US Strategy Weekly: Those Who Forget History

Those Who Forget History are Doomed to Repeat it

George Santayana

Our paraphrasing of this famous quote from philosopher George Santayana is important for understanding many bits of life including world conflicts, political movements, or even economic and stock market forecasting. But since courses on the rise and fall of civilizations and economic cycles have not been a staple of higher education for several decades, an understanding of history may be what is missing in current political and economic debates. In particular, we find the distress expressed by some about Federal Reserve Chair Kevin Warsh and his return to a less transparent Fed to be fascinating. Note the word “return.” Decades ago, when we entered the financial world, there were no Fed statements, no Fed Chair press conferences, and no ever-present speeches by Federal Reserve Board members. Economists read and analyzed economic data and did not rely on the Fed for their forecast.

In fact, until the Financial Crisis of 2008, the Federal Reserve was relatively opaque. The Fed Chair did make bi-annual presentations to Congress and occasional speeches, but Fed members discussed economics not Fed policy. In fact, Alan Greenspan became synonymous with Fed Speak, a way of making wordy statements without much substance. This was purposeful in order to keep monetary policy unknown, which in turn would dampen speculation, and allow Fed policy to have maximum impact. There was only one way to monitor Fed policy and that was by monitoring the Fed’s transactions in the open market. Most bond trading desks had a designated “Fed Watcher” whose job it was to observe the Fed’s trades and announce them to the trading desk. The Fed’s transactions were, and still are, executed by the Federal Reserve Bank of New York through designated primary dealers (https://www.newyorkfed.org/markets/primarydealers#primary-dealers). However, the role of “Fed Watcher” disappeared once the Fed became transparent.

The transparency began with Ben Bernanke during the Financial Crisis when the entire banking system was in jeopardy and the Fed initiated a large number of emergency measures to stabilize the balance sheets of the banks and calm the markets. And though the banking crisis is long over, and most emergency measures have ended, the transparency remains. Financial markets are inherently risky, but a transparent Fed eliminates a major unknown, or risk, for investors. This creates a safety net and inspires speculation.

It is important to know that recent history is not the norm, and the Federal Reserve is not supposed to be a cornerstone of equity investing. Chair Warsh is aware of this and wants investors and markets to monitor economic data for decision making, and not rely on the Fed. But the blowback is surprising. 

It is also important to understand that easy monetary policy during the 2022-2025 period resulted in an inverted yield curve for nearly four years. (For reference, the COVID-19 Recession was short and took place in February to April of 2020.) See page 3. Inverted yield curves are usually predecessors of recessions and occur when the Fed is aggressively lowering interest rates to support a weakening economy. Conversely, a steepening yield curve is a normal curve and characteristic of economic expansions. With this historical perspective, we are puzzled by economists who have issued warnings in response to the present steepening of the yield curve. Moreover, the yield curve is not unusually steep. The 30-year-to-2-year spread is currently 98 basis points versus the long-term average of 82 basis points. See our 60-year history of yield curves on page 3. Long-term interest rates are driven by many factors, including sovereign deficits, inflation, but most importantly the state of the economy.

In terms of the US economy, there is plenty of good news to report. The ISM Manufacturing Index rose from 53.3 in June to 55.6 in July and is positive for a seventh straight month. This follows all but three of the 38 months between November 2022 and December 2025 when it was in recession territory. All components increased in July except for prices paid and customers’ inventories. The employment index increased again, moving into expansion territory above 50, for the first time in 33 months. See page 4. This bodes well for the third quarter.

Real GDP grew 1.5% (SAAR) in the second quarter after increasing 2.1% in the first quarter. This may appear to be a deceleration in economic activity, but personal consumption expenditures were up 2.12% in the quarter, a big increase from 0.37% in the first quarter. Gross private domestic investment increased 0.53% in the quarter, down from 1.35% in the first quarter. However, the factors that lowered second quarter GDP were government investment (subtracting 0.14%), a decline in inventories (subtracting 0.67%), and net exports (subtracting 1.01%). Imports rose 1.51% in the quarter, led by increased semiconductor intake due to fears of limited supply and rising prices. See page 5.

The GDP price deflator rose 4.3% YOY in the second quarter, after increasing 3.3% YOY in the first quarter. This increase is negative. However, inflation is closely linked to the price of oil, which rose nearly 42% YOY in the first quarter. Since crude oil prices affect the economy with a lag, energy negatively impacted inflation numbers in the second quarter. (The current drop in crude oil is a potential plus for the third quarter.) A chart of the GDP deflator with the 10-year Treasury bond yield clearly shows that interest rates have not been a good predictor of inflation. Nevertheless, the 4.7% yield in the 10-year Treasury bond at the end of June is justified by the 4.3% increase in the GDP deflator at the end of the quarter. See page 6.

Equity indices are at record highs as we go to print, fueled by fresh hopes for a Mideast deal, tumbling crude oil prices, and solid earnings reports from AI-related companies. Second quarter earnings season has been superb to date. Last week the LSEG IBES consensus earnings estimate for 2026 rose $3.84 to $353.54, the 2027 forecast rose $1.86 to $407.72, and the 2028 forecast increased $3.80 to $461.17. The S&P Dow Jones consensus earnings estimate jumped $6.29 for 2026 to $354.94 and rose $1.55 to $403.74 for 2027. These increases follow a steady stream of rising forecasts this year! The market is now trading at 21.9 times the IBES 2026 estimate and 19.0 times the 2027 estimate. The S&P’s forward earnings yield of 5.2% and dividend yield of 1.1% compare well to a rising 10-year Treasury bond yield of 4.6%. Plus, the S&P Dow Jones consensus 12-month trailing sum of operating earnings shows a gain of 25.9% YOY, which is far better than the 75-year average of 8.1% YOY. Forward operating earnings growth is also strong at 22.5% YOY. See page 8.

Combining 2026 and 2027 S&P Dow Jones earnings estimates, the 12-month forward PE multiple is 17.5 times and below its long-term average of 17.9 times. When this PE is added to inflation of 3.5%, it comes to 21.0, which places it within the normal range of 15.0 to 24.4. In short, the equity market is at a new high, but valuation has improved due to excellent earnings growth. See page 9.

Technical indicators have also recovered in the last two trading sessions. The NYSE cumulative advance/decline line rose to a record high on August 4, 2026, confirming new highs in the DJIA, S&P 500, and Russell 2000 index. Volume in stocks advancing rose to 70% and 69% in the last two trading sessions, the best in many months. In sum, we remain a buyer on weakness.

Gail Dudack

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