A New Chair

Kevin Warsh is now the Federal Reserve Chair, and he is bound to be in the news this week when the PCE deflator is reported for April. The consensus expectation is that the deflator will show inflation rising to 3.9% YOY and investors may rush and take this data point to hypothesize what the Warsh-led FOMC will do in June. However, in his own words, Kevin Warsh wants to be a less-public more reform-oriented Chair of the Federal Reserve. He may remain silent on the matter. We believe his true legacy will be in revamping the Federal Reserve’s policy on communications (a return to pre-Financial Crisis levels), retooling bank regulation (which would include reducing “matters requiring attention,” or MRAs, and ask regulators to focus more on operating principles. According to Vice Chair for Supervision Michelle Bowman, an obsessive use of MRAs has been distracting both regulators and bank management. This was seen by the Silicon Valley Bank bankruptcy which had 19 open MRAs when it collapsed, most of which did not focus on the core issues that brought it down. Bowman’s recent remarks indicate she is looking for changes that would reduce attention on foot-faults and focus more on real risks) and rethinking monetary policy tools (more use of interest rates which impact all individuals versus expanding the Fed’s balance sheet which mainly helps equity holders). If a Warsh-led Fed is less transparent and reduces the use of quantitative easing, it would not hurt the financial markets, but it could dampen risk-taking in the equity market.

Peace Rally

It was surprising to us that the equity market rallied strongly ahead of 3-day holiday weekend. Traders tend to be risk-averse and as a result reduce exposure ahead of most long weekends. However, last week equity traders were clearly expecting a peace plan with Iran (lower oil prices, inflation, and interest rates) and the market rallied strongly. The Dow Jones Industrial Average jumped 294 points on Friday after having gained nearly 922 points in the prior two days! We are less convinced than most that true peace with Iran is on the horizon. Israel is increasing its operations in Lebanon. Still, even as the US conducted “self-defense” strikes on boats and missile sites in Iran on May 26^th and Iran indicated they had the right to retaliate, the DJIA retrenched a mere 118 points. At the same time the S&P 500 and Nasdaq Composite index rose to record highs.

Last week’s action is a bit manic in our opinion, and our technical indicators show that the recent advance took place on weakening breadth. Although the NYSE cumulative advance/decline line made a new high on May 26^th, our 25-day up/down volume oscillator continues to oscillate around zero. This latter indicator reveals that the volume in declining stocks over the last 25 days has been slightly greater or equal to the volume in advancing stocks. See page 7. In short, buying pressure was not convincing. Over the last 10 days the number of stocks recording new highs has averaged 303 and the number recording new lows has averaged 135. With both highs and lows above the 100 benchmark, this indicator became neutral two weeks ago. The daily high/low numbers were much stronger with 350 new highs and 53 new lows at the end of April. See page 8. These are subtle, but important signs of breadth weakness. In our view, it also means that a lot of good news has been discounted by current prices, which makes the equity market riskier than it was a few weeks ago. We remain long-term bullish, but last week we became a bit worried about the near-term outlook.

Earnings Driven

The most amazing thing about the equity market is that while the indices have been making a series of record highs over the last six weeks, the price-earnings multiples for 2026 and 2027 have remained constant at roughly 22 times and 19 times earnings, respectively. This is the basis for our long-term bullishness. But our concern is that positive earnings surprises are no longer surprising and have become expected. According to recent LSEG data, first-quarter earnings growth is projected to be 29% YOY compared with the 16.1% estimated a month ago. This is more than 3.5 times the long-term average of 8.1% YOY. In short, the first quarter has been spectacular, but spectacular may be difficult to maintain. Semiconductor stocks were the darlings of the market last week, and this helped drive the iShares MSCI South Korea Capped ETF (EWY – $200.65) up 15% over the last five trading days generating a gain of more than 106% year-to-date. See page 10. And an analyst’s price target of $1,625 for Micron Technology Inc. (MU – $895.88) drove the stock up 19.3% in a day making it a $1 trillion market capitalization. While the AI mania may not be over, these are signs that it is heating up. 

Economic News

The University of Michigan consumer sentiment index fell from 49.8 to a revised 44.8 in May, falling below its previous record low of 50 in June 2022. The revisions suggested that confidence fell substantially late in the month. Present conditions fell 6.7 points and expectations fell 4 points.

Conference Board consumer confidence fell from an upwardly revised 93.8 in April to 93.1, due entirely to a 3.2 decline in present conditions since expectations actually rose 1 point. Note the recent negative disparity in the University of Michigan sentiment index. However, both sentiment surveys have been overly pessimistic and wrong for the last four years. In short, they have not been the helpful predictive tools that they were a few years ago. See page 3.

Housing and autos are two of the most important sectors of the US economy, and yet both have been languishing for the last three years. For example, total seasonally adjusted unit sales of vehicles were 16.54 million in April 2026 which is just slightly higher than the 16.41 million units sold in April 2023. In terms of housing, total residential construction spending was $924.9 billion in April 2026, which is even lower than the $934.5 billion seen in November 2022. Future spending does not look promising given recent housing starts and permits. April housing permits were down 0.2% YOY and single-family permits fell 5.5% YOY. April’s total housing starts were down for the month but up 4.6% YOY, but single-family starts decreased 2.4% YOY. In short, both the auto and housing market have been in a multi-year slump and if inflation and interest rates continue to rise it could put even more downward pressure on these important parts of the economy.

Gail Dudack

Click to Download

The S&P 500 had its first three-day decline since March 30, and in our view, this pullback was long overdue. There is no denying that the current advance has been remarkable. Yet even as the S&P 500 rallied 11% in the last six weeks, the price-earnings multiples for the S&P 500 remained consistently at 22 times 2026 earnings and 19 times 2027 earnings. Seen another way, the S&P 500 index has increased by a stunning 23.3% since May 19, 2025, while earnings for the S&P 500 have increased an even greater 25.1% YOY in the same timeframe. In short, it has been an amazing time for equity investors, and we believe there will be more good times ahead.

Caution

Nevertheless, we became a bit more cautious last week. Much of this was due to the fact that we feel the Iranian conflict is unlikely to be resolved without more bombing, some of which could impact Iranian energy facilities. If this were to occur it would send energy prices even higher and trigger more inflation fears. In short, things could become worse before they get better.

This week President Trump indicated he was only an hour away from ordering another huge attack on Iran before leaders of Qatar, Saudi Arabia and the United Arab Emirates asked him for time to pursue an agreement over Iran’s nuclear program. However, some market gurus suggest there would have been a pause in the conflict regardless. And this view is supported by the fact that the Senate just advanced a war-powers resolution that could end hostilities with Iran unless President Trump obtains Congress’ authorization.

But if we are right, more bombing would be a negative surprise, and in our opinion, the Senate’s resolution may only serve to hasten President Trump’s decision to act. It should not go unnoticed that the concept that President Trump always “chickens out” or, TACO, has become popular on Wall Street. But this assessment fails to understand how complicated international negotiations are, how divergent geopolitical forces require President Trump to allow Iran and any other nations involved — directly or indirectly — sufficient time to try to negotiate, or what is involved in deciding what the best options are for the US, and last, but far from least, how determined President Trump is to remove the Iranian nuclear threat.

This administration, like most of the world, knows that there is no way to negotiate with the Islamic Revolutionary Guard Corps (IRGC). The IRGC believe that by using stalling tactics they are winning, and that in the end they will always win. Therefore, they have no need or desire to negotiate. But perhaps this recent delay actually helps the US cause. For example, Europol, the law enforcement agency of the European Union, designated the IRGC to be a terrorist group in February, and this week announced a major digital crackdown that led to the removal of thousands of online accounts linked to Iran’s IRGC. It also suspended the group’s primary X account in the EU. This online digital presence was used by the IRGC to communicate, spread propaganda, recruit supporters, and raise funds. These moves by Europol are a blow to the IRGC.

In addition, new US sanctions are targeting Iranian regime currency exchange houses and associated front companies and blocking 19 vessels involved in Iranian petroleum and petrochemicals shipments to foreign customers. In sum, the US Treasury is systematically dismantling Tehran’s shadow banking system and shadow fleet under Economic Fury. The US Treasury also froze nearly half a billion dollars in regime-linked cryptocurrency. What we see is a flurry of action taking place behind the scenes to cut off revenue to Tehran, but in our opinion, these acts are in anticipation of more bombings in the near future. If so, the risk for equities is high in the next few days or weeks.

Inflation Dominated Economic Data

Moreover, the financial backdrop has deteriorated in the last week. The 10-year Treasury note yield touched 4.687% this week, marking its highest level since January 2025. The 30-year Treasury yield hit its highest level in nearly 19 years and West Texas Intermediate futures, while down slightly this week, are still trading well above $100 a barrel. This puts downward pressure on equity valuation models and high interest rates are also a blow to the housing and auto markets which have been under stress this year.

Some housing data showed improvement in April. The pending home sales index, which precedes existing home sales by about two months, increased 3.2% YOY which was the largest annual increase since August 2025, but this followed seven straight months of flat or declining activity. And the data was mixed, increasing in the South, West, and Midwest, but declining in the Northeast. The South had the strongest gain of 4.7% YOY.

Most economic releases have revealed how the conflict with Iran and the rise in energy prices have taken a toll on consumers. In particular, April inflation data was striking. The CPI rose from 3.3% YOY to 3.8%, core CPI rose from 2.6% YOY to 2.8%; final demand PPI rose from 4.3% YOY to 6.0%, the PPI for intermediate unprocessed goods rose from 12.4% YOY to 21.2%. Import prices rose from 2.3% YOY to 4.2%, import prices excluding fuel rose from 2.4% YOY to 2.9% and export prices rose from 5.4% YOY to 8.8%. These reports point to the fact that while inflation is already high, more inflation is in the pipeline.

Retail sales for April looked strong with a headline increase of 4.9% YOY, up from 4.2% in March. But due to higher inflation, real retail sales increased a mere 0.8% YOY, down from 1.3% in March. The best part of retail data was from internet sales, which increased to $326.7 billion in the first quarter of the year, up 9.8% YOY. Even after inflation (which averaged 2.7% in the same period) this was an impressive gain, and internet sales now represent roughly 17% of total retail sales. Many retail companies will be reporting earnings this week as is typical of the end of earnings season. Looking ahead there are no significant economic releases next week, earnings season is ending, and the next FOMC meeting is June 16-17. In short, a dearth of economic data will bring political news to the forefront.    

Earnings Forecasts

For the first time in fifteen weeks the LSEG IBES S&P earnings estimate for 2026 declined and for the S&P/Dow Jones survey forecasts declined for the first time in twelve weeks. See pages 3 and 10. The declines were small, totaling 35 cents for LSEG IBES and 86 cents for S&P/Dow Jones, but the shift may prove significant since the market has reached all-time highs and the financial backdrop is less supportive. We do not believe the market has reached extreme valuations that would require a major setback, but we worry that the market has become too complacent about Iran, the price of oil, and inflation. Moreover, Nvidia Corporation (NVDA – $220.61), the stock at the center of the AI cycle, and key to S&P 500 earnings, reports after the close on Wednesday. The market’s reaction to this earnings report may be a sign of how the broader market will do in the near term.

Gail Dudack

Click to Download

It has been a quiet week in terms of the Iran conflict, but we would be wary of becoming complacent about the Middle East since there is a good reason why it has been a relatively peaceful week. Neither the US nor China would benefit from fireworks ahead of this week’s Trump-Xi summit taking place in Beijing. The media is calling this a “high stakes summit” but that seems nonsensical to us since these summits are carefully and methodically planned well in advance. Advance planning is why Treasury Secretary Scott Bessent traveled to China this week after first making a stop in Japan to meet with Japanese Prime Minister SanaeTakaichi and then stopping in Seoul, South Korea to meet with Chinese Vice Premier He Lifeng and Chinese trade negotiators. The real work is done at these preliminary meetings to ensure that both parties can leave the summit with clear deliverables for their respective countries.

On May 14, when President Trump and China’s Xi Jinping meet, the discussions are apt to be more ceremonial than material. The topics to be discussed by these two leaders will certainly include Iran, but we expect both sides will focus more on personal economic issues with the hot topics being Taiwan, semiconductors, rare earth metals, tariffs, jailed Hong Kong activist Jimmy Lai, and AI. We expect there will be a lot of dealmaking by corporate leaders as well.

But when President Trump returns to the US at the end of the week, we would not be surprised if Iran takes center stage again. And Trump has already warned that Iran is on “life support” and the proposal from Tehran was “totally unacceptable.” This is a thinly veiled threat that bombing may resume. The only question is what targets will be bombed (military or energy?) and who contributes (Israel, UAE, Saudi Arabia?). Recent reports reveal that both the UAE and the Saudis have responded to Iranian attacks with covert bombing of their own. Their participation in future bombings could suggest a decisive power shift is taking place in the Middle East. In short, the equity market has recently reached record highs, but we would not chase stocks at this juncture since geopolitical events could trigger a correction, particularly if the US bombs Iranian energy infrastructure.

Nevertheless, we are not in agreement with those like Michael Burry who feel the market has “jumped the shark” and is approaching a crash. We lived through several major stock market bubbles and while AI has all the earmarks of creating an equity bubble (and probably will eventually), the current equity market is still supported by fundamentals. Yes, the semiconductor group made a perpendicular advance last week, but this has attracted so much attention and created so much negativity that it is likely that the semiconductor blowoff will reverse or stall without damaging the broader market. Plus, the semiconductor industry is only the first act of the AI story, and it is more likely that money will shift from the semiconductor stocks to the next step in the AI story such energy producers, transformers, software, and eventually end users.

When we look at the macro fundamental landscape, we do not see a bubble. In fact, we are amazed at the strength in first quarter earnings results. Last week we upgraded our S&P 500 2026 and 2027 earnings forecasts (see page 14), and they may still be too low. This week the LSEG IBES consensus earnings estimate for 2026 rose $8.62 to $336.49, the 2027 forecast rose $5.91 to $386.70 and the 2028 forecast rose $6.50 to $435.44. The S&P Dow Jones consensus earnings estimate rose $2.16 for 2026 to $333.72 and rose $2.67 to $384.61 for 2027. This means that even though the indices have recently hit all-time highs, the market is still trading at 22.0 times the IBES 2026 earnings estimate and 19.2 times the 2027 estimate. At both the March 2000 and March 2022 peaks the trailing PE was 32.1 times versus 24.7 today and a 32 multiple times 2026 earnings would equate to the S&P 500 moving over 10,000. And the S&P 500 forward earnings yield of 4.7% and dividend yield of 1.1% compare well to a 10-year Treasury bond yield of 4.4%. Plus, the S&P Dow Jones 12-month sum of operating earnings shows a gain of 21.1% YOY, far better than the 75-year average of 8.1% YOY. See pages 7 and 8. In the longer run, we remain a buyer of dips.

We also have a nonconsensus view of the recent jobs report. In fact, in our view, the April jobs report provides an argument for lowering the Fed funds rate. Although the headline shows employment grew by 115,000 jobs and the unemployment rate was unchanged at 4.3%, this is a very superficial analysis. The establishment survey showed a better-than-expected increase of 115,000 jobs, but revisions to prior months lowered employment by 16,000. More importantly, the household survey indicated that employment in April fell by 226,000 and the number of unemployed grew by 134,000. The fact that employment fell more than unemployment grew meant the unemployment rate was relatively unchanged (although it did increase fractionally). See page 5. Still, the household survey indicated 226,000 fewer people were employed in April versus March. This is a sign of weakness. Plus, people no longer counted in the labor force increased by 5.29 million in April. Although the labor force can decline for multiple reasons, one is that unemployment insurance has run out, and a worker is still unable to find a job. Overall, the government is not good at measuring why the labor force has declined.

Every month we look at the year-over-year increase/decrease in employment in both BLS surveys. In our view, it is the single best indicator of economic strength and also the best indicator of a pending recession. In April, the establishment survey showed job growth of 0.16% YOY and the household survey showed employment fell 0.8% YOY (the fourth consecutive month of job losses). These rates are well below long term averages of 1.7% and 1.5%, respectively. In short, the Fed’s job is to achieve maximum employment and stable prices, and this is challenging in the current environment. In our opinion, the Fed should always defer to stabilizing employment first since this is less in its control than inflation. Oil prices will come down eventually and inflation will moderate. But with the housing and auto industry already struggling, and AI challenging the work environment, lower rates are what the average household needs in 2026.

The counter argument to the Fed lowering rates is April’s CPI report. Energy prices drove April’s CPI up 3.8% YOY versus 3.3% a month earlier. This was the highest inflation rate seen since the 4.1% YOY recorded in May 2023. Core CPI rose from 2.6% YOY to 2.75% YOY, the highest since the 2.81% YOY recorded in October 2025. (We added a second decimal point since rounded both April 2026 and October 2025 were 2.8%.) The energy component of the CPI rose nearly 18% YOY, with fuel oil up 54% YOY and gasoline up 28.4% YOY. This actually seemed tame given that WTI crude oil futures were up 84% in the same period. The food component of the CPI increased 3.2%, up from 2.7% in March and the combination of higher fuel and food prices is a hardship for lower income households. We would note that all items less energy rose 2.8% in April, up slightly from 2.6% in March. See page 3. In terms of the heavyweight components of the CPI, transportation was up 7.1% YOY, up significantly from 5% a month earlier. Housing was up 3.6% versus 3.4% in March. Food and beverages rose 3.1%, up from 2.6%. Medical care prices rose 2.5%, down from 3.1% in March. Service inflation was 3.4% versus 3.1% a month earlier; service less rent of shelter was 3.5% relatively unchanged from 3.4% in March. Nondurable inflation was 6.6% YOY (fuel) versus 4.9% in March and 1.7% in February. Conversely, durables fell 0.1% YOY, little changed from the 0.1% YOY gain in March. Owners’ equivalent rent was 3.3%, little changed in four months. Recent declines in home prices suggest this index will inch lower in the months ahead. See page 4. All in all, the CPI report revealed the impact of energy on inflation, a fact that may inspire President Trump to end the Iran conflict one way or another. Investors should remain nimble. 

Gail Dudack

Click to Download

Earnings Revision

In “The Outlook for 2026 – A Year of Great Promise with Risks” (December 24, 2026) we estimated S&P 500 earnings of $315 for 2026 and $350 for 2027 while adding the caveat that “we believe our forecasts could prove too conservative.” Our forecasts seemed optimistic at the time, but with first quarter earnings season now more than 65% complete, it is obvious that we were indeed too conservative about earnings growth.  

First quarter earnings results have been stellar. LSEG Data Analytics reported that 83% of reported earnings have exceeded consensus estimates and first quarter year-over-year earnings growth is expected to be nearly 28%. This is nearly 3.5 times the long-term average of 8.1% YOY and the steadfastness of solid and broad-based earnings growth continues to defy the naysayers worried about the negative impact of tariffs in 2025 and high gasoline prices in 2026. Energy prices are likely to lift inflation in coming months, but to Corporate America the offsets to this have been lower taxes on individuals which helps consumption, lower corporate taxes, productivity gains due to AI, and robust capital investment due to a tax law change that allows businesses to deduct the full cost of new investments in the year they are made.

As a result, we are increasing our 2026 estimate from $315 to $330 and our 2027 estimate from $350 to $382. These represent earnings growth rates of 27.5% and 9%, respectively, and are only slightly above the current LSEG IBES consensus estimates of $327.87 and $380.79, respectively. Our revisions also imply that while positive earnings surprises have boosted stocks consistently in recent quarters, these positive surprises will be more difficult to generate as the year advances. In short, the equity market has been driven and supported by excellent earnings growth, but in large part, that has been discounted in prices.

No Target Revision

With the S&P 500 closing at 7259.22, it means the equity market is currently trading at 22 times this year’s earnings and 19 times next year’s earnings. The Outlook for 2026 also stated that “The trailing PE multiple of the S&P 500 index has hovered around 26 times for most of the last twelve months and we do not expect this to change. And when we apply a 26 PE multiple to our earnings forecast of $315, we get an S&P 500 target of 8190, which represents a gain of 18%.”

In our view, our original 8190 target is still a good forecast for the S&P 500 but for different reasons. Earnings have been better than expected, but inflation has increased. History shows that higher inflation has been and should be a drag on PE multiples. Nevertheless, a blended earnings estimate (one-third of 2026 plus two-thirds of 2027 earnings) times the current multiple of 22 equals an S&P 500 target of 8170. In sum, the 8170-8190 range appears to be a justifiable target for this year.

Great Promise with Risks

Our theme of “great promise with risks” remains a good description for 2026. The conflict with Iran was not a risk that we anticipated this year, but we were concerned that the Supreme Court could rule against Trump’s tariff policy and have a negative impact on GDP. This has come to pass; however, it appears that there are several ways to implement tariffs, and the administration is finding a work-around. Hopefully this change will be successful, narrow the trade gap, and boost GDP. A strong economy is a must for several reasons, but none more important than it helps a country carry its huge deficit. The key ratio is the debt-to-GDP ratio and debt should not be growing faster than GDP to prevent a debt crisis. At the end of March, the 12-month sum of deficits to GDP was 5.2%, well above the administration’s 3% target, but also down from the frightening 7.2% seen in January 2024. See page 4.

A big concern has been the K-shaped economy and how this could impact consumption. Unfortunately, recent economic data is showing some consumer stress. GDP grew 2.0% (SAAR) in the first quarter of 2026, following a weak 0.5% pace in the fourth quarter due to a record-breaking 43-day government shutdown. See page 3. A major contributor to first quarter GDP was consumer spending, which added 1.1% to growth; however, the largest contributor was personal consumption of services, which added 1.11%, while consumption of goods was slightly negative. The Federal government added 0.6% to GDP, nonresidential investment added 1.4%, inventory accumulation added 0.4% and exports added 1.3%. Residential investment subtracted 0.3% and net exports decreased first quarter GDP by 1.3%. Net exports were the second worst drag on quarterly real GDP growth in four years. See page 4.

In nominal terms, gross domestic product rose 6% in the first quarter, driven largely by personal consumption which increased 5.5% YOY. Gross private domestic product rose a mere 1.6% YOY overall, but investment in equipment and software rose 13.7% and investment in intellectual property increased 10.7%. Nonresidential investment in structures fell 3.9% YOY and residential investment fell 2.9% YOY. It is clear from the data that capital investment has been helping the economy, but big consumer areas like housing and vehicle sales have been weak. Total vehicle sales, including light weight trucks, were 16.3 million units (SAAR), down 1.3% for the month of April and down 7.2% YOY. See page 5.

The ISM manufacturing index was unchanged in April, but six of ten components declined in the month and one of the “positive” components was prices paid to vendors. The ISM nonmanufacturing index fell 0.4 in April to 53.6, but four of its nine components rose in the month and one, prices paid, was unchanged. All in all, the ISM indices displayed a mixed economic picture for April. But note the combination of the two ISM employment indices was 94.4, up 2.1 in April, and while still weak, remains safely within the long-term neutral range. See page 6.

New home sales were better than expected in March, rising 7% for the month to 682,000 annualized units, representing a 3% YOY increase. Sales are still recovering from a sharp decline in January. The price of a new median home was $384,000, down 6% YOY. Housing starts were strong in March, increasing 10.8% YOY and single-family starts rose 8.9% YOY. But housing permits weakened and total permits were down 7.4% YOY and single-family permits were off 7.9% YOY. Rising inflation will make housing less affordable in coming months, and we expect the housing market to remain sluggish in the second quarter. See page 7.

Still Buying Dips Fundamentals remain solid for US equity markets and technical indicators are also supportive. The Russell 2000 index is the best performing index this year with a gain of 14.6%, followed by the Nasdaq Composite up 9%, the S&P 500 up 6%, and the DJIA up 2.6%. A market led by small-capitalization companies is a bullish characteristic. The NYSE cumulative advance/decline line made a record high on April 20, 2026, but is only 325 net advancing stocks away from a new record. This is positive.

Gail Dudack

Click to Download