US Strategy Weekly: Remain Nimble

It has been a quiet week in terms of the Iran conflict, but we would be wary of becoming complacent about the Middle East since there is a good reason why it has been a relatively peaceful week. Neither the US nor China would benefit from fireworks ahead of this week’s Trump-Xi summit taking place in Beijing. The media is calling this a “high stakes summit” but that seems nonsensical to us since these summits are carefully and methodically planned well in advance. Advance planning is why Treasury Secretary Scott Bessent traveled to China this week after first making a stop in Japan to meet with Japanese Prime Minister SanaeTakaichi and then stopping in Seoul, South Korea to meet with Chinese Vice Premier He Lifeng and Chinese trade negotiators. The real work is done at these preliminary meetings to ensure that both parties can leave the summit with clear deliverables for their respective countries.

On May 14, when President Trump and China’s Xi Jinping meet, the discussions are apt to be more ceremonial than material. The topics to be discussed by these two leaders will certainly include Iran, but we expect both sides will focus more on personal economic issues with the hot topics being Taiwan, semiconductors, rare earth metals, tariffs, jailed Hong Kong activist Jimmy Lai, and AI. We expect there will be a lot of dealmaking by corporate leaders as well.

But when President Trump returns to the US at the end of the week, we would not be surprised if Iran takes center stage again. And Trump has already warned that Iran is on “life support” and the proposal from Tehran was “totally unacceptable.” This is a thinly veiled threat that bombing may resume. The only question is what targets will be bombed (military or energy?) and who contributes (Israel, UAE, Saudi Arabia?). Recent reports reveal that both the UAE and the Saudis have responded to Iranian attacks with covert bombing of their own. Their participation in future bombings could suggest a decisive power shift is taking place in the Middle East. In short, the equity market has recently reached record highs, but we would not chase stocks at this juncture since geopolitical events could trigger a correction, particularly if the US bombs Iranian energy infrastructure.

Nevertheless, we are not in agreement with those like Michael Burry who feel the market has “jumped the shark” and is approaching a crash. We lived through several major stock market bubbles and while AI has all the earmarks of creating an equity bubble (and probably will eventually), the current equity market is still supported by fundamentals. Yes, the semiconductor group made a perpendicular advance last week, but this has attracted so much attention and created so much negativity that it is likely that the semiconductor blowoff will reverse or stall without damaging the broader market. Plus, the semiconductor industry is only the first act of the AI story, and it is more likely that money will shift from the semiconductor stocks to the next step in the AI story such energy producers, transformers, software, and eventually end users.

When we look at the macro fundamental landscape, we do not see a bubble. In fact, we are amazed at the strength in first quarter earnings results. Last week we upgraded our S&P 500 2026 and 2027 earnings forecasts (see page 14), and they may still be too low. This week the LSEG IBES consensus earnings estimate for 2026 rose $8.62 to $336.49, the 2027 forecast rose $5.91 to $386.70 and the 2028 forecast rose $6.50 to $435.44. The S&P Dow Jones consensus earnings estimate rose $2.16 for 2026 to $333.72 and rose $2.67 to $384.61 for 2027. This means that even though the indices have recently hit all-time highs, the market is still trading at 22.0 times the IBES 2026 earnings estimate and 19.2 times the 2027 estimate. At both the March 2000 and March 2022 peaks the trailing PE was 32.1 times versus 24.7 today and a 32 multiple times 2026 earnings would equate to the S&P 500 moving over 10,000. And the S&P 500 forward earnings yield of 4.7% and dividend yield of 1.1% compare well to a 10-year Treasury bond yield of 4.4%. Plus, the S&P Dow Jones 12-month sum of operating earnings shows a gain of 21.1% YOY, far better than the 75-year average of 8.1% YOY. See pages 7 and 8. In the longer run, we remain a buyer of dips.

We also have a nonconsensus view of the recent jobs report. In fact, in our view, the April jobs report provides an argument for lowering the Fed funds rate. Although the headline shows employment grew by 115,000 jobs and the unemployment rate was unchanged at 4.3%, this is a very superficial analysis. The establishment survey showed a better-than-expected increase of 115,000 jobs, but revisions to prior months lowered employment by 16,000. More importantly, the household survey indicated that employment in April fell by 226,000 and the number of unemployed grew by 134,000. The fact that employment fell more than unemployment grew meant the unemployment rate was relatively unchanged (although it did increase fractionally). See page 5. Still, the household survey indicated 226,000 fewer people were employed in April versus March. This is a sign of weakness. Plus, people no longer counted in the labor force increased by 5.29 million in April. Although the labor force can decline for multiple reasons, one is that unemployment insurance has run out, and a worker is still unable to find a job. Overall, the government is not good at measuring why the labor force has declined.

Every month we look at the year-over-year increase/decrease in employment in both BLS surveys. In our view, it is the single best indicator of economic strength and also the best indicator of a pending recession. In April, the establishment survey showed job growth of 0.16% YOY and the household survey showed employment fell 0.8% YOY (the fourth consecutive month of job losses). These rates are well below long term averages of 1.7% and 1.5%, respectively. In short, the Fed’s job is to achieve maximum employment and stable prices, and this is challenging in the current environment. In our opinion, the Fed should always defer to stabilizing employment first since this is less in its control than inflation. Oil prices will come down eventually and inflation will moderate. But with the housing and auto industry already struggling, and AI challenging the work environment, lower rates are what the average household needs in 2026.

The counter argument to the Fed lowering rates is April’s CPI report. Energy prices drove April’s CPI up 3.8% YOY versus 3.3% a month earlier. This was the highest inflation rate seen since the 4.1% YOY recorded in May 2023. Core CPI rose from 2.6% YOY to 2.75% YOY, the highest since the 2.81% YOY recorded in October 2025. (We added a second decimal point since rounded both April 2026 and October 2025 were 2.8%.) The energy component of the CPI rose nearly 18% YOY, with fuel oil up 54% YOY and gasoline up 28.4% YOY. This actually seemed tame given that WTI crude oil futures were up 84% in the same period. The food component of the CPI increased 3.2%, up from 2.7% in March and the combination of higher fuel and food prices is a hardship for lower income households. We would note that all items less energy rose 2.8% in April, up slightly from 2.6% in March. See page 3. In terms of the heavyweight components of the CPI, transportation was up 7.1% YOY, up significantly from 5% a month earlier. Housing was up 3.6% versus 3.4% in March. Food and beverages rose 3.1%, up from 2.6%. Medical care prices rose 2.5%, down from 3.1% in March. Service inflation was 3.4% versus 3.1% a month earlier; service less rent of shelter was 3.5% relatively unchanged from 3.4% in March. Nondurable inflation was 6.6% YOY (fuel) versus 4.9% in March and 1.7% in February. Conversely, durables fell 0.1% YOY, little changed from the 0.1% YOY gain in March. Owners’ equivalent rent was 3.3%, little changed in four months. Recent declines in home prices suggest this index will inch lower in the months ahead. See page 4. All in all, the CPI report revealed the impact of energy on inflation, a fact that may inspire President Trump to end the Iran conflict one way or another. Investors should remain nimble. 

Gail Dudack

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