q1). They are also well above the prior year’s 12.9% and the 5-year average of 12.3%. Second chart is from last week when they were at 15.7%.

And Factset notes in contrast with the historic averages, next quarter (Q3) earnings estimates have risen since the start of the quarter (July 1st) by +0.3% vs the 5-yr average of -1.0% and 10-yr average of -1.3% (the chart is since Q4 2021, since then the average is -1.1%).

Factset notes:

This marks the 2nd consecutive quarter and the 4th time in the past 5 quarters that the bottom-up EPS estimate has increased during the first month of the quarter. At the sector level, five of the eleven sectors witnessed an increase in their bottom-up EPS estimate for Q3 2026 from June 30 to July 30, led by the Energy (+2.6%) and Financials (+1.7%) sectors. On the other hand, six sectors recorded a decrease in their bottom-up EPS estimate for Q3 2026 during this period, led by the Materials (-5.0%) sector.

At this point that Q3 estimate stands at another huge gain of +27.4%, which would be the third consecutive over 20%. As in Q2, Energy is expected to lead at 88.2% y/y growth, followed by Tech +59.2%, Comm Services +50.7%, and Materials +31.6%.

Unlike Q2 no sector is expected to have negative y/y growth with Financials the least at +3.6%.

Those rising expectations have seen 2026 SPX earnings growth expectations also continue to ratchet higher now at +29.1%, up from +17.1% March 31st and from +14.8% at the start of the year.

As in 2025, Tech is a leader with y/y earnings growth of +49.6% (up from +28.6% at the start of the year) but Energy will exceed that (on a percentage basis) at +71.7% (up from +6.4% at the start of the year) and now so will Comm Services +53.2%, along with Materials (+37.3%) representing the four sectors expected to come in above the SPX average.

And 2027 earnings are expected to be up another +14.1%, which is down though from +17.5% two weeks ago as analysts are no longer carrying over all (but still most of) the boosts in 2026 (such as the investment gains by some hyperscalers) to next year. That’s also down from +16.5% at the start of the second quarter (Apr 1st). Still it’s a double digit advance on top of what is expected to be a nearly 30% gain in 2026.

2027 is expected to be led again by Tech (+32.8%, up from 24.6% at the start of the second quarter despite the huge increase in 2026 estimates) followed by Health Care (+22.5%) which is expected to see a big turnaround after lagging in 2026.

That would represent a fourth straight year of double-digit earnings growth for the S&P 500, fairly unprecedented.

I n terms of the note at the start, though, on investment gains not continuing, Comm Services (-10.0%) has joined Energy (-9.1%) as the sectors expected to see negative growth next year, and Consumer Discretionary has now fallen to +3.3% from +13.9% at the start of the quarter.

And earnings expectations continue to be supported by very strong earnings revisions which moved higher for a second week in the week of July 24th after cooling off for two weeks following ten straight weeks of well above average revisions. Overall it marks the best 14 weeks since 2021.

As a result, the 20-week moving average has lifted to the best since 2021 as well, as 12-month out EPS estimates continue to rise to new highs, as they’ve done each week since the turn of the year.

In looking at how markets are rewarding beats and punishing misses, according to Factset (who looks from the two days before to two days after a report) in line with the high bar coming into earnings beats are being rewarded well under the typical amount, although improving from the prior week’s -0.3% to +0.1% (as compared though to the 5-yr average of +1.0%, and down from +1.2% in 1Q and 4Q ‘25 and +0.4% in 3Q and 2Q ‘25).

Misses though are now being punished less than average at -2.4% (down from -4.0% the prior week) vs the 5-yr avg of -3.0% and also better than the -4.3% in 1Q. Previous to that we saw -1.4% in 4Q, -5.0% in 3Q, and -5.5% in 2Q (the last of which BoA said was the worst negative reaction since 2000).

And here is Goldman’s take on earnings season thus far which adds some color to the above:

While investors debate the long-term earnings implications of the AI boom, the Q2 earnings season so far has signaled continued strength in near-term fundamentals. Among the largest AI infrastructure stocks, while recent estimate upgrades have not been as large as revisions last quarter, earnings estimates have continued to climb. Outside of the AI complex, fundamental outlooks have also remained strong, and share prices have climbed steadily alongside rising earnings.

SMH semiconductor ETF

Source: FactSet, Goldman Sachs Global Investment Research

Source: FactSet, Goldman Sachs Global Investment Research

61% of S&P 500 companies representing 66% of market cap have now reported Q2 2026 results, including most of the mega-cap tech stocks. Nvidia, the largest stock left to report, is scheduled to release earnings on August 26th.

Source: Goldman Sachs Global Investment Research

Nearly 2/3 of S&P 500 companies have beaten consensus EPS estimates this quarter, one of the highest rates on record. This represents one of the highest frequency of earnings surprises on record, exceeded only by last quarter, the Q3 2025 reporting season, and the COVID reopening period in 2020-2021.

Source: Goldman Sachs Global Investment Research

However, the “reward” for earnings beats has been lackluster, particularly within TMT. Within TMT, the median stock beating on EPS has lagged the S&P 500 by 192 bp on the day after reporting, compared with 75 bp of outperformance for the median stock in other sectors. During the last couple decades, the median S&P 500 stock beating EPS has outperformed the S&P 500 by 95 bp on the day after reporting.

Source: Goldman Sachs Global Investment Research

Source: Goldman Sachs Global Investment Research

Aggregate S&P 500 earnings growth is tracking well above consensus estimates this quarter, even adjusting for non-recurring “other income.” S&P 500 EPS growth is tracking 45% year/year in Q2 compared with a consensus estimate of 22% coming into the quarter. However, 19 pp of that growth is attributable to Alphabet and Amazon’s combined $151 billion of “other income” related to equity investments. Microsoft contributed an additional $3 billion of “other income.” Excluding these gains, S&P 500 EPS growth is tracking at 26%, an acceleration vs. Q1 and the fastest pace of growth since 2021. EPS growth for the median S&P 500 stock is tracking at 12% year/year, also exceeding consensus estimates, which pointed to 9% growth at the start of the season.

Source: FactSet, Goldman Sachs Global Investment Research

“Other income” has recently represented an unusually large share of mega-cap tech earnings. Last quarter, Alphabet and Amazon GAAP net income was boosted by $53 billion of combined “other income,” with $49 billion explicitly stemming from equity stakes in private companies. This quarter, Alphabet reported roughly $98 billion of “other income” driven by unrealized investment gains and Amazon reported $53 billion of “other income” from private investments.

Mega-cap tech includes Alphabet, Amazon, Apple, Broadcom, Meta, Microsoft, and Nvidia

S&P 500 adjusted earnings include GAAP \”other income\” reported by Alphabet, Amazon, and Microsoft that includes investment gains. Q2 reflects figures for companies that have reported results so far.

Source: Bloomberg, Goldman Sachs Global Investment Research

AI infrastructure stocks are expected to account for nearly a third of S&P 500 earnings growth in Q2. Analyst estimates point to AI infrastructure stocks contributing more than half of S&P 500 earnings growth for the remainder of 2026 and in 2027.

* indicates company has not yet reported Q2 results

Source: Goldman Sachs Global Investment Research

In addition to strong backward-looking results, Q2 reports have driven continued upward revisions to analyst 2027 earnings estimates. Since the start of Q3, consensus estimates for S&P 500 2027 EPS have been revised up by 1%, with the strongest revisions to Energy and Financials. Broad based upward revisions to 2027 earnings have been reflected in continued positive revision breadth across the S&P 500.

Source: FactSet, Goldman Sachs Global Investment Research

Source: FactSet, Goldman Sachs Global Investment Research

Input cost pressures remain a risk to corporate profitability. Net profit margins for the median S&P 500 stock have remained relatively unchanged during the past several quarters as companies managed headwinds from tariffs and energy prices. While the profitability of the largest tech stocks has continued to lift margins for the aggregate S&P 500, analysts have recently trimmed Q3 margin estimates for most stocks that have reported Q2 results.

Source: FactSet, Goldman Sachs Global Investment Research

Source: Compustat, Goldman Sachs Global Investment Research

Analysts also collectively continue to think that the S&P 500 has a lot of upside, but for the first time in a few months FactSet’s compilation of analyst bottom-up SPX price targets has fallen back w/w, although very mildly by just -11 points to 9,060 (still ~+1,935 pts since Thanksgiving, ~+2,885 pts since July 1st, and ~760 just since March 31st). That would be +21.8% from Thursday’s close.

Comm Services (+29.9%) remains the sector seen with the biggest upside, followed by Tech (+29.3% from +27.0% the prior week) and Cons Discretionary (+25.4% from 23.8% and +20.4% the week before that). On the other side Financials (+10.4% from +11.7%) has edged under RE (+10.9%) as the sector with the least upside.

As FactSet reminded us in December, the last 20 yrs (through 2024) analysts have been on avg +5.9% too high from where they start the year (which was 8,000 for 2026) but note they underestimated it five of the past six years (including 2025 when they saw 6,755 at the start of the year (we ended at 6,845)).

Over the previous 20 years (2005 – 2024), the average difference between the bottom-up target price estimate at the beginning of the year (December 31) and the final price for the index for that same year has been 5.9%. In other words, industry analysts on average have overestimated the final price of the index by about 5.9% one year in advance during the previous 20 years. Analysts overestimated the final value (the final value finished below the estimate) in 11 of the 20 years and underestimated the final value (the final value finished above the estimate) in the other 9 years. It is interesting to note that analysts have underestimated the final value in five of the past six years (2019 – 2024).

In terms of analyst ratings, buy and hold ratings continue to dominate with buy ratings at 59.2% seven tenths below the record high of 59.9% the last week of April. The 5-year month-end average though is 55.8% according to FactSet, so we’re well above that.

Hold ratings are at 35.9%, off the 35.4% record low (to 2009), but well below the 5-year month-end average of 38.7%, with sell ratings at 4.9%, remaining in their narrow range since 2009 but below the 5-year month end average of 5.6%.

Tech leads in buy ratings (69%) while Staples leads in sell ratings (8%).

The increases in earnings with stock prices easing have seen valuations (price to next-twelve-month (NTM) earnings) fall to below (Mag-7) or near (SPX) the April 2025 lows for the large cap indices, while small and mid-caps remain further off those levels.

Breadth

Breadth, which had shown improvement on balance over the first half of July, has softened in the second half.

The McClellan Summation Index (“what the average stock is doing”) continues to head lower.

Although percentage of stocks over 200-DMAs (red lines) has continued to trend upwards on the NYSE, not so much though on the Nasdaq.

While SPX percent of components above their 200-DMAs challenged the downtrend line from 2021 last week before falling back.

While shorter-term 20-DMAs are looking to stabilize.

SPX new 52-week highs minus new lows though continued to deteriorate ending the week at just four, the least since April, while the 10-DMA is also the least since then.

While the ratio of the equal-weight SPX to the cap-weighted fell back sharply.

And small caps to large caps (Russell 2000 to SPX) fell to the least since May after hitting the highest since July 2024 two weeks ago.

While S&P 500 growth/value rebounded back up to 2.39 from 2.35 the prior week, the least since early May, still down from its all-time high of 2.52 hit at the end of May.

Even as the ratio of forward earnings for growth/value pushed to a new all-time high, at 2.05.

Positioning/Flows

Turning to equity market positioning, after dropping back the last few weeks, positioning is now much cleaner although systematic positioning is still “overweight” but better than last week’s “elevated and vulnerable” per DB.

Deutsche Bank:

Our measure of aggregate equity positioning was choppy this week and remained slightly below neutral (-0.06sd, 37th percentile).

Discretionary investor positioning (-0.53sd, 17th percentile) remained notably underweight, near its early-April lows, while systematic strategies’ positioning (0.51sd, 70th percentile) stayed overweight.

Large-cap positioning (0.28sd, 59th percentile) was also choppy but remained modestly overweight, as did large-cap Tech positioning (0.47sd, 62nd percentile). Small-cap positioning (-0.12sd, 44th percentile) remained modestly underweight.

Goldman in turn notes that their Prime Desk found

Hedge Fund flows felt capitulatory to start the week, with the majority of activity being driven by selling of AI favorites & covering of shorts, especially in macro products. Toward the back end of the week, we began to see signs of re-grossing from both HFs & Asset Managers as momentum stabilized and strong prints from AMZN and MSFT reassured investors around the next potential leg of the AI trade.

In that regard, they said “ US equities saw the largest net buying since Nov ‘20, driven by short covers across Macro Products and Single Stocks ” with “US Info Tech stocks bought at the fastest pace since Dec ’22, driven by long buys as well as short covers.”

But the combination of a near record drop in shorts with subdued buying of longs means gross (longs+shorts) positioning saw its second largest degrossing over the past decade second only to the meme craze of January 2021.

BoA sees overall systematic positioning as having pulled back last week between the equity declines and the higher volatility, led by sales from CTAs and vol-control, although most of the selling from CTAs according to BofA was in the Nasdaq with “S&P 500 and Russell 2000 positioning … largely intact and still stretched long”. Positively, though, the Thursday-Friday rebounds “provided some cushion” against selling.

Importantly they now see “ systematic flow risk … more two-sided than in recent weeks,” particularly as it applies to the Nasdaq.

Specifically they see:

• +$33B of buying in a flat market (from -$15B of selling two weeks ago);
• +$19B of buying in an “up” market (from -$33B of selling two weeks ago; ”up market” defined as 97.5th percentile price path or ~+3.5% similar to Goldman); and
• -$77B of selling in a “down” market (from -$212B two weeks ago; “down market” defined as the 2.5th percentile price path or ~-2.9% (different than Goldman who uses -4.5%)).

Specifically on CTAs, BoA says:

Looking ahead, contagion risk to broader equities persists should markets roll over. However, if equities continue to recover, near-term CTA buying would likely be concentrated in Asian indices, while CTAs could also partially re-accumulate NDX exposure, potentially adding fuel to the rebound.

Goldman though is less optimistic about CTA flows this week:

Short term trend signals are recently more negative in the US, in S&P, Nasdaq and Russell and below the 7445 area for reference in S&P today. The medium-trend area is around 7215, and medium and longer-term signals remain more positive to date….

The result, all told, is that we estimate CTA/trend followers have sold a small $7bn in the last one week, due to $11bn of US sales vs. some slight overall buying in global markets. We estimate for them to be relatively neutral in the next one week in the baseline scenario, with some continued and modest-sized US sales of $5bn. If price action deteriorated meaningfully however, the sales could grow a lot

DB also sees lower positioning in the Nasdaq with overall CTA positioning in the US edging back to the 66th percentile to 2009, but Nasdaq-100 just at the 38th while SPX and RUT are at the 70th and 82nd respectively.

In terms of vol control positioning with the continued rise in volatility DB saw a continued drop in AUM now down to the 67th percentile from the 96th two weeks ago leaving a more positive setup going forward:

Vol control funds’ equity allocation declined this week closer to neutral (67th percentile). Selloff sensitivity rose slightly over the week but eased from elevated levels mid-week.

With positioning no longer extended, they retain capacity to add on lower volatility, but the higher downside sensitivity leaves flows less supportive in drawdowns.

Tier1Alpha saw less of a pullback but they had also seen much less of a buildup in exposure coming into mid-July.

While for risk parity DB sees equity positioning as having edged higher for a third week now to the 66th percentile from the 37th three weeks ago. That takes it from historically underweight to slightly overweight. Bond exposure is at the 43rd percentile (little changed, down from the 65th three weeks ago) but commodities remain elevated at the 94th (but down a little the past two weeks”.

“Overall, the funds continued to shift toward equities while maintaining meaningful exposure to inflation-linked securities and commodities.” (the same commentary as last week).

Despite the uptick in volatility, 1-month realized volatility remains just under 3-month making 3-month the dominant trigger.

And we’re not going to get much help from the lookbacks. There is just one 1%+ day in the 3-month lookback (and none in the 1-month lookback), making the outlook for vol control buying unfavorable for a second week.

Like call buying (which also creates additional upward pressure on equities particularly in a rising market as dealers have to “chase” price rises), leveraged positioning acts as a “negative gamma source” as Charlie McElligott has put it (meaning that there is added buying/selling pressure from them in the direction of daily flows as they rebalance each day).

Positioning in Nasdaq-100 and SPX leveraged ETFs saw a rebound last week according to BofA, after Nasdaq-100 leveraged ETF had hit the least since April. However both remain far off the highs of the year.

Although ZeroHedge noted Friday (per Goldman data) that across the broader complex of all US leveraged ETFs AUM continued to fall:

US-listed levered/inverse ETF AUM hovered just shy of $150 billion, shedding nearly $60 billion since June highs. However, the reversion of AUM has had an outsized impact on net exposure for the complex, which has slid by roughly $170 billion over the past month and now represents $300 billion after yesterday’s close (yielding an asset-weighted leverage ratio of ~2.1x).

But that wasn’t due to people pulling money out as “ inflows into the levered suite have accelerated even as price action has faded from June highs, with the complex gathering $6+ billion so far in July.”

There’s one chart that illustrates the durability of ETF demand: while the SOX index has faced one of its worst months of performance in nearly two decades (-21%), semiconductor ETFs (SMH + SOXX) are on track to have their best month of fund flows since the inception of SMH (+$13bn)

And Tier1Alpha notes: “Ultimately, the key structural risk continues to come from the leveraged fund complex. "SOXL, the 3x leveraged semiconductor ETF, gained more than 24% [Thursday] and generated a $7.5B MOC imbalance in its wake. Given SOXL’s swap-based exposure, we suspect much of this was hedged by counterparties throughout the trading day, creating the conditions for a supportive feedback loop that pushed the SOXX index, and its underlying holdings higher."

In that regard, looking specifically at single-stock leveraged ETF AUM, we saw a return to AUM drops in the memory names which offset modest increases across the rest of the complex.

While put buying (which adds incremental downside pressure) remains elevated, with the 10-DMA of the put/call ratio just off the highest since April.

While DB says the 5-day ratio of call/put buying for equities (just the flip over a shorter timeframe) “declined again this week, reaching its lowest level in a month (31st percentile).”

But they also note that “S&P 500 options skew (3m, 90%-110%) declined sharply late in the week after reaching a three-month high.”

And at least to start the week, the selling from retail investors continued:

According to data from Vanda Research, retail investors Tuesday sold a net $243 million of single stocks — marking the biggest one-day outflow since March 2020.

Investors logged nine net-selling days for single stocks in 2026, which began March 23. Prior to this year, the last time retail investors sold single stocks was almost three years ago.

But Viraj Patel, global macro strategist at Vanda Research notes the “record selling was concentrated in a handful of individual stocks rather than a wholesale exit from equities,” with the outflows focused on memory stocks. However they were net buyers of the DRAM Roundill Memory ETF.

“This is a classic defensive move,” Patel said, adding that retail traders are increasingly making use of exchange-traded funds as a defensive alternative. “In other words, this is turning into a common theme: sell individual names, buy broad index ETFs.”

Meanwhile, dip-buying activity in Nvidia Corp. continued to be “unusually weak,” as retail just bought $108 million following the chipmaker’s selloff on Monday. All three of the weakest dip-buying sessions for the company have taken place in 2026, Vanda data showed.

Overall, retail investor activity remains “extremely high,” said Patel. “Retail aren’t leaving the market. They’re turning far more discerning.”

BoA client retail equity positioning also reflected a second week of pullback to 65.5% in stocks (down -0.1% w/w, record was 66.1% June 5th), 17.5% in bonds (unch w/w, 17.2% June 5th was lowest since Mar ‘22), while cash edged up to 9.7% +0.1% from the joint record low (hit four times this year).

Turning to gamma:

BoA saw gamma as of Thursday’s close little changed over the week at a very modest $1.8B, but they note that most of that was tied to expiring options. We will have to see how much is rolled over Monday, but it appears gamma will likely be even thinner to start the week, meaning we start the week with even more potential volatility, which looks to increase on any market decline:

Realized vol rose this week and SPX hedger gamma faced negative pressure as customers opened large intraday downside positions ahead of the FOMC policy action on Wednesday. Gamma ended 30-Jul positive at $1.8bn (29th%ile in last year) but the 31-Jul weekly expiry was the main contributor as of 30-Jul, driven mostly by customers holding short upside call positions.

While outcomes depend on flow and spot levels, with hedgers now net short contracts near spot (~6.6k between 7350 – 7600) in Monday’s expiry (3-Aug), gamma could decline to start the week as the 31-Jul position expires.

Tier1Alpha’s update was also as of Thursday night and they continued to see gamma in negative territory, and they don’t see it moving sustainably positive until around 7,500.

SPX remains in negative gamma territory, although conditions have improved materially from earlier in the week.

Turning to buybacks, we continue to move off the max blackout window now up to around 60% of discretionary buybacks by index weight (discretionary buybacks represent ~30% of all buybacks) for S&P 500 companies will be active this week according to Citadel’s Rubner, and that will be at 80% in a week as that tailwind returns.

While BofA says buybacks are now +19% y/y on a 4-week average basis. “Corporate client buybacks slowed last week and were below the historical avg. for Week 2 of earnings season when normalized by mkt. cap.”

YTD they say annualized buybacks are “slightly below full-year ‘25 levels and below ‘24 records, but above 2016-23 levels,” and as a% of market cap are the least since late 2023 (on a rolling 52-week basis).

Sentiment

Sentiment was mixed this week:

American Association of Individual Investors (AAII) sees little change this week with bulls remaining just off the least since September and below the bears:

AAII bulls (those who see higher stock prices in 6 mths, blue line) edged up to 31.0% from 29.6% the prior week, the least since September and down sharply from 44.9% the week before that, remaining below the long-term historic average of 37.5% for a second week. Bulls also remained below the level of the bears (who see lower stock prices in 6 mths, red line) for the 17th week in the last 22 as the bears edged to 42.1% from 42.3%. Bears also remain above the long-term average of 31.0% for a 24th straight week (they’ve only been below it 9 weeks since Dec 12, 2024). The Neutral camp (yellow line) came in at 26.9% from 28.1% a three-month high. It remains under the long-run average of 31.5% and has been over that only twice since July 2024.

Like AAII, the NAAIM (investment managers) exposure index* (blue line) saw modest changes this week but unlike AAII moved less bullish, falling to 79.7%, the least since June 10th, from 84.0% the prior week and 95.6% the week before that, overall remaining in its range since mid-April (albeit at the bottom). The 4-wk avg (reddish line) edged down to 85.6%, the least since the end of April, from 90.5% two weeks ago which was the highest since May 13th. *The index “represents the average exposure to US Equity markets reported by our members” and which ranges from -200% (2x short) to +200% (2x long).

But Goldman’s US Equity Sentiment Indicator*, after easing off for three of the prior four weeks from the 2.0 June 26th, the highest since December 2024, jumped back over the “stretched” threshold of 1.0 at 1.56, the highest since that 2.0 reading.

This is since 2009 actually the weakest 1-month average return bucket at ~-0.3% although the positive rate is not terrible at 55%.

*The indicator combines “six weekly and three monthly indicators that span [across the more than 80% of the US equity market that is owned by institutional, retail and foreign investors]. Readings of +1.0 or higher have historically signaled stretched equity positioning. Readings of -1.0 or lower have signaled very light positioning and have historically been a statistically significant signal for subsequent S&P 500 performance”.

The CNN Fear & Greed Index (blue line) edged up for a second week to 42.5 from 39.4 the prior week and 37.1 the week before that, still down from 47.9 the week before that, which was the highest since June 4th, but remaining well above the recent low of 24.7 June 26th (which was the least since early April). The indicator remains in “Fear” where it’s been for the most part the past nine weeks.

We remain for a second week with one indicator above neutral:

Extreme Greed = junk bond demand (vs investment grade) (from Neutral)

Greed = None

Neutral = market volatility (VIX & its 50-DMA); safe haven demand (20-day difference in stock/bond returns) (from Greed)

Fear = market momentum (SPX vs 125-DMA); stock price strength (net new 52-week highs); put/call options (5-day put/call ratio)

Extreme Fear = stock price breadth (McClellan Volume Summation Index)

https://www.cnn.com/markets/fear-and-greed

And BoA’s Bull & Bear Indicator eased back to 9.4 from 9.6 the prior week, the joint highest (with February) since December 2020, but remaining above its sell signal (8.0) which it crossed back above the week of May 22nd :

down to 9.4 from 9.6 on EM debt outflows;

extreme bull market positioning remains headwind for risk assets, as has been case since BofA Bull & Bear Indicator "sell signal" triggered May [22nd] (since when a lot of rotation and a little retreat...healthcare up 9%, banks 8% vs. ACWI -3%, MAGS -8%, SOX -11%, oil -11%, bitcoin -15%); "old" Bull & Bear Indicator at 7.4

[And from two weeks ago]:

BofA Bull & Bear “sell signal” remains in place, extreme bull positioning says markets “toppy”, reduce equity exposure, retreat or rotate much smarter summer tactic for risk assets than reload.

17 “sell signals” since '02, average loss for global stocks over 2-3 months is 2-3% (hit ratio of ~60%), with max drawdowns of 15-20% (caveats always “tops are a process, lows are a moment”, i.e. greed harder to reverse than fear).

As a side note, if you’re wondering since May 20th the SPX is +0.3%.

But Helene Meisler ’s followers back to bullish for the first time in three weeks.

Helene Meisler’s Saturday poll asked, “The next 100 points for the S&P?” The final results were 53.4% UP and 46.6% DOWN from 1,728 votes.

Seasonality

As we move into the first half of August, seasonality for all years since 1950 has seen a median gain of less than 0.1%, the fifth worst of all half-months.

And taking a step back and looking at the next several months both from an all-year and midterm year basis, BofA finds that since 1940 there has been late-summer weakness in August and September, which is exacerbated in midterm years, which flips in October and November, also more intense in midterm years :

Since 1940, the S&P 500 has averaged a small 0.06% gain across all years, but a 0.71% decline in midterm years which then increases to a 1.10% decline in September versus a 0.59% decline for all years.

The pattern then flips: October has averaged a 2.98% gain in midterm years versus 0.99% across all years, followed by a 2.36% November Presidential Year 2 gain versus 1.32% normally.

And Goldman did a deep dive into midterm seasonality:

With the 2026 midterms three months away, investor focus is likely to turn increasingly to elections in coming weeks. Midterm elections will take place this year on November 3. During the last few decades, economic policy uncertainty and equity market volatility have typically begun to rise in the late summer ahead of midterm elections. Our economists have found the same pattern after adjusting for the economic cycle as measured by the unemployment rate.

Alongside elevated uncertainty, mutual funds and foreign investors have typically demonstrated reduced demand for US equities ahead of midterm elections. Around the past 10 midterm elections, US mutual funds increased their cash holdings by an average of 0.4% of AUM during the 3 months before the elections and then reduced those cash positions by 0.6% during the 3 months post-election. Similarly, foreign investors on average sold 0.1% of their US equity assets during the 3 months before the election and then added 0.5% during the subsequent 3 months.

Mirroring the pre-election patterns in uncertainty, volatility, and investor flows, US equities have typically traded sideways in the few months ahead of midterms. US equity returns are generally modest during this part of the calendar year but have been weaker on average in midterm election years. During midterm election years of the past few decades, the S&P 500 has generated a median return of 0% from the start of August through Election Day. Returns have typically improved as uncertainty subsided post-election, with the S&P 500 returning a median of 6% in the subsequent 3 months.

Source: Goldman Sachs Global Investment Research

Very few parts of the equity market have demonstrated a recent relationship with midterm election odds. We regress returns across US equity sectors, factors, and thematic baskets on prediction market odds. Most parts of the equity market have demonstrated little to no correlation with shifting election probabilities in recent months, with the results similar across varying time horizons and controlling for varying sets of other variables like interest rates and the price of oil. The most notable exception is the Consumer Discretionary sector, which has traded with a negative recent correlation to Republican odds, although the relationship has not been extremely strong.

Regression of 3-day returns since the start of Q2 on prediction market odds, controlling for changes in 10-year Treasury yields and crude oil; sectors reflect equal-weight returns; returns evaluated relative to equal-weight S&P 500 except for long/short Momentum factor

Source: Polymarket, Kalshi, Goldman Sachs Global Investment Research

I’ll also leave up the Fed seasonality information. We are now squarely into the “rockier 2-3 month stretch” which has so far panned out.

And I noted two weeks ago the tendency for equities to be down for the first meeting of a new Fed chair, bounce back over the next couple of weeks, but see a much rockier 2-3 month stretch. Jeff also looks further out (from the start of a new Fed chair which would have been May 22nd for Warsh) and if you exclude Greenspan since 1933 the 6-month and 12-month returns have been pretty good. I’m going to leave this in to see how we track as time goes on.

Rates/Fed

Turning to interest rates, I noted last week that after thinking that a rate hike this year was a low probability event, the chatter from Fed members, including the new Chair, made me “increasingly convinced that a hike is a real possibility this year, something I thought was unlikely absent a continued push higher in inflation.”

That possibility materially escalated after the at best confusing performance by Chair Warsh at the press conference. I have a hard time believing that his goal was to see the long end running higher, but here we are. Questions about the Fed’s credibility are swirling and the bond vigilantes have been reawakened.

Yardeni:

Yardeni: Fed officials just won't listen to us! We warned them that the economy didn't need the four cuts in the federal funds rate (FFR) at the end of 2024. The Bond Vigilantes agreed with us and pushed the 10-year Treasury bond yield up by 100bps at the time (chart). The same happened late last year. The Fed lowered the FFR three times. The bond yield drifted higher and continued to do so this year. We correctly anticipated that the FOMC would pivot from its dovish stance in April to a hawkish stance in June. Then we predicted that the committee would follow up with a rate hike in July. They didn't listen to us. Once again, the Bond Vigilantes are pushing bond yields higher. In effect, they are saying that if the Fed won't be vigilant about inflation, then they will have to maintain law and order in the economy. Under the circumstances, we conclude that the Fed has to raise short-term rates to lower long-term rates. Talking hawkish but not acting so reduces the Fed's credibility.... Arguably, Warsh failed his first credibility test. Warsh's own hawkish words set the standard against which he is judged.

BBG's John Authers: The fall in the two-year yield suggests that traders think [Warsh] revealed himself as a dove. The rise in the 30-year yield, which touched its highest since 2007, shows traders think this will prove to be a mistake, bringing higher inflation and forcing the Fed to hike more in the longer term. That’s quite a vote of no-confidence. The predominant emotion was confusion, plain and simple, as both ends of the yield curve retraced a lot of their moves after the conference ended. What went wrong? Those dissents can best be interpreted as the governors registering their belief that rates were going to go up at this meeting, in line with the hawkish stance Warsh had outlined in June. If you’re going to be a hawk, at some point you need to bare your talons and pounce. The dissenters — in line, apparently, with the market — didn’t find complete inactivity this month to be credible.

BofA:

"The Fed stayed on hold [Wednesday}, as expected. Chair Warsh made a few starkly dovish remarks at his presser. -First, he opened the door to looking at other inflation indicators besides PCE. -Second, he suggested there could be other tools besides hikes to fight inflation. -Third, he implied that markets have done some of the Fed’s tightening work for it. This could mean that he sees less need for the Fed to actually hike as a result. "Markets responded by questioning the Fed’s credibility: long-end yields (led by breakeven inflation), equities and the dollar sold off substantially. "Ironically, we think the need to re-establish credibility increases the probability that the Fed will hike in September, all else being equal. Therefore, we remain comfortable with our forecast of 25bp hikes at each of the remaining three Fed meetings this year.

Wei Li (Blackrock):

"This Fed easing cycle is highly unusual. 22 months after the first cut, long term yields are higher, not lower. In fact, [the] 30yr yield has now risen [the most of any cycle in the] past 40 years (chart). "Warsh wants to 'observe; markets and the message markets are sending is one of inflation if left unaddressed [equals] more rate vol. "The [two] times [the] long end increased similarly since [a Fed] first cut were 2020 and 1998. In the first, aggressive cuts preceded surging inflation amid pandemic supply constraints. In the second, insurance cuts preceded the dotcom boom."

So while I think very much that Warsh didn’t intend to raise rates, but use “tough talk” (reiterated commitment to price stability, etc.) in the near term until he could get the results from his hand-picked task forces that would give him proper cover to keep rates on hold until inflation hopefully dials back, the markets may force his hand.

In that regard, in a surprising (to me) interview with the Financial Times, the president of the St. Louis Fed, Alberto Musalem said the quiet part out loud (I consider Musalem a less consistent member of the Fed, one who has flitted between positions in the past, but currently is considered on the hawkish wing (but definitely not a leader in that regard)):

“Mr Market spoke this week, and I took [a] signal from it,” Alberto Musalem, president of the St Louis Fed, told the FT. “The signal emphasised to me that we need to continue to earn our credibility every day with both effective communications and actions as needed.”

While Musalem isn’t a voting member of the FOMC this year, he seemed to indicate he would have dissented for a hike saying h e had “expressed a preference” for raising rates. “The folks in my district, whether it’s businesses or households, continue to report broad-based price increases in both goods and services,” he added, voicing concerns that echo those of other regional Fed presidents.

His thoughts echoed those of Minneapolis Fed President Kashkari who I posted on this week that earlier, incremental, gradual interest-rate action is preferable, less costly and less disruptive than potentially later, larger and abrupt actions.”

Further, in what has been a repeated criticism by many of Warsh, he said Fed officials have a responsibility to explain their policy moves and clarify what central banks refer to as their “reaction function”. “It’s very important to clearly communicate the reaction function to businesses, households and markets,” Musalem said. “They need to understand what we’re doing and why we’re doing it in certain situations.”

That was something that was sorely lacking on Wednesday.

As a reminder as I said a week ago “ even if my thinking was correct and the Fed doesn’t raise rates, while it will likely mean a softening of shorter-term rates (which in fairness is where my focus was for the most part), it very likely doesn’t mean the long end will soften as resurgent inflation expectations will offset any softening in fed funds expectations. In fact, it may very well steepen rates, and then those rising inflation expectations may lead to just that forced Fed hike to calm them.”

That seems to be playing out at this point, although it should be mentioned that inflation expectations have only represented about half of the move in nominal rates. The other half has been a continued move in real rates which means a tightening of financial conditions.

For now we remain in my new ranges established last week: “I still think that 5% on the 10-year and 5.75% on the 30-year represent areas where we will see very strong buying. On the 2-year I think a lot depends on whether the Fed hikes. If they do there’s potentially another ~25 basis points to the upside. If they don’t, I think we’re going lower from here.”

Here’s a link to the Friday update if you want to review where rates and Fed hike expectations currently stand.

And the rapid rise in yields has seen expected Treasury market volatility (MOVE index) at the highest since March.

In terms of those inflation expectations the Fed favorite 5-year, 5-year forward rate (expected inflation for the 5 years starting 5 years from now), is now up to +2.30%, but that’s just barely into the top of the range over the past five years.

Similarly 10-year breakeven rates were up just 0.02% to 2.28%, well off the highs of the year.

Wrap-Up

As mentioned in the Markets Updates this week, we saw the “on again, off again” nature of the AI-trade, which spent much of July “off” (leading to the worst month for one broad semiconductor index since 2022 as noted in the Friday Markets Update), flip back to “on again” Thursday and Friday.

I had mentioned all month that “ we have seen pullbacks several times previously in the AI trade over the past year, and they have all resolved relatively quickly to the upside. It would be a meaningful change in character if that did not happen this time as well,” and last week said while we had seen one of the sharpest pullbacks in the trade to date, it certainly wasn’t unprecedented (see DB’s note in the Flows section), and the momentum/Tech may be turning back up “on schedule. ”

Given the weight of the components of that trade (semiconductors are 19% of the SPX by market cap, with Tech over a third in total) plus the leverage employed, (as noted by Tier1Alpha also in the Flows section) it will make a big difference in where the market cap indices go.

Of course, there are many other ways to play the market beyond buying the SPX and throughout July we saw broad strength which though seemed to fizzle out the last two days just as AI saw a resurgence. Hopefully we are not returning to the “either/or” market we saw at times earlier this year, but it all remains to be seen.

As mentioned Friday and in the Flows section, the deleveraging we have seen puts us in a much better position from a positioning standpoint than we were coming into the month, with BofA flipping to a net positive base case for the upcoming week, and DB becoming more constructive as well (in addition to JPM, Goldman, etc., per posts this week and several that will be in the Monday note (be sure to check the “Other Stuff” area tomorrow).

One thing we will need to keep an eye on is long-end yields. As I mentioned Wednesday “until long-end yields stabilize, it will keep pressure on the ‘elsewhere’ stocks.” Hopefully we see buyers come in next week to at least stabilize rates, although as mentioned in the Rates section I think they have more room to the upside potentially.

So, as I said last Sunday:

overall, I remain broadly constructive on markets, but cautious in the near term. Corrections happen, and there are a lot of reasons one could happen now: investor caution over heavy capex spend and competitive concerns leading to AI/Tech weakness which has outsized market impact given the heavy leverage, thinner gamma support, less helpful systematic, corporate, and retail flows, a more hawkish Fed and rising oil prices pushing rates to new highs, and still-unsettled Middle East risk. At the same time, earnings continue to beat a very high bar, and the story outside of Tech has been very favorable. As I said last week, “it seems odd if earnings continue to beat that it would happen now, but as I often say, you never know with these things.” That remains the case.

And I think I’m a little more constructive this week in large part due to the cleaner positioning as well as still robust earnings growth with DB notes is not fully reflected in equity prices. It seems investors are back to being a little more comfortable with AI/Tech cash flows coming around post AI-buildout, and discretionary buybacks are returning, although retail flows remain subdued.

While gamma looks to start the week relatively low meaning there is room for larger moves in both directions, a deal with Iran as anticipated by President Trump if it happens may mean that large move is to the upside.

DB: Pullbacks of -5% or more have historically occurred every 3 to 4 months.