Why 2026 Is Not 2022
The market is not overextended or heading for a crash this year. The biggest difference between now and 2022 is earnings. In the first half of 2022 I was bearish, and that period had an earnings recession. Now earnings are booming. Booming earnings are what matters most to an equity investor, so the setup for 2026 is fundamentally different despite fears that similar conditions could repeat.
Other supports back this up. The Fed today is generally neutral to supportive. Financial conditions across the board are loose and helpful. A lot of progress has been made on inflation. All of this gives the Fed less reason to overdo tightening and harm the economy right now.
The Fed and Jackson Hole
All eyes point to Friday, when the new Fed chair speaks at the Jackson Hole financial symposium, the annual meeting. The advice to policymakers is simple: do no harm. Pulling forward guidance forces the Fed to be more data dependent, and that makes financial conditions even more powerful. The old rule "don't fight the Fed" turns into "don't fight the markets," especially the bond market.
Look at the 10-year Treasury bond yield. Even after the recent backup in yields, the yield still sits comfortably below the pace of nominal GDP growth. That gap is generally a good environment for stocks.
Pullbacks as Opportunities
Stocks remain closer to all-time highs than not, even after last week's pullback. This point in the calendar year brings technical and seasonal effects, so it is reasonable to expect some tactical softness in share prices. The real question is whether to act tactically or strategically. As long as the overall operating environment stays friendly and not hostile, treat these pullbacks as gifts, not punishments - a chance to buy things on sale.
Labor Market: Cooling, Not Collapsing
Recent weakness in the labor market can be good news for stocks because it takes pressure off inflation. Where is the line between healthy cooling and something worse? Look at economywide capacity utilization, which combines the employment rate plus the industrial capacity utilization rate. Right now that combined measure is normal - not too hot, not too cold. That is a Goldilocks operating environment.
The next step is what that means for inflation. Core inflation trends are running right about where you would expect based on that economywide capacity utilization rate. This again supports the message: Fed, do no harm.
Inflation Outlook
On inflation and the PCE reading this week, recent trends in CPI and PPI plus lower energy prices from their peak point to more of the same - continued progress. The San Francisco Fed publishes an inflation shock momentum index that compares positive and negative shock categories. It currently sits below the horizon line, which means there have been persistent negative or downside inflation shocks. If recent history is any guide, more encouraging inflation news should follow.
