It is not clear if the current war between Israel and Iran qualifies as a black swan (cygnus atratus) event or not, but to the extent that the US could be drawn into this Middle East conflict, it is clearly a sudden, relatively unpredictable, and powerful issue that was not on the minds of investors even a few days ago. As we write, President Donald Trump is calling for Iran’s unconditional surrender, warned that US patience was wearing thin and that Iran must abandon its nuclear ambitions. Meanwhile, the US is moving fighter jets to the Middle East. And, as this war enters its sixth day, a Reuters headline states that explosions are hitting a Tehran suburb, sending flames and smoke into the sky.

Perhaps more surprising is that financial markets remain relatively undisturbed, at least to date. WTI crude oil has jumped to $75.41 from an early May low of $58; however, it is still below the $80.33 level seen in June 2024 and is down on a year-over-year basis. This is important for future CPI reports, because year-over-year increases in the price of oil could feed into energy prices and ignite inflation. In terms of equities, the S&P 500 index is up a mere 1.7% year-to-date but is also a mere 2.5% below its all-time high of 6144.15. The 10-year Treasury bond yield is similarly complacent and trading at the midpoint of the 4.0% to 4.7% range it has maintained all year. In short, markets appear unconcerned about a war in the Middle East.

We are less complacent. Still, we know that wars trigger substantial government spending and historically have been a boost to economies. This is particularly true for the defense industry; and in the current environment, where drones, spyware, hackers, trackers, and robots dominate, we expect the conflict will also generate income for a variety of technology companies.

But while Iran dominates the headlines, there are other significant events taking place this week. The G7 meeting is taking place in Canada, although President Trump left early due to the escalation of the Israel-Iran battle. The Federal Reserve also meets this week; but we do not expect any policy changes. The Senate is tweaking the Big Beautiful Bill in hopes of passing something before the July 4^th recess and the US Senate just passed a bill to create a regulatory framework for a dollar-pegged cryptocurrency token known as stablecoin. This stablecoin bill has been buried by geopolitical headlines, yet it could prove to be a turning point for the digital asset industry.

The technical condition of the equity market remains distinctly bullish and is relatively unchanged from last week. The 25-day up/down volume oscillator is at 0.67, down from a week ago and neutral. This intermediate-term oscillator was overbought for 9 of eleven days in May and reached a high of 5.10 on May 16. The 5.10 reading was the highest overbought reading since August 18, 2022, which was shortly after the market rebounded from its June 16, 2022 low. This is very positive action since it confirms that significant demand (volume) is driving stocks higher. More importantly, it is a characteristic of a bull market cycle. See page 11. The 10-day average of daily new highs is 196 and new lows are averaging 53. This combination of daily new highs above 100 and new lows below 100 is positive. The NYSE cumulative advance/decline line has been making a string of new highs, the latest on June 12, 2025. In sum, technical indicators are favorable. See page 12. Last week’s AAII survey showed bullishness rose 4.0% to 32.7% and bearishness fell 7.8% to 33.6%. These percentages are neutral but the April 2, 2025 reading of 61.9% bearishness was a new high for this cycle and very favorable. The 8-week bull/bear is currently at minus 14.5% and remains positive for the 16th consecutive week. See page 13.

First quarter earnings season is over, and second quarter results will not begin until mid-July, but we have noticed that earnings forecasts for 2026 and 2027 have been creeping higher in recent weeks. This is a good omen; however, equity valuation remains stretched with the 12-month forward S&P 500 earnings PE at 20.2 times. This is well above the long-term average of 17.9 times. See page 9.

A Bloomberg chart on page 3 is interesting given that this is Fed week. It shows that interest rates in the US and Hong Kong are well above interest rates in other developed countries. With the effective fed funds rate at 4.33% and inflation at 2.4%, this 197 basis point differential puts the real fed funds rate well above its long-term average of 1.3% (or 130 basis points). May’s PCE deflator will be released on June 27, but the current differential is 2.2%, well above the long-term average of 1.7%. In short, there is clearly room for the Fed to cut rates in June, but we doubt they will. In truth, the rising price of crude oil is a potential inflation risk. See page 3.

The May CPI report showed inflation was stable with the headline index up slightly to 2.35% YOY versus 2.33% YOY in April. Core CPI was unchanged at 2.8% YOY. In general, both indices have been trending lower since the 9.1% YOY peak seen in June 2022. Note that energy prices were 3.5% lower YOY which helped to keep inflation in check. As we noted, WTI crude remains down on a year-over-year basis, but oil will continue to be a risk factor as long as the Israel-Iran conflict continues. See page 4. And in terms of the main components of the CPI, it was food and recreation that moved slightly higher in May. Conversely, clothing and footwear, two areas one would assume would be negatively impacted by tariffs, fell 0.91% YOY and 1.59% YOY, respectively, in May. See page 5.

The June University of Michigan consumer sentiment indices recovered to February and March levels with the main index up 8.3 points to 60.5, the present index rising 4.8 to 63.7, and the expectations index jumping 10.5 to 58.4. However, all three indices remain below levels seen in December. However, we have downgraded the significance of most sentiment indices recently due to the bias seen with respect to political affiliation. As seen on page 6, the consumer expectations index for Republicans was 95.9 in June versus 22.7 for Democrats. This disparity degrades the integrity of sentiment readings.

All components of the NAHB Single Family Housing Environment survey moved lower in June, with the traffic of potential buyers falling to 21 for the first time since November 2023. The housing market has been weak for months, but the current instability in the Middle East will add greater uncertainty to the housing market. In addition, the Federal Reserve reported that household net worth fell in the first quarter from $170.9 trillion to $169.3 trillion, due primarily to a decline in household assets, including small losses in equities, mutual funds, and real estate. Liabilities also declined in the quarter. Disposable personal income to liabilities rose to 107.2%, the highest and best since June 2020. Nonetheless, declines in net worth are rarely good for the residential housing market. See page 7.

Retail sales for May were disappointing and fell to $715.4 billion on a seasonally adjusted basis, down from $722.0 billion in April. Still, this was up from $692.6 billion a year earlier. Total retail & food services sales rose 3.3% YOY, down from the 5%+ levels seen in recent months, but still respectable. Retail sales excluding autos rose 3.5% YOY and excluding autos and gasoline, sales rose a healthier 4.6% YOY. The weakness in retail sales is seen after adjusting for inflation. Real retail sales rose a mere 0.9% YOY in May, down from the 2.6% pace seen in recent months. See page 8.

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The World Bank is the latest entity to lower its global economic forecast stating that “downside risks to the outlook predominate, including an escalation of trade barriers, persistent policy uncertainty, rising geopolitical tensions, and an increased incidence of extreme climate events.” The report focused on “erratic trade policies” and indicated that higher tariffs posed a significant headwind for nearly all economies. And while the World Bank stopped short of forecasting an outright recession this year, it wrote that global economic growth this year would be the weakest since 2008. Moreover, in 2026 and 2027, the Bank expects a “tepid recovery” averaging just 2.5%, the slowest pace of any decade since the 1960s.

What was not explained in the report was that the European economies, with the exception of Ireland, have been already been suffering from extremely sluggish growth. Seasonally adjusted GDP increased by 1.6% in the Eurozone in the first quarter of 2025 (its best pace since the fourth quarter of 2022), after growing 1.4% in the fourth quarter of 2024. In short, tariffs could weaken the Eurozone further if negotiations fail, but the EU economies have been frail for more than two years. A good trade deal could potentially boost trade with the US; however, negotiating a trade deal with the EU is likely to be far more difficult and filled with pitfalls than dealing with the UK. Therefore, US-EU negotiations could drag on and remain uncertain for much of this year.

To the extent that current tariffs are impacting China’s exports to the US, China’s economic activity could decline, however China’s economy grew 5.4% year-on-year in the first quarter of this year, maintaining the same pace it did in the fourth quarter, and exceeding market expectations of 5.1%. Thanks to ongoing stimulus, China’s economy remains at its strongest annual growth rate in 1-1/2 years. We doubt that this stimulus will change, and it would most likely increase if China’s economy slowed.

As for the US economy, the biggest uncertainty is not tariffs, but whether Congress will pass the “Big Beautiful Bill.” The administration wants it passed before the July 4^th recess and that may be difficult to achieve. But it is expected to be retroactive, and if so, it would provide important stimulus to the US economy. It appears that the administration is attempting to offset growing deficits by growing the economy. This is a dangerous strategy, but by increasing the denominator faster than the numerator, the deficit-to-GDP ratio will decline, and this could appease the bond market.

It is unfortunate that The World Bank does not mention the massive increase in global sovereign debt as a major financial and economic risk. Bankers understand that debt is an important factor for global growth since big debt burdens are deterrents to growth. But in reality, The World Bank is not really a bank. Its mission is “to reduce the share of the global population living in extreme poverty to 3% by 2030.” In other words, it is not an entity run by bankers or economists, which helps explain its forecast and, in our opinion, means its global economic forecasts lack in rigor.

Recent economic releases for the US were mixed, and the May employment report is a good example. Despite the fact that May’s payrolls increased by a larger than expected 139,000 jobs, March and April’s reports were simultaneously revised lower by a total of 95,000 jobs. The unemployment rate was unchanged at 4.2%, but only because the labor force (the sum of those employed and unemployed) decreased. The number of people employed actually fell by a substantial 696,000 while the number of unemployed rose by 71,000 in May. However, the broader U6 unemployment rate was also unchanged in May at 7.8%. Both the participation rate and employment population ratio decreased modestly in May; but again, this was due to the household survey showing a decrease of 696,000 employed. Nevertheless, the establishment and household surveys showed job growth of 1.1% YOY and 1.3% YOY, respectively. These rates fell below their respective long-term averages, but more importantly, they remain positive. See page 3.

Although May’s job growth of 139,000 was lower than the 147,000 jobs created in April, the 3-month moving average of newly employed rose from 123,000 to 135,330. In short, the economy is demonstrating a stable and steady uptrend in job growth. Another sign of a good job market was the decline in discouraged workers, which fell from 422,000 to 352,000 in May. This was the lowest level of discouraged workers since August 2024 and is down from a high of 630,000 in January of this year. See page 4. In addition, average hourly earnings and average weekly earnings both rose 4.0% YOY in May, in line with the pace seen over the last seven months.

Two major factors that impact household finances are inflation and unemployment. The sum of these two factors has been called the Misery Index and in May this was unchanged at 6.5%, which is just above the 5.7% level that is rarely reached but is considered extremely favorable. Note that April’s inflation rate was 2.3% and May’s CPI will be reported this week. Historically there has been a strong correlation between the 3-month average of job growth and consumer confidence. But as seen on page 5, this relationship broke down in 2020 during the pandemic and sentiment has remained substantially more negative than employment data ever since.

The ISM nonmanufacturing index fell from 51.6 to 49.9 in May, the first contraction seen since June 2024. The drop was due in large part to a decline in business activity, which fell to the neutral level of 50 and new orders contracted for the first time since June 2024. The employment index expanded after two months of contraction. Firms are citing long-term policy uncertainty as a primary source of concern, adversely impacting hiring and purchases. The ISM manufacturing survey was reported last week, and it edged 0.2 lower in May to 48.5. Imports fell to 39.7, the lowest since March 2009, and exports declined to 40.1, the lowest since May 2020. These numbers were unusually low; however, it was due to businesses building inventories ahead of April’s tariffs, and we expect these extremes will be temporary. See page 6.

The Small Business Optimism Index increased 3 points in May to 98.8, moving slightly above the 51-year average of 98. Of the 10 components, seven increased, two decreased, and one was unchanged. The Uncertainty Index rose 2 points from April to 94. Expected business conditions and sales expectations contributed the greatest to the rise in the Optimism Index. Note that actual earnings and sales polled lower in May, but expectations for economic improvement, real sales and credit conditions moved higher. Most importantly, the March/April decline in business confidence has been erased. See page 7.

Consumer credit outstanding increased by $17.9 billion in April, an increase from March’s downwardly revised $8.6 billion increase. Non-revolving credit which includes auto and student loans, grew by $10.2 billion, a 3.4% annualized rate. Revolving credit, which includes credit cards and other short-term borrowing, increased by $7.6 billion, an annualized rate of 7.2%. This marks a clear acceleration from the 4% average pace in 2024. In sum, revolving consumer credit grew on a monthly basis for the first time in five months and non-revolving credit grew month-to-month for the first time in three months. This is good news. See page 8.   Technical indicators continue to be solidly bullish. The 25-day up/down volume oscillator is at 2.37 this week, neutral, but moving back toward overbought territory. This indicator was already overbought for 9 of eleven days in May, which was sufficient to confirm a new cyclical or all-time high in the equity indices. And the fact that this oscillator never reached oversold at the April 2025 low suggests that the current advance is a continuation of a longer-term bull market cycle. In addition, the NYSE cumulative advance/decline line hit a record high on June 10, 2025, another confirmation of new highs in the indices. It is unusual for the oscillator to reach overbought territory or the advance/decline line to hit new record highs prior to the equity market making a new cyclical high in price Typically, we wait for these indicators to confirm a new high in the S&P 500 index. Nevertheless, the strength seen in technical indicators shows that there is solid volume and breadth supporting the equity market and this implies equities will move higher. We have been expecting the market to find a ceiling at the recent highs until Congress passes the “One Big Beautiful Bill Act” and second quarter earnings season begins. However, both are only a few weeks away.

Gail Dudack

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To date, the media-driven panic that the newly installed Department of Government Efficiency (DOGE) would generate waves of joblessness due to staff and agency cuts and “Trump tariff wars” would trigger a US recession appear to be unfounded. Nevertheless, monthly employment data will be important in the months ahead and results for May will be released later this week. A small increase in job openings in the JOLT report has triggered optimism that May’s report will be favorable and with the S&P 500 less than 3% from its record high, the equity market needs a good report.

DOGE fears have been exaggerated, in our opinion. As of April 2025, there were a total of 2.99 million federal government employees, which represented less than 1.9% of total nonfarm payrolls. A 10% reduction in staff would be significant, but not recessionary, in our view. However, it is highly unlikely that such a cut could ever materialize in the political world. Still, similar job cuts are common in the private sector. This year Microsoft Corp. (MSFT – $462.97) projected a cut of over 6,500 jobs, or 3% of its global workforce. Amazon.com, Inc. (AMZN – $205.71) has reduced its workforce by roughly 27,000 since 2022. Meta Platforms, Inc. (META – $666.85) said it is aiming to lay off another 5% of current employees through performance-based cuts. Chevron Corp. (CHV – $ 139.55) is cutting up to 20% of its global headcount. Kohl’s Corp. (KSS – $8.37) is slashing its corporate workforce by 10% and Southwest Airlines Co. (LUV – $32.60) plans to lay off 15% of its corporate staff in a cost-cutting effort. DOGE has attempted to make less dramatic cost-cuts in order to make the federal government more efficient (and more importantly free of waste and fraud) but has been obstructed by legal battles.

Tariff fears may prove to be equally unfounded. Tariff negotiations are ongoing, but political and media pressure are making it more difficult for President Trump and his administration to negotiate effectively, and we expect President Trump will end up with less than he had hoped for. But either way, the result of the tariff negotiations are more likely to add to GDP than detract from it.

The recent revision to first quarter GDP is a perfect example. The second estimate for GDP in the first quarter showed a decline of 0.2% (seasonally adjusted annualized rate), up from the original estimate of negative 0.3%. However, this decline does not really represent a decline in domestic economic activity but rather a massive increase in imported goods in the first quarter, i.e., a large inventory buildup ahead of April’s anticipated tariffs. GDP would have been positive if trade were excluded, or even if international trade in goods were excluded. See page 3. And, once the tariffs were in place the trade deficit also changed. April’s trade deficit fell to $87.6 billion, down 46% from March, and down 10% from the April 2024 trade deficit of $97 billion. In April 2025 exports grew 10% YOY and imports grew 2.3% YOY. In short, trade is apt to generate less drag on GDP in the second quarter. And while the OECD recently lowered global growth for this year from 3.1% to 2.9%, we expect US growth estimates will begin to rise after second quarter GDP is released for the US.

Overall, recent economic releases have displayed solid economic activity. In the month of April, personal income rose 5.5% YOY, a big rise from 4.8% YOY in March, and real personal disposable income rose 2.9% YOY, up from 2.1% in March. These are impressive numbers and are well above their long-term averages of 5.2% and 2.7%, respectively. But note, government transfers rose 11% YOY in April. Still, this increase in household income continues to support consumption. Personal consumption expenditures rose 5.4% YOY, in line with the pace seen in recent months. Yet despite solid consumption, the savings rate increased to 4.9% in April, up from 4.3% in March. This was the highest savings rate since May 2024. See page 4.

The 11% increase in government transfer payments was unusual and it was the direct result of the Social Security Fairness Act which was signed into law on January 5, 2025. This Act ended the Windfall Elimination Provision, and the Government Pension Offset Provision which reduced or eliminated Social Security benefits to over 2.8 million people who receive a pension based on work not covered by Social Security because they did not pay Social Security taxes. These workers include some teachers, firefighters, police officers, employees covered by the Civil Service Retirement System and people covered by a foreign social security system. The jump in Social Security payments in April reflected the retroactive payments related to this Act. See page 5. As a result of these transfer payments, social security represented 6.5% of total personal income in April, up from 6.1% in March.

The PCE deflator was also good news. April’s headline index fell from 2.3% YOY to 2.1% YOY and the core PCE deflator fell from 2.7% YOY to 2.5% YOY. Note that favorable news on the inflation front is a global trend. Eurozone inflation for May fell to 1.9% YOY and core inflation fell to 2.3% from 2.7%. The ECB meets this week, and after seven consecutive rate cuts in the 12 months, the consensus is looking for another ECB rate cut this week. See page 6.

Technical indicators are another bright spot. The 25-day up/down volume oscillator is at 2.01 this week, neutral after being in overbought territory for 9 of eleven days in May and reaching a high of 5.10 on May 16. The 5.10 reading was the highest overbought reading since August 18, 2022, which was shortly after the market rebounded from its June 16, 2022 low. This is all favorable. The recent overbought reading is reflective of a bull market cycle since this indicator is confirming that volume in advancing stocks is driving stocks higher. See page 9.

However, it is highly unusual for this oscillator to become overbought before the equity market makes a new cyclical high. Typically, we wait for this indicator to confirm a new high in the equity indices and look for a minimum of five consecutive trading days in overbought territory. Similarly, the NYSE cumulative advance/decline line also made a new high on May 16, ahead of the indices making a new high. See page 10. Some of this can be explained by sector performance. On pages 12 and 13 we rank year-to-date performances of ETFs, industries, and S&P sectors and both tables show the S&P 500 index lagging behind more than half of the eleven S&P sectors with the exception of technology, healthcare, energy, and consumer discretionary. But note that 41% of the weight of the S&P technology sector is in only three stocks: Microsoft, Nvidia Corp. (NVDA – $141.22), and Apple Inc. (AAPL – $203.27). And 47% of the weight of the consumer discretionary sector is in three stocks: Amazon, Tesla Inc. (TSLA – $344.27), and Home Depot Inc. (HD – $373.08). In sum, the majority of stocks have been outperforming the S&P 500 index this year and while this is rare, it is bullish.

The only concern we have in the near term is valuation. With the S&P 500 closing on its recent high PE multiples have also been rising. After reaching a recent intra-month low of 20.7 times earnings in early April, the SPX trailing 4-quarter operating earnings multiple is now 24.8 times. Using 2025 and 2026 S&P Dow Jones estimates, the 12-month forward PE multiple is currently 20.2 times and back above its long-term average of 17.9 times. When this forward PE is added to inflation of 2.3%, it comes to 22.5, which is not seriously overvalued, but it does show the market to be at the top of the normal range of 15.0 to 24.1. In sum, we are near-term cautious and long-term bullish.

Gail Dudack

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