The macro picture is getting harder
Macroeconomic reading is turning difficult. JOLTS job-openings data came in with nothing strange. Two reports land before the September Fed meeting: Friday's employment data and the CPI report. These matter, but the setting is messy - the timing sits before the midterm elections, which adds a political layer, and Iran adds an unpredictable one.
Corporate America is posting fairly high profits, which helps markets. On the Fed, Chair Warsh does not like to give forward guidance and set up a much more "hawkish" mood than before. The market reaction looked much like the June meeting. Futures markets put the odds of a 25 basis point September hike at 50/50 or a bit higher.
Whether a hike helps the market is unclear, because there are many worries about currency depreciation and moves aimed at pushing down Treasury bond yields. The jobs picture is already roughly known - stable, without sudden jumps. Every Fed member has named inflation as the main thing to track. So next week's CPI report is the most important event.
Why one or two hikes barely matter
A single 25 basis point September hike does not matter much unless it starts a broader rate-hike cycle. Long-term rates sit at their highest, and the term premium has risen, meaning bond investors want more pay to hold longer-dated debt. That signals investors questioning whether the equilibrium rate is higher than assumed.
One or two hikes is not a big problem. Last year brought three "scary" recession fears when people thought the job market was collapsing, and it turned out not to be true. That is the baseline. How resilient the market stays depends on the economy, the path of AI, and corporate profits.
The long end of the curve would likely fall on one or two hikes - markets are already pricing this. There is more talk now about how monetary policy works and what the Fed plans than at any point in the last 20 years. Warsh's measured speech last week strengthened confidence in the Fed: the yield curve flattened, the dollar rose, and gold fell - clear signs of growing trust. In that setting, even a September hike would probably push the long end down and make little difference to the economy or markets.
The case for a 5-10% pullback
A 5-10% pullback in stocks looks likely, a fairly common view. If earnings stay as strong as expected, what triggers the drop? The search for a new catalyst has run for weeks, with focus landing on interest rates as the leading story. Price dynamics matter most, and nothing significant has changed there.
The seasonal setup adds risk. After Labor Day everyone is back at work, and midterm elections are coming. Markets often pull back before an election. This would not change the economy's overall course. But comparing polls to bookmakers' odds, the chance of a strong Democratic win runs 20-25% higher than investors expect in November - a point of vulnerability and some overconfidence.
Stacking these together - Fed uncertainty, the midterms, and no fresh company reports showing standout earnings per share - September could be a tough stretch for the market over the coming weeks. Year-end S&P 500 (SPX) targets remain upbeat, with one forecast at 8400.
What to buy into the weakness
For a 5-10% pullback in this seasonally weak period, aiming at the year-end bounce, the pick is a balanced portfolio of cyclical stocks in both the US and international markets. AI and infrastructure deserve attention. The recent reporting season showed hyperscalers can work well alongside AI tool and hardware providers, so the aim is broad coverage.
Avoid defensive sectors - they feel expensive right now. Healthcare is the exception, offering some protection with its own upside. Consumer staples and utilities are ones to stay away from in current conditions. With higher nominal growth in the backdrop, a pullback would be a chance to add to cyclical, AI, and healthcare exposure.
