US Strategy Weekly: A Little History Lesson

Stocks remain inversely linked to the price of crude oil. So, it is not surprising that this week’s bombing of Iran drove WTI crude futures to $90.66 (in after-market trading) and stock prices fell. However, the 419.02-point decline in the DJIA and 54.67-point decline in the SPX may seem like a mild response to what was a significant jump in energy prices. The charts on page 3 may help explain this lack of concern about the Middle East escalation.

Comparing 2026 to 2022

WTI is trading above $90 a barrel today, but it remains well below its peak of $123.70 a barrel recorded in March 2022. There was no war in the Middle East in 2022, but the conflict between Ukraine and Russia had begun in February 2022 and there was fear of oil shortages due to this conflict. However, a main issue impacting energy supply was the Biden administration’s green energy campaign and the restrictions it placed on fossil fuels. The Biden administration declared US oil production was at record levels in 2022, but this was inaccurate. US crude production was up from the anemic levels seen during the COVID shutdown, but it was not at record levels. According to the US Energy Information Administration (EIA), the average annual US production of oil was 11.91 million barrels per day in 2022, down from 12.29 million barrels per day in 2019. The US went from producing 15% of world crude production in 2020 to 14.6% in 2021 and 2022. In comparison, the EIA projects US 2026 production will be a record 13.8 million barrels per day, and this will represent more than 16.1% of total global crude production.

Rising energy and gasoline prices are what drove the CPI to 8.5% YOY in March 2022; however, this was only a stop on the way to the CPI’s 9.1% YOY rise in June 2022. In short, inflation problems were much worse in 2022 than they are today.

The 10-year Treasury bond yield jumped to 4.79% on this week’s war news. But it is the rise in global benchmark yields that is also spooking the fixed income market. Japan’s 10-year benchmark yield hit 3% the highest in 30 years, and British and euro bonds reached their highest levels in over a decade. The rise in the US 10-year Treasury yield is relatively modest in comparison since it remains below its 5.02% high made in October 2023.

Comparing Treasury bond yields in 2022 to current levels is complicated. The 10-year Treasury bond yield was only 2.4% in March 2022, but it was pegged to the fed funds rate that was zero at the start of the month. In early March 2022, the Federal Reserve had not begun to increase interest rates even though inflation had been running above 7% YOY for three consecutive months! The Federal Reserve finally raised rates in mid-March to a range of 25 basis points to 50 basis points. This started the US Treasury bond yield’s steady rise to 5.02% in October 2023.

Continuing our comparison, GDP declined 1.0% in the first quarter of 2022 and rose a mere 0.6% in the second quarter of the year. S&P trailing operating earnings grew 39.8% in the first quarter of 2022, or 31.3% after inflation, but this earnings gain was a rebound from negative earnings growth a year earlier. More importantly, positive S&P 500 earnings growth was not sustained in 2022, and operating earnings growth was negative 5.4% by the end of the year.  

In our view, the current rise in crude oil prices is substantial, but not as extreme as in 2022, and it is taking place in a very different environment. The crude price spike is apt to be temporary, particularly if the conflict in the Middle East is settled quickly. If not, oil production in the US and Venezuela may compensate for what might be lost from the Middle East. Iranian oil goes primarily to China, so China may be suffering the greatest risk if the conflict continues. In sum, crude oil and inflation are not as high as they were in 2022, and both are apt to trend lower in the longer run. The US economy and corporate profits are healthier today than they were in 2022 due to a business-friendly approach to fiscal policy. These are some of the reasons why the equity market is not panicking.  

But this does not mean there are no other things to worry about. Debt issuance by hyperscalers is also stressing the fixed income markets and the AI revolution is coming under heavy scrutiny. Data centers are facing a very harsh and public backlash. Analysts are worried that the $460 billion debt issued by major AI players, supplemented by an estimated $1.2 trillion in off-balance sheet lease commitments for future data centers, will not be justified by future revenues. Not surprisingly, the AI-driven momentum trade that powered stocks higher in recent quarters, suddenly unraveled in August. Some analysts may be concerned about this about-face in AI-related stocks, but we believe it is a good thing for the long run. For those worried about a stock market bubble, this AI skepticism is the opposite of what is seen at a bubble top.

Is Seasonality a Factor

Seasonality is not a perfect guide since stocks are constantly buffeted by a variety of unexpected factors. Nevertheless, the monthly seasonality reported in the 2015 Stock Trader’s Almanac has not changed significantly in the last 11 years. See page 4. Specifically, the weakest months of the year tend to be September, August, June, and February, in that order. Conversely the strongest months are December, November, April, and March, in that order. More recent data shows the weakest months tend to be the same, but best monthly performances in order are now November, April, December, and July. This seasonal pattern tends to be exaggerated in the midterm election year due to a normal pre-election selloff and a post-election rebound. This is not good news as we begin the month of September, but it does suggest a good buying opportunity may lie ahead.

Earnings Season Comes to a Close

As second quarter earnings season ends, we are surprised that consensus forecasts for this year and next continue to rise by dollars not cents. This week the LSEG IBES consensus earnings estimate for 2026 increased $0.57 to $362.26 and the 2027 forecast rose $2.45 to $412.46. The 2028 forecast increased by $3.60 to $470.50. The S&P Global consensus earnings estimate rose $1.00 for 2026 to $359.85 and increased $7.66 to $414.92 for 2027. These changes mean the market is now trading at 21.2 times the IBES 2026 estimate and 18.6 times the 2027 estimate. The forward earnings yield of 5.2% and dividend yield of 1.1% still compare favorably with a rising 10-year Treasury bond yield approaching 4.8%. Moreover, the estimated S&P Dow Jones 12-month trailing sum of operating earnings shows a gain of 29.9% YOY (it was 17.6% in December), which is far better than the 75-year average of 8.1% YOY. Forward operating earnings growth is currently 16.9% YOY. See page 5.

In terms of valuation, note that the current 12-month forward PE multiple is 17.6 times. This is below the long-term average of 17.9 times. And when this PE is added to current inflation of 3.4%, it comes to 21.0, which places it well within the normal range of 15.0 to 24.4. In short, stocks represent good value. The conflict in Iran may get worse before it gets better so we would wait to see what unfolds this week. Nevertheless, wars tend to be positive for earnings, so we remain bullish on equities.

Gail Dudack

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