Softer Inflation Gives Summer Rally a Boost
Softer-than-expected Consumer Price Index (CPI) and Producer Price Index (PPI) readings last week reinforced the view that inflation pressures are moderating. This pushed interest rates lower, particularly the 2-Year Treasury yield.
The bumper crop of earnings that has been announced so far is averaging 30% above expectations—powering stocks to record highs. If this level remains as the actual “beat number” for the quarter, it will mark the highest earnings surprise reported by the S&P 500 index since FactSet began tracking this metric in 2008. Earnings are up 51% year-over-year, putting the index on track for a second consecutive quarter of earnings growth above 25% and a seventh consecutive quarter of double-digit growth. Revenues for the quarter rose more than 15% year-over-year, the strongest pace since the fourth quarter of 2021. Five sectors delivered at least double-digit revenue growth: Energy, Information Technology, Communication Services, Financials, and Real Estate.
Consumer Price Inflation Data Easing
The July CPI report showed headline inflation rising just 0.1% month-over-month and 3.4% year-over-year. The surprise was that the previous month’s reading was revised down to -0.4%. Core CPI (excluding food and energy) advanced 0.2% month-over-month and 2.5% year-over-year, the slowest annual core reading since early 2021. The softer inflation data eased concerns about interest rate hikes later this year.
PPI Confirms the Disinflationary Trend
The Producer Price Index (PPI) came in below expectations, with the month-over-month reading at 0.0% (versus the expected 0.2%) and the year-over-year reading at 4.7% (below the expected 4.9%). PPI excluding food and energy came in slightly above expectations, but the market focused on the softer overall data. Declining energy and food input costs are feeding through to wholesale prices, giving the Federal Open Market Committee (FOMC) additional flexibility on interest rate decisions. The market continues to lower expectations of an interest rate hike this year.
Retail Sales Come in Significantly Below Expectations
July retail sales came in significantly below expectations, declining 0.6% versus expectations for a 0.1% increase. A lower-than-expected number could be due to a drop in sales following the World Cup, which ended on July 19. This surprise is lowering interest rates while pushing out an expected interest rate hike. Federal Reserve Chair Kevin Warsh is believed to be more likely to favor cutting interest rates than raising them, and the latest data increasingly supports that view.
Wage Growth Is Falling Which Should Ease Inflation
Annual growth in weekly earnings of production workers continues to slow. Weaker wage pressures reduce one of the key arguments for additional rate increases and support the outlook for lower front-end yields. Wage growth is a key indicator of future inflation, and slowing wage growth signals that inflation should ease in the months or quarters ahead.
Two-Year Treasury Yields Breaking Down
Last week highlighted that the 2-Year Treasury yield appeared to be breaking down. Confirmation came from the weaker inflation and retail sales data. The target is a move toward 4.0%–3.8%. Lower interest rates are supportive of higher stock prices. Historically, the trend in the 2-Year has foreshadowed the direction of Fed interest rate policy.
The Odds of a Near-Term Rate Hike Are Receding
Market-implied odds of a 25-basis-point hike at the September, October, and December FOMC meetings have retreated sharply following soft inflation reports. September probability has fallen from a mid-July peak near 72% to roughly 32%. The term structure now shows December higher than September, suggesting the market sees a higher chance the Fed skips a hike at the September meeting and potentially acts later, if needed.
Earnings Are Extraordinarily Strong Across Sectors
Ten of the eleven S&P 500 sectors reported positive year-over-year earnings growth in the second quarter. Only the Healthcare sector had a decline in earnings.
- Energy and Communication Services had year-over-year earnings growth above 100%.
- Consumer Discretionary and Technology followed with 92% and 70% earnings growth, respectively.
- Part of the strength in 2Q earnings is coming from tariff refunds.
Revenue Growth Remains Powerful
S&P 500 revenue growth for 2Q26 reached 15% year-over-year, the highest pace since the fourth quarter of 2021. Energy led with more than 40% growth, followed by Information Technology with 36%. Strong top-line expansion provides a solid foundation for continued earnings momentum. Business backlogs have been rising, indicating demand remains strong within the economy.
Net Earnings Revisions Rise Sharply
Analyst net earnings revisions continue to rise substantially, supporting higher stock prices in the months ahead. Seasonally, earnings estimates tend to fall as we move into the third and fourth quarters. Estimates rising sharply now point to the strength of earnings power in this AI-driven business cycle. Revisions to earnings estimates are the strongest models for predicting the direction of stock prices. The rate of increases in earnings estimates for the S&P 500 is a strong confirmation that we remain in a secular bull market. The S&P 500 target for this year is 8,225, raised in June from 7,500.
Market Breadth Confirms Record Highs in Stocks
The S&P 500 cumulative advance-decline line has reached a new all-time high. Broad participation across stocks reduces the risk of a narrow, fragile rally and reinforces the secular uptrend. Commercial and Industrial (C&I) loans are expanding at an 8% annual rate. This indicates ongoing business investment and credit demand, consistent with an expanding economy, even if the pace remains below prior cycle peaks. This is bullish for bank earnings going forward.
Return on Equity Favors Technology
Return on Equity (ROE) is a key measure of how efficiently a company generates profits from shareholders’ capital and one of Warren Buffett’s preferred indicators of business quality. At 33%, ROE among Technology stocks remains substantially higher than the 20% for the broader S&P 500. This differential continues to support the sector’s long-term leadership within the secular bull market.
Technical analysis suggests gold prices have found a base near $4,000. The SPDR Gold Shares ETF (GLD) and related stochastic oscillators point to a very oversold and improving price momentum following the recent correction. The target on Gold remains $5,000, serving as a solid hedge in portfolios.
Junior Gold Miners Offer Leverage to Higher Gold Prices
Gold mining equities, particularly the more leveraged junior producers, stand to benefit if Gold prices resume their advance. The VanEck Junior Gold Miners ETF (GDXJ) shows similar technical oversold conditions, with price momentum starting to turn positive
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