Second Quarter Earnings Season

Second quarter earnings season is having a stellar start with bank earnings beating most analysts’ expectations. However, an announcement from JPMorgan Chase & Co. (JPM – $342.89) indicating it was raising expense forecasts for 2026 was greeted by heavy selling. Conversely, Goldman Sachs Group Inc. (GS – $1140.00) reported huge earnings gains as a result of corporate mergers, AI-driven capital raising, and active financial markets. The 94-point gain in Goldman’s stock was a boon to the Dow Jones Industrial Average. But International Business Machines Corp. (IBM – $217.07), also a DJIA stock, suffered a record one-day drop of 73 points, or 25%, as a result of pre-announcing lower-than-expected second quarter revenues and earnings. The explanation for this revision was that the tight inventories and expected price increases in semiconductors resulted in clients “temporarily” shifting capital expenditures toward servers, storage, cybersecurity, and memory purchases and away from mainframe and software investment. The fact that IBM was experiencing canceled or postponed contracts triggered selling in many mainframe and software stocks. In short, disappointments are being punished and good news is being celebrated. In our view, this is because investors are nervous that earnings growth may be decelerating and equity valuations may be deteriorating. It is a justifiable concern. So, right from the start this earnings season is markedly different from previous quarters and the environment is becoming a market of stocks rather than a stock or sector-driven market. We see this as a healthy shift; more importantly, it is not the behavior of a late-stage stock market bubble.

Oil and Inflation

We remain a buyer on weakness, but we are concerned that the rise in crude oil prices could reignite inflation. The recent cease fire with Iran may have seemed like a waste of time but it was a valuable pause. It allowed the oil trapped in the Strait of Hormuz to be shipped and it triggered a concentrated effort by oil producing countries to bypass the Strait by rerouting oil pipelines or to build new ones. Many countries began increasing investment in non-fossil fuels. Plus, countries like Venezuela and the US boosted production and found new markets for their oil. In time, we believe the Strait of Hormuz will be far less relevant than it is today. But today, crude oil prices are rising and that is a negative. However, even after renewed bombing and a war of words between Iran and the US, the August WTI light crude oil future (CLc1 – $79.93) remains well below the peak prices seen in April. This is important both for inflation and market sentiment.

What helped the stock and bond markets this week was June’s CPI report. Headline CPI was better than expected at 3.5% YOY, down from May’s 4.2% YOY. Core CPI was also surprisingly favorable at 2.6% YOY, down from May’s 2.9% YOY. This headline inflation number was the best since March and the core CPI pace was the lowest since February, before the Iran conflict began. See page 3. However, the report shows how sensitive the CPI is to the price of oil. In the month of June, the energy index fell 4.9% and this resulted in a 0.35% month-to-month decline in the CPI headline index. Nonetheless, this eased the fears of a fed funds rate hike in July.

Of the four major heavyweight components of the CPI — transportation, food and beverages, housing, and medical care — transportation is the area most directly impacted by the price of oil. The CPI’s transportation index was up 6.5% YOY in June, down from 9.3% YOY in May, but still high, which is a concern since transportation impacts so many areas of the economy. For perspective, the average closing price for the August WTI crude oil future was $98 in April, $99 in May, and $81.80 in June. In other words, oil is unlikely to trigger higher inflation in the CPI unless the price of oil rises well above $80 a barrel. This is something we will be monitoring.

Meanwhile, all other heavyweight indices show inflation is trending below 3.7%, or the long-term average. Housing inflation was 3.3%, food and beverages inflation was 2.99%, medical care was 2.0%. Service inflation has been the stickiest part of the CPI for the last two years, but it fell to 3.2% YOY in June, with services less rent of shelter at 3.15% YOY. The impact of energy is seen in the nondurable goods which rose nearly 6% YOY (down from 8.0% YOY). Meanwhile, durable goods prices rose a modest 2.5% YOY. See page 4.

There were signs of improvement in the small business sector in June. The NFIB small business optimism index was 97.4, up 2.1 points from May and moving back toward its 52-year average of 98.0. June was the fourth consecutive reading below 98. Of the 10 index components, seven increased and three decreased. Most importantly, plans to raise prices fell while hiring plans rose. Expectations for both better business conditions and real sales improved substantially and primarily drove the rise in the Index. See page 5.

Tariffs, Trade, Deficits

But recent reports on the budget deficit were not so good. The Treasury’s deficit for June was $120.3 billion, down from $292.7 billion in May, but up substantially from the $27.0 billion surplus reported in June 2025. As a result, the 12-month deficit is now $1.8 trillion, up from $1.66 trillion seen in May. This means that total deficits over the last twelve months ending in June were 5.7% of GDP (1Q26), up from 5.2% in May. This is the first time there has been a monthly increase in the debt-to-GDP ratio of more than 0.1% since Scott Bessent became Treasury Secretary. Most months have seen steady declines in the debt-to-GDP ratio.

This 0.5% increase was largely due to the fact that the government issued tariff refunds of more than $49.2 billion in June, dragging custom duties down to a monthly net loss of $25.5 billion in the federal accounts. Tariff refunds totaled $22 billion in May 2026, when refunds began. A year ago, the June 2025 net customs collections were $26.6 billion and reduced the federal deficit by that amount. Net custom collections exceeded $100 billion for the first time in any fiscal year. In sum, tariffs, which were blocked by the Supreme Court, helped our trade balance, deficit, and GDP. The Supreme Court ruling was based on a technicality, and we expect the Trump administration will be able to reinstate targeted tariffs in the future. See page 6.

Technical Indicators

In general, our collection of indicators continues to display a bullish bias. But for example, the 10-day average of new daily highs is currently at 240 and the 10-day average of new lows is a 122. Typically, a 10-day average greater than 100 in new highs defines a bullish trend and vice versa. In this case, daily new highs are greater than new lows, but both are above 100. This is the definition of a neutral trend, but with a bullish bias. Our 25-day up/down volume oscillator is at 0.43, which means that over the last 25 trading sessions the volume in stocks advancing barely exceeded the volume in declining shares. A strong bull market typically sees this oscillator move over 3.0 on each new high because volume in advancing stocks is strong. This neutral reading in the volume oscillator reveals the fact that there has been persistent selling into strength. All in all, it means the market is at risk of having its first 10% pullback. But as we noted last week, even without any multiple expansion, current earnings suggest a target of roughly 8350 in the S&P 500 by year end, so we remain a buyer on weakness.

Gail Dudack

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We are raising our 2026 S&P 500 earnings estimate from $330 to $350 and our 2027 estimate from $382 to $400.75. These forecasts are in line with current consensus estimates and represent growth rates of 27.6% in 2026 and 14.5% in 2027. Note that in December 2025 we initiated earnings forecasts that were well above consensus and though we are only midway through the year, this is the second time we have raised our estimates.

Also note that 2026 and 2027 follow an earnings gain of 17.6% in 2025. This means these three years might generate a combined earnings gain of 59.6% which would represent the best period for S&P 500 earnings since 2009 (14.8%), 2010 (47.3%), and 2011 (15.1%) and their three-year gain of 77.3%. This earlier three-year period was also followed by another solid earnings increase of 10.2% in 2012. However, it also was preceded by the financial crisis of 2008 and an earnings decline of 40%. See page 15.

The drivers of the current earnings spurt began with the tax law change (One Big Beautiful Bill Act signed July 4, 2025, effective for the 2025 tax year) which allowed capital expenditures to be deducted in the same year as expensed. This stimulated capital investment. Equally important, it was coupled with a massive investment demand in AI infrastructure including, but not exclusive to, semiconductors, data centers, and utilities to support these data centers. Earnings are also improving as businesses find new efficiencies, i.e., margin improvements from implementing AI software. It has been a “perfect storm” for earnings growth. However, after four consecutive quarters of positive earnings surprises, we believe earnings surprises will become more difficult to generate in the second half of the year.

The second half of 2026 will certainly be impacted by the midterm elections; however, in July we expect the market will focus on 1.) the price of oil and 2.) second quarter earnings results. We expect earnings will be solid and supportive. If the price of WTI crude oil (CLc1 – $70.44) remains at $70 or less, we foresee a decline in headline inflation. This will help households in terms of lowering energy expenses and could lead to stronger-than-expected economic activity in the third quarter. It could also lead to lower long-term interest rates (helpful to the housing market) and higher PE multiples.

The 2026 stock market has been driven more by fundamentals than sentiment. For example, in the twelve months ending June 2026, the S&P 500 index was up 21% YOY and S&P 500 earnings were up 22% YOY. On page 3 we have two charts, the first with the S&P Index overlaid with actual 12-month earnings forecasts. The scale in this chart is 20 to one, or $50 of earnings equals 1000 points in the SPX. The second chart plots the SPX with a history of S&P 500 forecasted earnings multiplied by 21. Note that while both charts are similar, a PE of 21 is a much better fit to the S&P index than 20 times, and each breach below this level has been a buying opportunity for investors.

If oil remains below $70 a barrel, and inflation falls from the current 3.5% to 4.2% range to 3% to 3.5%, PE multiples could expand beyond 21 times. Even so, the current trend in earnings, without multiple expansion, suggests a target of roughly SPX 8350 in December 2026.

The charts on page 3 also show that the 2000 bubble top was preceded by two years of overvaluation. The December 2021 top was preceded by nine months of declining earnings, i.e., overvaluation. All in all, we do not believe the current market environment is bubbly or overvalued.

There are always risks. As we go to print there is news that the US has revoked the general license for Iran oil sales and is bombing Iran. We do not believe President Trump will authorize any destruction of Iran’s energy infrastructure, at least before the midterm elections, and if not, it should not impact the equity market. But despite the recent strength seen in retail sales and consumer credit, the job market is a concern.

The June BLS employment report was a disappointment with the addition of 57,000 payrolls in the month and revisions that decreased previous reports by 74,000 jobs. Most of this weakness was in the leisure and hospitality sector, which lost 61,000 jobs in June. The losses in leisure and hospitality seem inconsistent with the fact that the US is hosting the FIFA World Cup games from mid-June to mid-July. Since the games have attracted significant crowds from all over the world, it will be interesting to see if there is an upward revision to the leisure and hospitality sector with July data. See page 4.

The household and establishment surveys continue to diverge, and June’s household survey indicated a loss of 507,000 jobs and a decrease in the labor force of 720,000 workers. These huge decreases explain why the participation rate declined to 61.5%. However, the disparate trends in the household and establishment surveys continue to grow as seen on page 5. The six-month average job growth for the establishment survey is now 92,000 jobs; whereas the household survey shows a massive decrease of 288,000 jobs per month. Note that swings in household data have become more extreme in the last few years which makes us question the reliability of the data. Since the pace of job loss in the household survey is the equivalent of a recession, it is difficult to trust the data. See page 5.

On a more positive note, the misery index, which is the sum of inflation and the unemployment rate, is upbeat. This is a tool to demonstrate how favorable or hostile the economic environment is for the average household since it is directly impacted by inflation and employment. In June, the misery index eased from 8.5% to 8.4% and remains well within the normal range of 5.7% to 12.5%. Note that the last hostile reading was in June 2022 when inflation was 9.1% and unemployment was 6.7%. See page 6. 

After months of lagging sales, total vehicle unit sales rose 3% in June, up 4.1% YOY. And for the first time in a while, foreign vehicle sales rose more than domestic sales. Total foreign vehicle sales increased 10.7% YOY, led by imported trucks which rose 14.6% YOY. Domestic unit sales increased 2.6% YOY, led by domestic truck sales which grew a similar 2.6% YOY. See page 6.

The ISM services index decreased from 54.5 in May to 54 in June, but the employment index jumped to 51.2 and into expansion territory for the first time since February. The ISM manufacturing index eased from 54.0 to 53.3, but the employment index also rose from 48.6 to 49.7. The combined employment index is now at 100.9, the highest since February 2025. This is encouraging and again it suggests there are problems in the BLS household survey. In both ISM surveys the prices paid index fell, which is also positive news for future inflation. From a technical perspective, it is noteworthy that over the last 25 trading sessions, despite a string of all-time highs in the averages, the percentage of volume in advancing stocks has only exceeded 50% seven times. This means there has been significant selling into strength in the June-July market. In sum, the recent rally has not been impressive, and we would not be surprised to see a correction or sideways market in the near term. Even so, we remain a buyer on weakness.  

Gail Dudack

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The stock market has been resilient in the face of on-again, off-again negotiations on a memorandum of understanding (MOU) with Iranian officials and a tenuous 60-day ceasefire. But with August WTI crude oil futures (CLc1 – $69.50) trading below $70 a barrel, it is not surprising that equities were unfazed and scored the best second quarter performance in six years. The indices registered gains of 12.9% in the DJIA, 14.0% in the S&P 500, 19.6% in the Nasdaq Composite Index, and 20.6% in the Russell 2000 Index. The DJIA and Russell 2000 index closed the quarter with record highs of 52,319.20 and 3024.37, respectively.

However, the only index with a better year-to-date performance than its second-quarter performance was the Russell 2000 index! Year-to-date gains were 8.9% in the DJIA, 9.6% in the S&P 500, 12.8% in the Nasdaq Composite index, and 21.9% in the Russell 2000. Market commentators continue to call 2026 a narrow AI-led stock market, but the excellent performance by the Russell index indicates otherwise. The NYSE cumulative advance/decline line also recorded an all-time high at the end of June, which also suggests 2026 is a broad-based advance.

Still, from a technical perspective there may be a reason to be cautious near-term. In the last two trading days of June, while the DJIA was hitting new highs, the percentage of volume in advancing stocks was 45% and 37%, respectively. The fact that advancing volume was not well above 50% indicates a significant amount of selling was taking place as stocks moved higher. This selling could be related to quarterly rebalancing by mutual funds and money managers, or it could be investors rotating out of previous market leaders into more economically sensitive stocks. It could also be traders taking profits ahead of a long holiday weekend, but more importantly, it could be a sign of buyer fatigue. All in all, it would not be a surprise if the market had a pullback or took a pause. If so, we remain a buyer on weakness.

Our long-term bullishness is based upon the stock market’s solid fundamental underpinnings. It may surprise some that the S&P 500 Index is up 21% in the twelve months ending in June and 12-month trailing earnings have increased 22%! In short, earnings, not sentiment, have been driving stocks higher this year.

Second quarter earnings season will begin in several weeks and LSEG IBES estimates show analysts are expecting earnings to grow 24% YOY. This follows a stunning increase of 29.4% YOY in the first quarter. Although positive surprises will be more difficult to generate now that analysts have become more optimistic and have raised forecasts, we do think the second quarter earnings season will be good, particularly if gasoline prices continue to fall and inflation eases.

Plus, there are a number of reasons to be bullish on the US economy. GDP grew 2.1% in the final estimate for the first quarter and this was an upward revision from the initial estimate of 1.6%. Key contributors to this growth were nonresidential fixed investment, as well as exports, government spending, and consumer spending. Residential investment, on the other hand, continues to be weak. The upward revisions to first quarter GDP were largely due to a decrease in imports, particularly in consumer goods and capital goods (excluding automotive) and in transport services. Note that imports are deducted when calculating GDP, so these revisions were favorable. See page 3.

Fixed investment in intellectual property, as well as equipment and software, led GDP growth in the first quarter. The steady rise in capital spending this year is a result of a tax law change that allows companies to deduct investment in the year in which it is made. This part of the Big Beautiful Bill has been a boon to the economy. Inventory investment, structures and residential investment, and federal spending all detracted from year-over-year GDP growth. Examining government spending in the first quarter of the year, we found that national defense spending increased year-over-year, while federal nondefense outlays declined for the second quarter in a row. Given the conflict with Iran, it is not surprising to see defense spending rise, but we were surprised it grew less than 5% YOY. We also found an interesting pattern in defense spending. There were significant cuts in national defense during the Nixon, Clinton and Obama presidencies and each decrease in spending became more extreme. There were counterbalancing increases in defense spending during the Reagan, G.W. Bush, and Trump presidencies and surprisingly, each increase in spending was less extreme than the previous. See page 4.

Personal income was unexpectedly strong in May, rising 3.8% YOY, up from 2.6% in April. Disposable income rose 4.1% YOY (a sign of lower taxes) but since CPI was up 4.2% YOY and the PCE deflator rose 4.1% YOY, real personal disposable income was flat year-over-year. Nevertheless, unchanged is better than the decline of 1.1% YOY seen in April’s real personal disposable income report. See page 5.

The personal savings rate was stable in May at 3% but had been ratcheting lower since the 4.4% seen in January. However, despite the weak growth seen in real personal disposable income, personal consumption was surprisingly strong in May, rising 6.3% YOY, up from 5.6% in April. The biggest increase in expenditure was in nondurable goods (includes gasoline stations) which increased 8.0% YOY. Still, it was notable that durable goods spending also rose 7.2% YOY, up from 5.4% in April. See page 6.

We do not place much credence in sentiment indicators any longer, but according to the final report, the University of Michigan Consumer Sentiment Index rose to 49.5 in June from May’s record low of 44.8. The prior record of 50, reached in June 2022, indicates how low confidence remains. The positive revision in sentiment from the initial report for May suggests confidence was on the rise in recent weeks; nevertheless, confidence surveys have been extremely low for four straight years and therefore are of little use. The Conference Board’s Consumer Confidence Index ticked up to 91.2 in June from a downwardly revised 90.6 in May. The survey showed that sentiment around the present state of the economy weakened, and this offset an improvement in expectations. See page 7.

The SpaceX (SPCX – $170.86) record IPO on June 12, 2026 raised $75 billion and since active IPO offerings can be the sign of a market peak this is a topic we plan to monitor. New Federal Reserve Z.1 data provides information on equity issuance and retirement by nonfinancial corporations, but unfortunately it includes both common and preferred shares in both S and C corporations. This means the Fed’s data will include stock that is not traded on US exchanges. Nevertheless, the patterns of issuance and retirements are interesting. The peak issuance of equity at the March 2000 market high is distinctive. The data also demonstrates that total outstanding stock has been shrinking for most of the last 30 years. But if trends are important, take note that this changed in the first quarter of 2026 when net issuance turned positive. And this was prior to the SpaceX IPO. See page 8.
Gail Dudack

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The US equity market sold off dramatically on June 23^rd led by weakness in technology stocks. The Nasdaq Composite index tumbled 2.2% and Reuters News wrote that the selloff was due to worries about debt-funded spending for AI, coupled with concerns about a hawkish Federal Reserve. The characterization of the Fed as “hawkish” is a direct reference to the Fed’s June dot-plot that indicated nine of 19 Fed Board members had penciled in a rate hike for this year. In March, no officials expected a rate hike in 2026. This was a definite change, but in our view it is a ruse to use the dot-plot as a reason for the market’s selloff. Even former Fed Chair Jerome Powell has stated that “The dots are not a great forecaster of future rate moves,” and there is actually “no great forecaster.” We agree. Moreover, the Fed has never been a good predictor of rates, inflation or the economy. To us, this explanation for the June 23^rd selloff is nonsensical. More importantly, neither the debt-funded AI spending nor the dot-plot were new developments.   

Look Eastward

But there was something that happened on June 23^rd and it happened in South Korea. After soaring past the historic 9,100 level a day earlier, the South Korean SE KOSPI index plummeted 901.71 points, or nearly 10%, on June 23^rd. The KOSPI index is unique since it is dominated by two semiconductor stocks, Samsung Electronics Co. LTD. (005930.KS – 310000) and SK Hynix Inc. (000660.KS – 2555000), that together make up more than 50% of the index. Each of these stocks fell 12% or more for the day, wiping out billions in market value and triggering an automatic 20-minute bourse-wide trading halt during the trading session. That is drama. The trigger for this selloff appears to have been the Governor of South Korea’s Financial Supervisory Service, Lee Chan-jin, who said the government was too hasty in approving leveraged funds tied to some of the country’s semiconductor stocks. In May, South Korea introduced 16 domestic products, which aim to deliver 2x the daily performance of the underlying chipmakers. These highly leveraged products exploded in popularity and grew to over $9 billion shortly after their launch. Margin debt also rose to a record high in June and with the KOSPI up over 100% year-to-date, the leveraged South Korean equity market was an accident waiting to happen. And note, even after this week’s decline, the iShares MSCI South Korea ETF (EWY – $192.20) is up 90% YTD. See page 14.

This was not the first time semiconductor stocks have come under pressure, but the combination of huge price gains, soaring margin debt, and new highly leveraged ETF vehicles, made the KOSPI index vulnerable to any hint of bad news. And remember, money is fungible. The loss of billions of dollars in South Korea is a liquidity event that would certainly trigger selling in the US.

We think this is a better explanation for Tuesday’s selloff in the US equity market. And while concern regarding debt-funded AI spending is warranted, the KOSPI decline is what most likely caused that concern. Nevertheless, a correction and a little bit of fear is good for equity markets. It is not fear, but mania that worries us, and that does not describe the current US market.

Fundamentally Sound

In fact, the good news keeps on rolling on in terms of earnings forecasts. This week the LSEG IBES consensus earnings estimate for 2026 rose $0.43 to $340.82, the 2027 forecast rose $1.38 to $399.25 and the 2028 forecast rose $0.50 to $447.06. The S&P Dow Jones consensus earnings estimate increased $0.34 for 2026 to $336.97 and rose $1.03 to $395.02 for 2027. The market is now trading at 21.6 times the IBES 2026 estimate and 18.4 times the 2027 estimate. A blended 2026-2027 PE ratio for the US market is currently 20 times. That multiple coupled with the current CPI of 4.3% YOY sums to 24.3. This is an important statistic because market peaks tend to appear when this sum is substantially higher than 24.4. See page 7. And with the price of crude oil falling, we expect inflation will also decline in coming months and bring this ratio down. In short, fundamentals continue to support the equity market.

Good News in Economic Data

Recent economic news was surprisingly positive. Advance estimates for retail and food services sales were $763.7 billion, up 0.9% for the month and up 6.9% YOY. This was a big increase from April’s sales, which were up 4.8% YOY. May was also the highest year-over-year growth rate in total retail sales since January 2023. Motor vehicles and parts sales were $140.3 billion, up 4.4% YOY, the largest YOY pace since September 2025. US census data showed real retail sales for May were up 1.0% YOY, the best since December 2025. See page 3.

May retail sales excluding motor vehicles and parts grew 7.5% YOY, the best since January 2023. But more importantly in this period of high gasoline prices, retail sales excluding motor vehicles and parts and gasoline station sales, were a record $559.8 billion, up 5.6% YOY. This was the best YOY pace since December 2023. May’s record sales were led by miscellaneous stores, nonstore retailers, and furniture. See page 4.

The pending home sales index increased by 3.8% in May due to an increase in the number of properties under contract. The index was up 4.8% YOY with positive data across all four regions of the US but the Midwest led all regions with a stellar 9.3% YOY increase. In the first quarter of the year, the debt service ratio fell 16 basis points to 11.16%, which is 43 basis points below the first quarter 2020 level, i.e., before the pandemic began to negatively impact consumer finances. The mortgage component fell from 5.92% to 5.88% and the consumer component fell from 5.40% to 5.29%. Consumers continue to hold onto low-rate loans obtained during the pandemic and personal income is slowly growing. Personal income for May will be released later this week. See page 5.

Technical Indicators are Neutral or Positive

The 25-day up/down volume oscillator is 0.52, relatively unchanged from last week and still neutral. This indicator nearly registered a confirming overbought reading of 3.0 or greater in April but failed to do so. This was a sign of weakness in an otherwise bullish collection of technical data. In short, corrections are not surprising, but the long-term trend remains favorable. See page 7. The NYSE cumulative advance/decline line made a confirming all-time high on June 16, 2026 which is positive. New highs are averaging 288 a day and new lows are averaging 141. Again, with both averages above 100, this indicator is neutral but tilts bullish. See page 9. Individual investor sentiment has been on a roller coaster in recent weeks, and last week’s AAII survey showed bullishness rose 6.2% to 36.6% and bearishness fell 8.3% to 39.4%. Bullishness is now below average for the fifth time in eight weeks, while bearishness is above average for the 19th week in a row. The 36.6/39.4 split between bull and bears is neutral but is actually a significant positive since sentiment is far from displaying mania for equities! All in all, we continue to be a buyer of equities on weakness. And there is more good news. Argentina, France, Germany, Mexico, Norway and the United States have secured their spots in the knockout rounds in the 2026 World Cup. Go USA!

Gail Dudack

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