US Strategy Weekly: Hoping for a Peace Plan

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

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