US Strategy Weekly: Background Noise

A torrent of problems appears to be challenging US equities. Congress faces a January 30 deadline to fund the government or risk another partial government shutdown. Atomic scientists suggest the ‘Doomsday Clock’ is closer to midnight than ever before. The European Union and India reached a landmark trade deal to reduce tariffs and more importantly, trade in local currencies to sidestep the dollar. President Trump’s rhetoric to acquire Greenland has the Prime Ministers of Greenland and Denmark huddling with German Chancellor Fredrich Merz in Berlin, while UK Prime Minister Keir Starmer and Finnish Prime Minister Petteri Orpo are openly courting President Xi Jinping of China. All of this suggests a disturbing shift in geopolitics, so not surprisingly, many emerging market central banks (China, Poland, and Brazil) as well as individuals are buyers of gold sending precious metal prices to record highs. But it was the Trump administration’s proposal to keep the Medicare rates it pays insurers unchanged in 2027 that decisively smacked the health insurance sector this week, and the Dow Jones Industrial Average. Nonetheless, if one looks at the broad environment for equities, it is questionable whether these events present a shift for the financial world or are merely background noise.

In our view, it is merely background noise. In fact, even this week’s FOMC meeting has become less important to equity investors, who not long ago were laser focused on rate cuts to support their positive view of stocks. Today it is widely viewed that there will be no change in policy, and this is not expected to cause any ripples in the markets.

Earnings Are Stellar

What is important to the equity market is earnings and although the fourth quarter earnings season is still young, the season is off to a strong start, apart from a few isolated exceptions in the financial sector due to potential policy changes by the administration. According to LSEG IBES, of the 64 companies in the S&P 500 that released earnings last week, nearly 80% reported above analyst expectations. This was well above the long-term average of 67%. And equities are performing well. Small-cap stocks have outperformed large caps for 15 consecutive sessions, a run not seen in decades. The Russell 2000 index is beating the S&P 500 with a gain of 7.5% year-to-date, versus the S&P 500’s gain of 1.9%. However, even amid the turmoil we just noted, the S&P 500 and the Wilshire 5000 reached record high territory on January 27, 2026.The Russell 2000 index made an all-time high on January 22, 2026, at 2718.77.

None of this is surprising given the strength of the economy. The second estimate for third quarter 2025 GDP was 4.4% (SAAR), up from the initial 4.3% estimate. Part of this improvement came from updated data on trade. The net impact of trade on economic activity was negative 2.4% in the third quarter, down from negative 3.0% in the second quarter. More importantly, this percentage is below the long-term average of negative 3.7%. The improvement in net trade came primarily from a decline in the importation of goods which fell from 12.3% of GDP in the first quarter of 2025 to 10.4% in the third quarter. The imports of goods as a percentage of GDP have averaged 12.4% over the last 25 years. See page 4. In short, the administration’s tariff policy is raising money for the US Treasury and improving GDP. And as we noted last week, it is also improving the all-important US debt to GDP ratio.

This stellar economic activity is also supporting corporate earnings. Four-quarter trailing GDP corporate earnings increased 6.9% in the third quarter, after growing 4.5% in the second quarter. This is solid performance but far from the best performance seen in GDP profits. S&P 500 earnings grew at a healthy 13.0% pace on a cumulative four-quarter basis at the end of the third quarter, and some analysts see the current 14% YOY pace as peak earnings and a sign that earnings growth is about to decelerate. But historically, peak earnings growth has been greater than 25% YOY, as seen in the chart on page 5. Rates of 25% or more were seen in the quarters ending December 1973, September 1979, June 1984, December 1988, December 1993, June 2004, and September 2018. Peak growth rates more than 35% have been seen but were rebounds from recession level earnings. Plus, while the current trailing PE multiple is rather high at 26 times, it too has been much higher at major peaks. 

There were several economic releases in the past week but most of them were for November and not noteworthy. Pending home sales were down 3% YOY for December, a sign that the residential market continues to weaken. For the month of January, the Conference Board’s Consumer Confidence Index fell 9.7 points to a 12-year low of 84.5, but we would caution readers that the Conference Board has a pattern of revising previously released data upward. In sharp contrast, the University of Michigan sentiment for January rose 3.5 points to 56.4, and present conditions jumped 5 points to 55.4. The University of Michigan has a pattern of revising data lower. More importantly, both surveys are politically skewed and neither has been a good guide for economic or equity performance. See page 3.

Dollar Yen

We are not concerned about the current messiness of geopolitics, but we are worried about the weakness in the dollar and the yen and the ramification this can have on security markets. The weakness in the yen is the result of the stimulus proposed by Prime Minister Sanae Takaichi coupled with Japan’s debt to GDP ratio of 230%, the highest in the developed world. This combination makes Japanese sovereign debt a risky investment. Although foreign ownership of Japan’s sovereign debt has been rising in recent years, it is still less than 12%; nevertheless, foreigners account for over 50% of daily trading volume and this adds to volatility. Japan is also the single largest holder of US Treasuries with $1.2 trillion as of November 2025. Japan is followed by the UK with $888.5 billion and China with $682.6 billion of US Treasuries. In comparison, the Federal Reserve currently holds $4.24 trillion US Treasury securities. The immediate risks are twofold. Japan could intervene in currency markets to strengthen the yen which could also mean selling US Treasuries to buy yen. This would raise interest rates and weaken the dollar. A second concern in the yen-dollar carry trade. Estimates for the total size of the yen-dollar carry trade range from $250 billion to over $1 trillion (when leverage is included) and an unwinding of the carry trade could be very disruptive to markets. The yen-carry trade has worked for many years because borrowing in yen (where interest rates are currently low and were negative from January 2016 to March 2024) and investing in higher yielding investments, like US stocks and bonds is a solid strategy — as long as currencies remain stable. But with Japanese interest rates headed higher and US interest rates potentially headed lower, this trade is becoming less attractive, particularly in the current environment of weakening and/or volatile currencies. Keep in mind that a potential unwinding of the carry trade, while unsettling, would not impact corporate earnings growth, which is the foundation of the current bull market. In short, an unwinding of the carry trade would be a buying opportunity, in our view. Technical indicators improved this week. In particular, the NYSE cumulative advance decline line made a new high on January 27, 2026, in line with, and confirming the record highs seen in the S&P 500 and the Wilshire 5000. And while the S&P 500 made a new high, most sectors of the market are outperforming this index as seen on page 11. This is due to the rotation of leadership that has taken place this year. Rotation is a healthy sign in a bull market advance.  

Gail Dudack

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