US Strategy Weekly: Rotation is Good

Fed Week

This is Fed Week, and just as a chorus of voices has begun to warn investors that the FOMC could — or should — raise interest rates to fend off the rising inflation threat, crude oil prices began to fall. Lower oil prices are a major positive for the equity market and as we have often noted, if WTI crude future prices remain at $80 a barrel or less, inflation should slowly ratchet lower. It is clear that crude oil prices rise and fall on vacillating hope for peace in the Middle East and recent hope of an agreement may be dashed by a new wave of Iranian missiles fired on US forces in the Middle East. Still, we do not expect any major changes to Fed policy this week.

As we go to print, the September light crude future is trading at $77.98 a barrel, which means it is up 11% YOY. But more importantly, it is down 37% from the April 2026 closing price of $106.88 a barrel. In April, crude prices were up a shocking 84% YOY. Crude oil prices impact the broad economy with a lag, which means the April jump in crude oil prices led to the May 2026 CPI surge to 4.2%. With that in mind, remember that the WTI futures closed the month of June at $70.75. Therefore, the July CPI report may be more favorable than many expect. If so, it would be a big plus for both stocks and bonds and it is one reason we expect Fed policy to remain on hold in July.

Earnings Season

While the July FOMC meeting will dominate the financial headlines this week, the most important news is second quarter earnings season. Only two of the Magnificent 7 have reported earnings to date, and although Alphabet Inc. Class A (GOOGL – $333.71) beat expectations, its 2026 capital expenditure forecast triggered a significant selloff in AI-related stocks. Tesla Inc. (TSLA – $307.44) beat revenue estimates but missed earnings forecasts and noted that capital expenditure rose 142% to $5.79 billion with total 2026 capex spending expected to exceed $25 billion. Investors have turned skeptical about massive AI-related capital expenditures (which is reasonable) and coupled with the deleveraging of the tech-heavy South Korean stock market, and the Fitch third quarter Global Risk Outlook (warning of heavy capex spending on AI infrastructure), the AI leaders have come under substantial selling pressure. In the longer run, we believe this skepticism is healthy. This week’s earnings reports will include Microsoft Corp. (MSFT – $393.35) on Wednesday, and Apple Inc. (AAPL – $340.08) and Amazon.com (AMZN – $230.86) on Thursday. Nvidia Corp. (NVDA – $197.01) does not report until August 26, 2026. And though the market has discounted much of the risk in capex spending in current prices, we would not be surprised if the Mag 7 remain under pressure until NVDA reports.

More importantly, the AI selloff has materialized without causing major damage to the broader market. The S&P 500 is less than 2.5% away from its record high and the tech-heavy Nasdaq Composite is 8.2% from its all-time high. One reason for this resilience is that there has been rotation away from AI-related stocks and toward defensive and economically sensitive stocks. Note that over the last five trading sessions, the best performing areas of the market have been materials, healthcare, staples, homebuilders, and retail. See page 11. According to S&P data, the sectors that have outperformed the S&P index year-to-date have been energy, industrials, REITs, technology, and consumer staples. See page 12. What many investors may have missed, given the focus on AI and all its ramifications, is that the US economy appears to be doing quite well. This bodes well for a broad range of stocks. The initial estimate for second quarter GDP will be reported on Thursday, and the Federal Reserve Bank of Atlanta model is estimating growth of 1.5%. Real GDP increased 2.1% in the first quarter. We think the second quarter could exceed the Fed’s 1.5% estimate given the strength seen in retail sales, capital expenditures, and improvement in the goods trade balance. If so, it would explain why economically sensitive stocks are now outperforming the Magnificent 7.

Homeownership Declines

One area of the economy that continues to be in a slump is housing. The US homeownership rate fell from 65.3% to 65% in the second quarter of 2026, bringing the ratio below its long-term average of 65.3% for only the third time since December 2019. The Census Bureau estimates that total households in the US increased from 133.7 million at the end of 2025 to 134.0 million in June 2026, but households owning a home decreased from 87.8 million to 87.1 million in the same period. Younger households showed the greatest loss. Households under 35 years of age that owned a home fell from 36.8% to 35.2% and those in the 35 to 44 years of age bracket fell from 61.1% to 60.9%. Households 65 years of age or over increased homeownership from 78.4% to 78.6% in the first six months of 2026. See page 3.

Overeducated and Underpaid

Millennials have had a different experience from previous generations since they entered the workforce burdened by student loans, soaring home prices, relatively high interest rates, and very high healthcare insurance costs. Homeownership has been far more difficult for millennials than for their parents, and it may explain the current trend of disillusionment and interest in socialism. Some young people are described as “overeducated and underpaid” due to a mismatch between their education and job opportunities. A large part of this mismatch is a result of the long-held view that everyone needs a college education. This has proven to be faulty thinking since many trades such as construction workers, electricians, and utility workers rank among the higher paid and most rewarding jobs for young adults.     

But the current slump in the housing market may bring hope to this young generation. New home sales increased from 618,000 units in May to 628,000 units in June; however, even with this uptick, sales declined 5.6% YOY. The average price of a single-family home fell from $525,200 to $475,400 in the month, a 6.5% YOY drop and a decline of 14% from its July 2022 high. The median price of a single-family home also fell from $412,000 to $398,300, a 2.7% YOY decline. See page 4. All in all, this shows a deceleration in the housing market, which has persisted over the last three years.

Sentiment indicators shifted in opposite directions in July. Conference Board confidence fell to 90.8 from an upwardly revised 92.2 in July. This decline came primarily from the decline in present conditions, which fell to 114.9 from an upwardly revised 118.5 in June. Expectations were unchanged at 74.7. University of Michigan sentiment climbed from 49.5 to 54.4 in July due primarily to a big increase in present conditions from 47.7 to 54.9. The expectations index also rose from 50.7 to 54.0. In general, sentiment indicators have been poor guides for the economy and have been oscillating at recessionary levels for most of the last six years. See page 5.

S&P 500 earnings continue to surprise to the upside, and equity valuations remain stable to lower at 21.2 times the IBES 2026 estimate and 18.3 times the 2027 estimate. We believe these are reasonable valuations given the fact that earnings have grown 22.6% over the last twelve months and are forecasted to increase 22.5% over the next twelve months. In sum, we remain a buyer on weakness.

Gail Dudack

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