US Strategy Weekly: Sell on the News?

Last week we wrote “the real driver of equity prices in August may be the expectation that the fed funds rate will be cut at the September 16-17 meeting. History suggests that stocks rise in the months following the first rate cut, particularly if it is the first of a series of rate cuts. In short, despite the weakness seen in revised jobs data, the equity market is expected to be higher in the second half of the year.”

This week, after the CPI report for July, the consensus view began reversing in favor of a rate cut in September, and not surprisingly, the equity market, as measured by the S&P 500 and Nasdaq Composite index, rose to all-time highs. At present, this rally has an important technical flaw, but first it is important to look at the most recent CPI report.

July’s CPI report showed headline inflation to be 2.7%, up fractionally but essentially unchanged from June and core CPI was 3.1% YOY, up from the 2.9% seen in June. However, July’s rise in core CPI brings this benchmark back to the level seen in February 2025 and at 3.1% YOY, core CPI remains well below the inflation levels seen in the second half of 2024. More importantly, the rise in core inflation was NOT due to tariffs but was the result of large price increases in areas such as in motor vehicle maintenance and repair (up 6.5% YOY), fuels & utilities services (up 6.5% YOY), tenants’ and household insurance (up 5.8% YOY), other goods and services (up 3.9% YOY), and medical care (up 3.5% YOY). Meanwhile, areas expected to be impacted by tariffs such as apparel prices, new vehicles, and alcoholic beverages saw prices fall 0.2% YOY and rise 0.4% YOY and 1.4% YOY, respectively. In sum, the July report showed no sign of tariff inflation – to the despair of many forecasters. See page 3.

There will be new employment and inflation data prior to the FOMC meeting in September; however, unless the current trends in employment and inflation reverse dramatically, the Federal Reserve is apt to cut rates by 25 basis points at this meeting. This has been our expectation all year.

Unfortunately, it appears that politics is impacting Wall Street prognosticators. While most economists have been waiting for tariffs to trigger both inflation and a recession, little attention has been given to what we believe is the main risk of 2025 – deficits and government funding needs. In December, at the end of Biden’s term in office, the 6-month average of monthly federal deficits was $212 billion, an unsustainable pace. Recent US Treasury data for July 2025 shows the 6-month average of monthly deficits fell to $131 billion, down 38% from December and down 20% from the $164 billion seen in July 2024. As a result, the federal government’s need for debt issuance should also fall. The government’s “borrowing from the public” was only $3.2 billion in June but jumped to $573 billion in July, the highest monthly level in over three years. As a result of July’s increase, the 6-month average jumped to $224.9 billion in July, and the 12-month average increased to $133.7 billion. Still, the current 12-month average debt issuance to the public is below the pace seen from July 2023 through January 2025. See page 4. In short, Secretary of the Treasury Scott Bessent is doing a respectable, or one could say remarkable, job of lowering the deficit. It is therefore not a surprise that July’s $573 billion in new issuance did not disturb the debt market at all.

The Small Business Optimism Index rose 1.7 points in July to 100.3, slightly above the long-term average of 98. Of the components, six increased, two decreased and two were unchanged. There was good news and bad news in the details of this report. Plans to increase employment increased a point to 14 and plans to raise prices fell four points to 28. However, poor sales rose one point to 11 as the “single most important problem” for small businesses. This “poor sales” index appears to be in an uptrend. The problem with this is that the unemployment rate also moved up in July and a rising trend in these two indices has been a lead indicator of many recessions. We doubt that the FOMC monitors this parallel, but it does suggest that a rate cut may be a good insurance policy against higher unemployment. See page 5.

Total consumer credit in June was $5.055 trillion, up from $5.047 trillion a year earlier — a gain of 0.5%. The growth was concentrated in nonrevolving credit, which grew 1.6% YOY. Revolving credit (mostly credit card debt) decreased 2.5% YOY to $1.3 trillion. On a 6-month rate of change basis, total credit increased 2.1%, nonrevolving rose 2.8% and revolving credit was unchanged. The importance of this is that from December 2024 to February 2025 credit growth was negative on a year-over-year basis. Negative credit growth tends to be a sign of a recession See page 6.

With first quarter earnings season soon coming to a close, it is clear that corporate earnings were far better than analysts expected. Again, forecasters have been excessively pessimistic about tariffs. This week’s S&P Dow Jones consensus earnings estimate for calendar 2025 is $258.65, up $1.46. The earnings forecast for 2026 is $300.42, up $1.14. The LSEG IBES estimate for 2025 is $266.84, an increase of $1.98 this week, and the 2026 estimate is $302.61, up $1.17. The IBES guesstimate for 2027 is $342.44, a jump of $2.11. In sum, these are big earnings revisions and as a result S&P 500 estimates are approaching our forecasts of $270 for this year and $310.50 for next year. Keep in mind that our estimates may still be too conservative. See page 8 and 14.

Nevertheless, equity valuations remain rich. The S&P 500 trailing4-quarter operating earnings multiple is currently 26.0 times. The last time the market demonstrated great value was the intra-month PE low of 20.7 times earnings in early April. The PE is down this week due to higher earnings results, but still above both the 50-year average of 16.8 times and the 5-year average of 21.5. Using 2026 S&P Dow Jones estimates, the 12-monthforwardPE multiple is 21.8 times and well above its long-term average of 17.9 times. When this PE is added to inflation of 2.7%, it comes to 24.5, which places the equity market just above the normal range of 15.0 to 24.1. See page 7. However, neither PE multiple suggests the equity market is an extreme bubble-like levels. In short, stocks could go higher this year.

From a technical perspective, the NYSE cumulative advance/decline line made a new high on August 12, 2025, confirming the highs made in the S&P 500 and Nasdaq Composite. And the 10-day average of new highs and lows remains bullish. However, the 25-day up/down volume oscillator is at 0.49 this week and neutral. This indicator recorded one-day overbought readings of 3.15 on July 3 and 3.05 on July 25, which followed the indicator being overbought for 9 of eleven days in May. It reached a high of 5.10 on May 16, which was very positive performance, and it predicted the highs in the indices that began in June. Overall, this was characteristic of a bull market cycle. However, this indicator is yet to confirm the recent string of new highs made in the indices and reveals that advancing volume is weakening in August. To confirm the rally, the oscillator needs to maintain an overbought reading of 3.0 or more for a minimum of five consecutive trading days. There is still time for the oscillator to confirm, but the longer the nonconfirmation lasts, the more likely there will be a pullback – perhaps after the FOMC meeting. We would not be surprised if there is a “sell on the news” correction.    

Gail Dudack

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