The 2026 thesis
My call coming into the year had four parts: a small pullback in Q1, new highs by July 4th, then another drop in Q3. Q1 played out as an almost 10% dip. New highs by July 4th happened. The Q3 decline has not come yet, and we are about 60% through the quarter.
I do not have high conviction that the top is in right now. The risk sits in the next five or six weeks. That window brings pre-announcement season and seasonal headwinds. Short term, the market is not trading well. More stocks are making new lows, new highs are just okay, and it is a split market - the haves and the have-nots.
Add those factors together at this time of year, and a fall of 5-10% from the highs by early October would be healthy. That kind of reset would set up a double-digit rally into the new year. If I am wrong and the pullback does not come, I still expect the market to go higher into the new year, but as a slow drift rather than a fast climb.
Weak internals under the surface
Weak internals are normal before a pullback. The index masks underlying weakness. Using a war picture: the troops have left or died and only the generals are still standing. In the dot-com case, the market started to break down internally in May 1998, almost two years before the top - so bad internals can run early.
This is not a bull market peak that leads straight down. It is a routine, healthy reset that clears the way for a run to 8,000 and above on the S&P 500.
The catalyst problem
What is the catalyst in either direction? I do not know, and that is my blind spot. It is usually something out of left field, something I am not watching. NVDA is trading poorly into earnings. A hawkish Fed on Friday is possible, but I do not think it can do anything earth-shattering; it might cause a little volatility.
What happens if no tradable weakness shows up? I define tradable weakness as a drop of more than 5%. If we reach early October without it, the window for a reasonable 10% decline through January will have closed, and the market will drift higher. We will get through Q3 earnings season in October and things should be fine.
NVDA into earnings
NVDA reports tomorrow. Over the last eight quarters, looking a month past earnings, the stock was lower on the month in seven of the eight, even though all those reports arguably had good numbers. In six of the eight, it was lower the day after the report.
I want to see high-flyers sell off into earnings, and NVDA has been down roughly seven straight days. Sentiment is a little negative - people add a "but," saying not everything is perfect. That is a good setup. From a risk-reward view, a high-flyer selling off into earnings favors the upside afterward. When NVDA rallies into earnings and pops on the print, that is a sign to trim the position. I will not guess what the numbers should be; the sell-off tells me sentiment is weak and risk-reward favors the upside after the report.
Stock picks
I am staying away from semis and the high-flyer names until the pullback comes. Where I see value:
Software / AI. Software has set itself apart. The AI story there is overblown but the group holds strong names.
Tyler Technologies (TYL). Public sector technology and the dominant player. Growth has slowed from a very fast rate, but it beat recently on EPS. The stock is always expensive, which is fine. Earnings come at the end of October. I think it trades above 400.
Palo Alto (PANW) and CrowdStrike (CRWD). CRWD reports tomorrow. These two trade in tandem and are the industry standards in cybersecurity. I own PANW and the BUG cybersecurity ETF. PANW has a great balance sheet, cash flow, pricing power, and growth; earnings worries are overblown. CRWD could surprise to the upside because it is weak into earnings, like NVDA.
Defensive staples. I started building staples positions - boring dividend names - the same way I did with pharma in early July 2024.
- Kimberly-Clark (KMB): known as a diaper maker. Higher oil prices are a headwind since oil feeds its input costs. It offers 5% free cash flow and 54 straight years of dividend increases. The Kenvue merger is noisy short term but should be great long term. A lower-risk, smart play.
- Cal-Maine Foods (CALM): the largest egg supplier in the United States. Free cash flow around 9%, good balance sheet, low debt, high liquidity. Its dividend is quarterly and set at 33% of earnings, so the yield near 6% will change quarter to quarter. EPS comes at the end of September.
I am also building positions in software and consumer names. Once we reach the end of September I plan to go hard into consumer and retail stocks. That is the plan through year end: SaaS and defensive names in favor now, the consumer in focus for the fall.
