US Strategy Weekly: A Buyer of Weakness

Just like the market was not concerned about last week’s FOMC meeting, it was unaffected by the current partial government shutdown. Both are rational reactions in our view. Lower interest rates in a good economy are less necessary (and could be inflationary), and more importantly, fiscal policy will “trump” monetary policy in 2026. Plus, the anxiety surrounding a government shutdown and the political posturing during one has become far less relevant to equity investors today, particularly since the record-breaking 43-day shutdown that began on October 1, 2025, did little to nothing to impact the overall economy last year.

This latter statement is quite amazing, particularly since federal government employment fell by 179,000 in October 2025 during the shutdown, reaching its lowest level since July 2014. Recent data shows that over 212,000 civil servants have left the federal workforce through voluntary and involuntary mechanisms aimed at reducing the number of federal employees. This should dampen employment levels; nevertheless, in October 2025 while retail sales slowed to a gain of 3.3% YOY from 4.1% YOY a month earlier, this pace was still better than the 3.2% YOY gain seen in October a year earlier.

But, as we go to print, the threat of a shutdown is ending since the House of Representatives has voted to end a four-day partial shutdown. The legislation will fully fund five sectors of the federal government through the end of the fiscal year (September 30, 2026), while extending funding for the Department of Homeland Security for ten days, or until February 13, 2026.

And despite all the political bluster the economy appears to be strengthening. The ISM manufacturing index increased from 47.9 to 52.8 in the month of January, and this gave a boost to the stock market earlier this week. It was the first reading above the breakeven 50 level since the back-to-back 50.9 and 50.3 readings seen in January and February 2025. However, these two readings were preceded by 26 straight months of readings that were below the breakeven 50 level – a sign of contraction in the sector. Three of the ten components in the index shifted from under to over 50 in January – new orders were impressive jumping from 47.4 to 57.1 – and production rose from 50.7 to 55.9. Employment increased from 44.8 to 48.1 but remains in contraction territory. See page 3. The ISM nonmanufacturing index will be released later this week.

Despite our concern about housing affordability and the inability of young adults to buy homes, homeownership rates increased in the third quarter of the year, with the overall reading rising 0.3 points to 65.3%. The largest increases were seen in the Northeast (61.4% to 62.5%) and the South (66.6% to 67.2%). Homeownership rates were flat in the West and down in the Midwest. Still, the most surprising and important fact seen in the survey was the 1.1% increase in homeownership for those under 35 years of age which rose to 37.5%. Homeownership remains highest for those 65 years of age or more at 77.9%, however the percentage was down from 78.6% in the second quarter. See page 4.

In general, we believe inflation worries are fading; however, the 0.5% increase in the PPI index in December was the largest monthly gain in five months. Still, this larger-than-expected monthly gain left the year-over-year unchanged at 3% YOY. The increase in December’s PPI final demand index can be traced to a 0.7% rise in the index for final demand services. Prices for final demand goods were unchanged in December, again indicating that tariffs on imported goods are not the source of inflation.

The deceleration in CPI and PPI indices has carried most inflation measures to a range of 2.7% to 3%. On one hand this range is well above the Fed’s 2% target, but it is also below the long-term average for inflation of 3.4% YOY. More importantly, it would be highly unusual to see any acceleration in inflation in coming months since oil prices continue to be negative YOY. Lower oil and energy prices provide a favorable backdrop for consumers and inflation.  See page 5.

Labor productivity increased by 4.9% (annualized) in the third quarter, after rising 4.1% in the second quarter. This acceleration was predictable since GDP accelerated to 4.4% in the third quarter after rising 2.8% in the second quarter. The US Bureau of Labor Statistics (BLS) calculates labor productivity index by dividing an index of output by an index of hours worked. Output can be measured in most industries, but for those industries where employees do not punch a clock, hours worked can only be estimated. As a result, we believe productivity numbers are unreliable. But it is clear to us that productivity did rise in the third quarter because nonfarm unit labor costs decelerated to 1.2% YOY from 2.0% YOY in the second quarter. Note that the BLS data on employment costs also shows compensation has been relatively stable at 3.5% YOY. Stable labor costs are good for corporate profit margins and for earnings growth. See page 6.

While the economy appears to be doing well, the risk is that the job market may be weakening for a variety of reasons. Unfortunately, BLS will not release January’s employment data this week. However, the January jobs report is always fraught with issues since the establishment survey undergoes an annual benchmarking process and seasonal adjustment factors are updated. The household survey is also adjusted for updated population estimates from the Census Bureau. All these factors make January data difficult to compare to previous months. It will be an important, but tricky month to analyze when we get the data. 

But if we were to choose one factor that is important for the equity market it would be earnings. The LSEG IBES consensus earnings estimate for 2025 rose $0.35 (more than offsetting last week’s $0.30 decline) to $271.92 this week and the 2026 estimate was unchanged at $313.04. The 2027 forecast rose $0.71 to $361.32. The S&P Dow Jones estimate for 2025 rose $1.81 to $265.41 and the 2026 estimate fell $0.02 to $310.24. Using IBES estimates this means the market is trading at 25.4 times 2025 estimates, 22.1 times 2026 estimates, and 19.1 times 2027 earnings. What is interesting about these PE multiples is that they have not changed much in the last two years (apart from the tariff panic in April 2025) even as equity prices continue to rise. In short, this is, and has been, an earnings-driven market. That is the best kind of bull market.

And though PE multiples are rich, the forward earnings yield of 4.65% and dividend yield of 1.14% compare well to a 10-year Treasury bond yield of 4.2%. Perhaps most importantly, 12-month trailing operating earnings are growing at 16.2% YOY, far better than the 75-year average of 8.1% YOY. See page 7.

All in all, we remain a buyer of weakness, and as this will be a midterm election year, one should expect several bumps in the road ahead. But if the economy and earnings continue to grow, and we expect they will, we expect the long-term bull market will remain intact.

Gail Dudack

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