Rates and Nominal GDP
The 18-month climb in interest rates has pressured stocks, but the move makes sense. For the past year, nominal GDP - growth plus inflation - has been running at 6.6%. Yet the Fed cut rates over that same year. That gap had to close: either growth or inflation had to fall, or rates had to rise back up to match nominal GDP. Yesterday's report showed growth speeding up, maybe inflation speeding up too, so rates recalibrated toward nominal GDP. That is what drove the jump.
Some technical factors added to it. The 5-year Treasury auction was poor. There was likely some unwinding of the carry trade. This was a worldwide move, not only a US one. Right now the market is pricing a 5.5% Treasury yield at these levels, which looks fine.
The next Fed meeting falls at the end of the month, a few days before the election. The market puts a 70.9% chance on a 25 basis point hike. A 50 basis point move ahead of an election would be tricky and is not needed.
Last time nominal GDP sat at 6.6%, the Fed was at 5.5%. Today the Fed is at 4%. So the question is how much more accommodation gets removed - unclear, but a rate hike between now and year end looks locked in. Two things could ease inflation: a coming recalculation of the PCE price measure that may pull out about 2%, and an end to the war, which would remove some inflationary force. Holding off until December would be preferable, but cutting rates while nominal GDP rises is itself accommodation, so raising rates now is defensible.
Earnings Strength
Jobless claims came in under 200,000 for a second straight week. Nothing looks weak. Part of the earnings strength people cite as 50% is really closer to 30% once the hyperscalers are separated out.
Because nominal GDP is the revenue environment companies operate in, and it has been rising, corporate revenues and margins have both been strong. Earnings growth runs around 28-30% this quarter, maybe 30-33% for the year, then 15% into next year. Recent data looks a bit inflationary but also points to plenty of growth. Analysts expect $425 in S&P earnings next year, which lets you back into where multiples need to sit. All of that looks secure for now.
The Software and AI Trade
The interesting shift is away from chips, data centers, and frontier models toward the actual use of AI - who uses it and who makes money from it. Meta's (META) work on AI agents brings up the use case. If software companies are not wiped out by a "SaaS apocalypse" and instead become the agents themselves, interest in software names could return. These companies have real free cash flow. In a year where Oracle (ORCL) credit default swap spreads are blowing out again, and where investors care more about AI return on investment, software names may come back into favor.
Names in this group: ServiceNow (NOW), HubSpot (HUBS), Shopify (SHOP), Palantir (PLTR), Salesforce (CRM), and Atlassian (TEAM). The logic is simple: if using an agent is good for Meta, it is good for ServiceNow, Shopify, and Salesforce too. Any vendor that is agent-centric probably draws attention, and those names rose yesterday.
Valuations and the Election Setup
Going into a midterm election, charts usually show a stock market drawdown, then political clarity, then a rally. This year the S&P (SPX) did not show that drawdown - it fell about 5%. But semiconductors fell 30%. The drop showed up in valuations instead. S&P valuations came down 15%, the megacaps (MAG) about 20%, tech 25%, semis 35%. Because earnings were so strong, the usual price dip did not appear, but valuations compressed a lot.
The 10-Year Is the Whole Story
With earnings secure, the only variable left is the multiple, and the multiple tracks the 10-year interest rate. If the 10-year goes to 6%, the market is 6% lower. If it goes to 5%, the market is at least 10% higher - and it is ticking lower today. The market now trades at about an 18 multiple, which is not high. The S&P outlook between now and year end is higher than current levels.
Global View
Watch South Korean exports, since they signal the chip cycle - and those exports keep rising. That is a green light on growth. The Fed was right to raise rates and may be right to raise again. Much of this hinges on the war in Iran. Also in the picture: President Xi, oil above $90, and geopolitical events in the Middle East.
