📊 Yardeni Research — Intelligence Hub

I. Bonds

The global bond market remains jittery, though yields may be starting to stabilize after their rout in recent months (chart). Nevertheless, geopolitical turbulence may still buffet them.

Yields have risen for an assortment of reasons, from better-than-expected economic growth (US) to fiscal instability concerns (France). Brazil and China are the only major countries showing declines in bond yields so far this year (chart).

Bond yields have also risen on higher-for-longer oil prices as the war in the Middle East has continued to disrupt oil supplies. The Houthis have said airliners should avoid Saudi airspace, declaring it a zone of military operations after the Saudi-backed Yemeni government launched an offensive ⁠against the group earlier this month. On Saturday, a third attack this week on Riyadh's international airport left 12 people dead and dozens wounded. President Donald Trump said the US will "look at" joining Saudi strikes on Houthis.

II. Stay Home vs Go Global

So far this year, the US has held onto its 65% market-cap share of the All Country World (ACW) MSCI (chart). Japan's share has also held steady at 5%. However, Europe's share has slipped (13.3%) to the advantage of the share of the Emerging Markets (12.0%).

Nevertheless, last week, the US outperformed the Developed World ex-US as the French debt crisis weighed on European stock prices (chart).

So far this month, the US MSCI is the second-best-performing stock price index we track (chart). Brazil was the best-performing in response to first-round presidential election results showing conservative Flavio Bolsonaro, son of former President ⁠Jair Bolsonaro, exceeding expectations in the race against leftist President Luiz Inacio Lula da Silva.

III. Earnings & Valuation

The ratio of forward earnings for the US MSCI to the ACW ex US MSCI fell through the summer this year (chart). It stopped doing so in recent weeks.

Forward P/Es have been falling worldwide since the start of the year, as forward earnings have outpaced stock price gains (chart).

IV. Currencies

The French debt crisis is also weighing on the euro, which is down from $1.20 at the start of this year to $1.12 (chart).

As a result, the DXY dollar index has rebounded to its best reading since early 2025 (chart). We remain constructive on the US dollar.

V. Notable

(1) German factory orders fell sharply in August, plunging 10.6% m/m (chart). The primary driver behind the contraction was a steep pullback in large-scale contracts. The headline drop was almost entirely due to a 61.5% slump in large-scale orders for aircraft, ships, trains, and military vehicles, which suffered a major correction following an exceptional surge in July. When these volatile large-scale contracts are excluded, new manufacturing orders actually slipped by just 0.1%, indicating that core industrial demand was essentially treading water rather than experiencing a broad-based collapse.

(2) CQQQ continues to underperform QQQ (chart). While China's long-term industrial policy goals are ambitious, cyclical demand inside China has struggled to generate the same explosive revenue growth seen in Western tech sectors. Furthermore, China's tech industries carry a persistent regulatory discount. Chinese technology sectors have historically been vulnerable to abrupt policy shifts, anti-monopoly crackdowns, data security reviews, and ongoing geopolitical tensions (including US–China trade restrictions and semiconductor export controls), which compress valuations and deter long-term institutional capital inflows.

Bond yields edged down last week. As a result, the S&P 500 edged up, led by interest-rate-sensitive sectors. The AI-related sectors Industrials (-0.4%) and Information Technology (-0.3%) edged down and in fact were the only down sectors last week. The big interest-rate-sensitive gainers were Consumer Staples (4.0%), Utilities (3.9%), Consumer Discretionary (3.1%), and Financials (2.3%).

The year's laggards were last week's leaders (chart).

Let's have a look at the Energy, Financials, and Industrials sectors:

(1) Energy. S&P 500 Energy (3.6%) powered ahead on renewed risks to ships passing through the Strait of Hormuz (chart). Over the weekend, the Houthis attacked King Khalid International Airport in Riyadh and declared Saudi airspace a zone of military operations, warning airlines, travelers, and airport workers to steer clear of airports across the kingdom.

Sector momentum turned decisively positive mid-week, bolstered by a late-week surge as energy equities reacted to escalating Middle East conflicts and subsequent spikes in crude oil benchmarks (chart). Brent crude is quiet tonight at $103.65 per barrel. President Donald Trump helped calm the oil market by announcing that an energy ceasefire between Russia and Ukraine took effect immediately, saying on social media that both parties had agreed to the terms.

The rebound in the Energy sector's forward earnings this year has been attributable to the jump in the sector's forward profit margin, fueled by the jump in oil prices (chart).

The sector's forward earnings is up 61.7% y/y, and its stock price index is up 53.1% (chart). There should be more upside for the rest of the year, especially if the war in the Middle East heats up after the mid-term elections, as Trump has threatened.

Oil & Gas Refining & Marketing has been the sector's big winner so far this year (chart). A global shortage of refinery capacity might fuel more gains.

(2) Financials. The Q3-2026 earnings reporting season starts this week with the big banks. The sector's stock price index is nearly down at its 200-day moving average (chart). Solid earnings reports from the banks are likely, as we explained last week. If so, then the sector's uptrend should hold.

Rising interest rates are probably boosting the net interest margins of the large banks. However, the rapid ascent in bond yields in recent weeks has unnerved investors, as evidenced by the sharp drop in the sector's forward P/E since mid-August (chart). Bond yields may be stabilizing as investors are drawn to higher returns.

The sector's forward earnings is up 17.3% y/y, while its stock price index is up only 4.9% y/y (chart). A solid Q3 earnings season should lift the sector.

So far this year, insurance industries have performed best in the sector (chart).

(3) Industrials. Industrials balanced competing forces this week—benefiting from safe-haven rotation and robust structural demand, while facing occasional headwinds from surging energy input costs and persistent high-interest-rate pressures. This S&P 500 sector is also testing support at its 200-day moving average (chart).

This is another sector where forward earnings is rising faster than the sector's stock price index (chart). The price action sometimes leads the growth rate in forward earnings. This time may be different as the AI buildout continues to boost the sector's earnings.

Construction Machinery & Heavy Trucks is the sector's best-performing industry so far this year (chart). Second best has been Rail Transportation. Notwithstanding the wars in the Middle East and between Russia and Ukraine, Aerospace & Defense has been the weakest industry. Military budgets for large munitions and battlefield weapons may have to make room for more spending on AI-guided drones and "Terminators."

I. Treasury Yields

US Treasury yields fell sharply today, extending Wednesday's retreat from intraday highs. The 10-year yield dropped 9bps to 5.10%, while the 30-year fell 10bps to 5.43% (chart).

Even the 2-year yield declined slightly to 4.77% (chart).

Remarkably, this broad-based decline occurred despite two hotter-than-expected inflation reports. Normally, such surprises would push Treasury yields higher as investors priced in a more hawkish Fed.

So, what's going on? We think the bond market is focusing on the sustainability of the AI investment boom. That issue came to the fore this week as CoreWeave's bonds plunged below 80 cents on the dollar and debt financing major data center projects also tumbled. A new Gartner report estimates AI data center operators will need $8.5 trillion in revenues through 2030 to cover costs and earn healthy returns, versus projected revenues of "just" $3.6 trillion.

Why does this matter? The AI buildout has become a major engine of US economic growth. But doubts about future returns are pushing up borrowing costs, potentially constraining access to capital and ultimately slowing investment spending.

As a result, investors may be lowering their economic growth expectations amid concerns that the AI boom could slow, pushing Treasury yields lower. This reinforces our longstanding view that the earlier surge in Treasury yields largely reflected stronger-than-expected nominal GDP growth (chart).

We are nowhere near ready to write off the AI investment boom. Demand for compute continues to outpace supply, while rising adoption should fuel further investment. Indeed, just five hyperscalers (Amazon, Alphabet, Meta, Microsoft, and Oracle) are expected to spend a combined $892 billion this year and $1.1 trillion next year. Their strong balance sheets and cash flow generation make their spending plans relatively insensitive to higher borrowing costs. While heavily indebted AI infrastructure providers may struggle, we expect the hyperscalers to keep spending and the Roaring 2020s to keep roaring.

II. Inflation

Let's take a closer look at September's hotter-than-expected PPI report and what it tells us about inflationary pressures in the pipeline.

(1) PPI for final demand. September's PPI final demand surged 1.3% m/m, largely reflecting a 10.8% spike in energy prices. However, even excluding the volatile food, energy, and trade services components, producer prices still rose 0.5%, suggesting that inflationary pressures remain broad-based.

On a y/y basis, core PPI final demand rose to 5.0%, with services and goods prices rising 5.0% and 5.2%, respectively (chart).

(2) PPI for consumption. The PPI for personal consumption, a key input into the Fed’s preferred PCED inflation gauge, surged by 1.3% m/m in September (chart). Excluding food and energy, it was up 0.6%.

Core PPI personal consumption rose to 4.6% y/y and remained well above both core PCED and core CPI inflation, suggesting that upside risks to consumer inflation remain elevated (chart).

(3) Supercore inflation. The PPI supercore inflation rate rose to 4.6% y/y in September (chart).

(4) Core PCED. With September CPI and PPI now in hand, most forecasters expect core PCED inflation to rise 0.3% m/m in September, which would lift the y/y rate from 3.0% to 3.1%. The Cleveland Fed’s Inflation Nowcasting model projects 0.28% m/m and 3.05% y/y, respectively.

III. Booming Economy

For now, the US economy shows no signs of slowing down. Consider the latest data points:

(1) Jobless claims. Initial jobless claims edged up slightly to 199,000 in the week ended October 10, the fifth straight week below 200,000. That is the longest streak since 1969! Continuing claims declined to 1.71 million, dragging down the 4-week moving average to the lowest level since April 2023 (chart).

(2) Retail sales. September retail sales rose 0.8% m/m, partly driven by a 6.4% surge in gasoline station sales amid elevated pump prices (chart). Still, eight of the 13 major categories posted gains. Sales at food services and drinking places, the only services category and a key discretionary spending indicator, jumped 1.1% m/m, their eighth consecutive monthly gain. They rose 7.0% y/y, the strongest increase since March 2023.

(3) GDP. Reflecting today's retail sales report, the Atlanta Fed’s GDPNow model estimates Q3 real GDP growth at 3.6% (saar), unchanged from October 8 (chart). Consumer spending is projected to rise 3.6%. AI-related demand is boosting business equipment investment (17.6%), fixed business structures (7.0%), and intellectual property investment (6.6%). Final sales to private domestic purchasers are expected to grow 4.7%.

I. Risk Off Is Back

On September 15, we advised our readers to "Proceed With Caution." We postponed our year-end S&P 500 target of 8,400 to mid-2027. Our concern isn't earnings; it's stock valuations.

We remain bullish on the economy and earnings, expecting no recession through the end of the decade in 2029. Accordingly, we haven’t lowered our 2027 S&P 500 earnings forecast of $425 per share, which is only slightly above the industry analysts' current consensus of $423.08 (chart).

Instead, we lowered our year-end forward P/E forecast from 19.8 to 18.6; that’s what reduced our year-end S&P 500 target to 7,900. So far, our caution has been warranted. The S&P 500's forward P/E has been moving toward our targeted valuation multiple (chart).

Risk-off sentiment was on full display in the stock market today for most of the reasons we flagged in mid-September. The S&P 500 fell 1.1% to 7,718.94, while the Nasdaq Composite and Russell 2000 both dropped 1.9%. Selling pressure was particularly pronounced among technology stocks, with the SOXX tumbling 4.5% (chart). Interestingly, IGV fell 3.0%, while MAGS was down only 1.9%.

The AI trade is getting sloppy amid intensifying competition and doubts about returns on massive AI investments. Shares of heavily indebted neocloud provider CoreWeave plunged 16% today amid growing concerns about its ability to service its debt (chart). Furthermore, today's CPI was hotter than expected, raising the odds of two Fed rate hikes over the rest of this year. A cargo ship sank in the Strait of Hormuz after hitting an Iranian mine.

Meanwhile, the risk-off sentiment we anticipated may be helping Treasuries find their footing. On Saturday, we suggested that the 10-year Treasury yield might stabilize around 5.25%. So far, that call is holding up despite mounting fears of further Fed tightening today (chart). That's partly because Treasuries offer attractive real returns, with the 10-year TIPS yielding around 2.90% (chart).

Our worry list remains long, including more partisanship after the midterm elections and a re-escalation of the war in the Middle East. We expect risk-off sentiment to persist, further compressing valuation multiples. That's why we still recommend proceeding with caution. On the other hand, buying opportunities are increasing, and Santa could still deliver a year-end rally up to 7,900.

II. Inflation Is Back Too

Today's September CPI report fueled bets on further Fed tightening. The probability of an October rate hike jumped from 21% to 36%, briefly reaching 45%. Meanwhile, the 2-year Treasury yield surged as much as 13bps intraday before closing 3bps higher at 4.79%, roughly 95 bps above the midpoint of the federal funds target range (chart).

Here's more:

(1) CPI inflation (m/m). The headline CPI jumped 0.6% m/m in September, its biggest increase since March, led by a 9.3% surge in energy prices (chart). But inflationary pressures were broad-based, with the core CPI rising 0.3%, including gains of 0.3% in core goods and 0.4% in core services. Indeed, 52% of CPI categories recorded inflation above 3% y/y, with 70% above 2%.

Durable goods prices jumped 0.9% m/m in September (chart). Notably, prices of computers, peripherals, and smart home assistants rose 1.3%, pushing this three-month moving average inflation rate to a record high. That reflects surging semiconductor prices driven by the AI investment boom. Tariffs are also adding to inflation, with prices of other household equipment and furnishings jumping 2.1% m/m.

Nondurable goods prices jumped 1.4% m/m in September, led by a 9.3% surge in motor fuel prices (chart).

The services sector also showed broad-based inflationary pressures, with prices rising 0.4% m/m (chart). Higher energy costs are passing through to transportation and travel services, while robust aggregate demand is sustaining pricing power.

(2) CPI inflation (y/y). Both headline and core inflation accelerated on a y/y basis in September, marking the 67th consecutive month that inflation has remained above the Fed's 2% target (chart).

Both goods and services inflation rose in September (chart). With durable goods deflation unlikely to return soon, services inflation must fall more to bring inflation back to target. However, services inflation remains stubbornly elevated.

Supercore CPI inflation rose to 3.2% y/y in September, underscoring the persistence of underlying price pressures (chart).

III. The Fed's Beige Book

The Fed's October Beige Book, which summarizes economic conditions across the 12 Federal Reserve districts, reinforced the September CPI report's message that inflation remains troublesome.

Half the districts reported robust or accelerating price pressures, compared with broadly stable inflation in September. Four districts reported accelerating inflation, while three characterized price growth as robust, up from one previously. Higher energy costs, tariffs, and insurance premiums were the main drivers, with diesel costs passing through via freight surcharges (chart). Expiring hedges and contract renewals threaten further increases.

Meanwhile, economic activity remains robust, supported by strong manufacturing demand from AI data centers, defense, and energy.

I. Stocks: Happy Fourth Anniversary!

Yesterday marked the fourth anniversary of the stock market bull run. The S&P 500 is up 118.3% since it began. The bull market has survived the pandemic, global supply-chain disruptions, rebounding inflation, two oil price shocks, a significant round of Fed rate hikes, soaring bond yields, a financial crisis, Trump's tariffs, and two wars. It has also survived concerns about the market’s leadership being too concentrated in a few outperforming stocks.

Only two of the S&P 500's 11 sectors have outperformed the index: Information Technology (258.1%) and Communication Services (196.7%). The others posted reasonably strong bull-market returns. Keep in mind that the three most underperforming sectors include many companies that pay relatively high dividends to shareholders (charts).

Since 2025, the current bull market has been increasingly led by FEMO (Fabulous Earnings Momentum). Since the bull market started, S&P 500 forward earnings is up 73.9%, while the forward P/E is up 25.4% (chart).

A recent concern is that FEMO has been too concentrated. Our diffusion indexes show that the percentages of S&P 500 companies with positive 3-month and 12-month increases in forward revenues and forward earnings have risen significantly during the bull market (charts).

On a y/y basis, all sectors are showing solid gains in forward earnings, with the three worst laggards including many companies that pay relatively high dividends to shareholders, as noted above (chart).

Nevertheless, this has been a tough year for stock pickers so far, with 41.2% of S&P 500 companies’ stocks down ytd (chart).

II. Update on the US Economy

As we noted recently, analysts expect positive revenue and earnings growth across all 11 S&P 500 sectors in Q3 on a y/y basis. This broad-based strength reflects the remarkable resilience of the US economy. The latest economic indicators provide further evidence of that resilience. Here's more:

(1) Bank earnings. The big banks kicked off Q3 earnings season today, with JPMorgan Chase, Goldman Sachs, Citigroup, and Wells Fargo reporting solid results. Their commentary confirms that strong consumer spending and business investment are translating to robust lending growth and investment banking activity, while credit quality remains healthy (chart).

JPMorgan CEO Jamie Dimon pointed to "strong business investment and ongoing consumer spending," while Goldman Sachs CEO David Solomon observed that "the economy continues to be very, very resilient despite some of the headwinds." Wells Fargo CEO Charlie Scharf offered a particularly upbeat assessment, noting that despite mixed consumer sentiment, "consumers are spending more, loan delinquencies are low, and deposit and investment balances have grown." He added that strong employment, wage growth, and AI infrastructure investment continue to outweigh the risks from higher interest rates, oil prices, and inflation. Citigroup CEO Jane Fraser likewise observed that despite all the attention surrounding the AI boom, "the consumer is still driving much of the growth."

(2) Consumer spending. The latest Redbook data confirm the bank CEOs’ upbeat assessments of the US consumer. Redbook same-store sales surged 10.4% y/y during the week of October 9, the strongest increase since 2022 (chart).

Bank of America's September Consumer Checkpoint provides further evidence of consumer strength. Credit and debit card spending per household rose 6.2% y/y, or 5.1% excluding gasoline, both the third-fastest rates in four years! Even more encouraging, spending growth is broadening across income groups. Card spending rose 5.5% y/y among lower-income households, compared with 4.9% and 4.8% among middle- and higher-income households, respectively. Only the top 5% of earners posted stronger growth, at 5.9%.

(3) Labor market. What's behind the broadening of consumer spending? A key pillar is the labor market. Bank of America also reports that after-tax wage and salary growth reached 4.5% y/y among lower-income households in September, compared with 3.8% and 3.7% among middle- and higher-income households, respectively. Stronger wage growth is helping consumers absorb higher living costs without sacrificing discretionary spending.

The latest weekly ADP data suggest that labor market strength persists. Private-sector employment rose by 24,750 during the week of September 26, the sixth consecutive weekly acceleration and the strongest gain since early June (chart). That implies a monthly pace of roughly 96,300 jobs, comfortably above most estimates of the breakeven pace needed to keep the unemployment rate low and stable.

Meanwhile, small business hiring plans moderated somewhat in September but remained above historical norms. The latest NFIB survey showed that 17% of small businesses planned to increase employment, well above the historical average of 11% (chart). Job openings remained 8 percentage points above their historical average. A shortage of qualified workers continues to constrain hiring, with 45% of firms reporting no qualified applicants for their open positions compared with the historical average of 37%.

The bad news is that the NFIB survey shows that pricing pressures remained elevated in September (chart).

The most frequently cited problem faced by small business owners is the quality of labor (chart). We expect they will solve this problem by boosting productivity through AI and other technologies.

I. Adding It Up

The bond market had a good day today: It was closed for Columbus Day. We think that yields have risen high enough to attract buyers. If so, then yields should stabilize around current levels. Plenty could still go wrong, making bond yields even more attractive. The war in the Middle East is likely to heat up again after the midterm elections, sending oil prices higher. On the other hand, this week's core CPI is likely to rise just 0.2%, which would likely postpone a Fed rate hike from later this month to early December.

For now, let's focus on the supply of debt in the US, which is a longer-term concern for the bond market.

The US Treasury borrowed $749 billion during the three months through September (chart). That's the change in marketable securities held by the public over the three months. The 10-year Treasury bond yield rose from roughly 4.50% to 5.25% over that period. In the past, the supply of government securities rarely seemed to drive bond yields. The key drivers were expected and actual inflation and the Fed's reaction to both.

In the past, federal budget deficits tended to widen the most during recessions, when tax revenues fell faster than the government’s outlays (chart). The supply of Treasury securities would be increased as the Fed lowered interest rates to revive economic growth. The deficits would narrow during economic expansions, as revenues rose faster than outlays.

Over the past three years, the economy has been booming, but the government’s budget deficit remains very wide. It hasn't narrowed because outlays are growing faster than receipts. Allowing that to happen is fiscal recklessness. That’s because it requires increasing the supply of government debt during an economic boom, when private credit demands are surging, which necessarily puts upward pressure on interest rates. If rates get high enough to cause a credit crunch and a recession, attempts to revive the economy with deficit-bloating fiscal stimulus could backfire by pushing bond yields higher. If deficits are this large during good times, what happens when the bad times arrive?

For now, we believe the backup in US bond yields is driven more by better-than-expected US economic growth than by the government's deficit. In our view, bond yields are back to their "old normal," i.e., consistent with robust economic growth. In other words, the US isn't on the edge of a debt crisis. In the Roaring 2020s scenario we expect, productivity-led economic growth boosts government revenues and lowers America's deficit and debt ratios relative to nominal GDP. Both Treasury Secretary Scott Bessent and Fed Chair Kevin Warsh believe this will happen. The question is whether the Bond Vigilantes will patiently wait for this outcome. We're not so sure.

For perspective, let's add up US debt and compare it to public and private debt in other countries:

(1) Total US debt reached a record $118.9 trillion in Q2, including $83.8 trillion in nonfinancial debt and $27.7 trillion in financial debt (chart).

(2) The composition of nonfinancial debt has shifted dramatically since the Great Financial Crisis (GFC). Before 2008, Treasury debt was smaller than household and business debt. That relationship reversed as Washington borrowed heavily during the GFC while the private sector deleveraged. The Great Virus Crisis (GVC) in 2020 accelerated the shift. By Q2-2026, marketable Treasury debt held by the public had reached a record $30.9 trillion, exceeding both household and business debt (chart).

(3) Relative to nominal GDP, total US debt has declined since the GVC to 374.1% in Q2 (chart). The financial sector drove much of the decline, with financial debt falling from around 150% to 87.0% of GDP since the GFC. Nonfinancial debt is at 263.8%, remaining relatively stable in recent years despite rising government debt, with a brief exception during the GVC.

That stability masks a significant shift. Treasury debt has surged from around 30% of GDP before the GFC to 97.2% in Q2, while household debt has fallen from nearly 100% to 67.0% and business debt has also declined (chart). Private-sector deleveraging has partly offset rising government indebtedness relative to GDP.

Separating Treasury debt from total nonfinancial debt makes the divergence even clearer. Nonfinancial debt excluding Treasuries has fallen from roughly 200% of GDP during the GFC to 166.5% in Q2, as Treasury debt surged to 97.2% of GDP (chart).

(4) Total US debt securities and loans reached a record $120.1 trillion in Q2, comprising $67.3 trillion in securities and $52.7 trillion in loans (chart). Securities have grown faster than loans since the GFC.

Marketable Treasury securities held by the public have surged to $30.9 trillion, far exceeding corporate and foreign bonds, which they overtook following the GFC (chart). Government borrowing has become increasingly dominant in US debt markets.

In short, private-sector debt is down relative to GDP since the GFC, while the public sector has become more indebted relative to GDP. Healthier household and business balance sheets should make the economy more resilient to future shocks, reducing the potential need for government bailouts and additional borrowing. That could help preserve Treasuries' traditional role as a safe haven during the next crisis, despite elevated government debt.

II. Global Comparisons

(1) Total debt/GDP. Japan leads the pack, followed by France, Canada, and China. The US is roughly in line with the developed country average, while Germany has the lowest debt ratio among the countries shown (chart).

(2) Government debt/GDP. Japan also tops the government debt ranking, followed by Italy and China. The US and France are well above the developed country average, while Germany stands out with a relatively low government debt burden (chart).

(3) Private debt/GDP. Canada, France, and China have the highest private-sector debt ratios, while the US ranks below the developed country average. Italy has the lowest private-sector debt ratio among the countries shown (chart).

I. Bonds

The Economist just rang the all-clear siren for the bond market (chart). It is safe to buy bonds now that the front cover of the October 10 magazine is titled "Will bonds blow up?" This and other national magazines’ cover stories often have been great contrary indicators. It’s the “front-page curse” (once magazines put in the time it takes them to produce a cover article on a financial market trend, investors have moved on).

We think the 10-year Treasury bond yield is back to normal this year, i.e., in the 4.00% to 5.00% range (chart). We've disputed the widespread notion that "interest rates are likely to remain higher for longer." That implies that they should come back down at some point. We've argued that "interest rates are likely to stay normal for longer." They were abnormally low between the Great Financial Crisis and the Great Virus Crisis, when central banks rigged the fixed-income markets with zero and near-zero interest-rate policies and quantitative easing.

As bond yields rose in recent months to the top end of what we consider the normal range, we expected buyers to be attracted by higher yields, so we expected the range to be maintained (that’s what happened in in 2023, when the yield spiked to 5.00% in late October). This time, the yield spiked above the normal range, to around 5.25% (as it did during the 4.00%-5.00% normal-range period from 2002-07).

In recent conversations with several of our institutional accounts, many expressed interest in buying bonds at levels above 5.00%.

A slice-and-dice analysis of the 10-year yield shows that its rise this year has been almost entirely attributable to the rise in the comparable TIPS yield (chart). The spread, which is a proxy for inflation expectations over the next 10 years, has been range-bound roughly between 2.00% and 2.50% since 2023.

Since 2023, the TIPS yield has closely tracked the Weekly Economic Index, which tracks the growth rate in real GDP on a y/y basis (chart). This supports our view that the increase in US nominal yields has been driven by better-than-expected economic growth.

In the past, the expected inflation spread was highly correlated with the price of a barrel of crude oil (chart). That correlation has been weaker since 2023. Bond investors seem to believe that inflation will remain low in the 2.00%-2.50% y/y range over the rest of the Roaring 2020s into the Roaring 2030s. We agree.

Nevertheless, we can't rule out the possibility that another spike in oil prices, driven by a re-escalation of the war in the Middle East, won't push nominal bond yields higher. If so, that will likely be another buying opportunity.

By the way, the expected inflation spread closely tracks the 10-year forward inflation-linked swap (chart).

All major forward inflation-linked swaps are roughly in the 2.00%- 2.50% range (chart).

Meanwhile, the link between the 13-week change in the 10-year nominal yield and the Citigroup Economic Surprise Index suggests that the former's recent climb should abate (chart).

II. Stocks

The steep rise in bond yields since mid-August has weighed on the S&P 500 equal-weight stock price index, while the market-weight index rose to record highs last week (chart). The former may be finding support at its 200-day moving average.

The gap between XMAGS's outperformance and MAGS's underperformance has narrowed since mid-August as bond yields jumped (chart). Over the past couple of weeks, they both did well.

The Russell 2000 also dipped as bond yields soared since the late summer (chart). The index is back at its 200-day moving average, which should hold if US bond yields continue to stabilize.

III. Sentiment

Investor sentiment turned more bullish last week according to the two bull-bear ratios we track. (chart). Like the front-page curse, they also tend to be contrary indicators. However, they aren't bullish enough to be bearish for stocks.

I. FEMO in Q3

We have spent much of the past few months marveling at Corporate America's Fabulous Earnings Momentum (FEMO). S&P 500 earnings per share growth approached 30% y/y in Q1 and accelerated to more than 50% in Q2, although unusually large mark-to-market investment gains boosted both figures. Even excluding those gains, earnings grew roughly 20% and 25%, respectively. Q2 also marked the fifth consecutive quarter with record earnings.

Q3 is shaping up to be another blockbuster quarter. As Joe reported this week, industry analysts' consensus forecast for Q3-2026 S&P 500 EPS growth started the quarter at an already remarkable 27.6% y/y. Rather than declining as it typically does during the quarter, it climbed 3.0 ppts to 30.6%. The level of expected Q3 EPS rose 2.2% over the quarter, ranking as the 12th-largest upward revision in the 130 quarters since Q2-1994. That's no small feat!

Better yet, FEMO is broadening across Corporate America. Analysts expect all 11 S&P 500 sectors to deliver positive y/y growth in both revenues and earnings. Only once before, in Q2-2021, has such a perfect sweep occurred in the 25 years we've tracked the data. Overall, S&P 500 revenues are expected to grow 11.6% y/y, compared with earnings growth of 30.6% (chart).

Energy is expected to lead Q3 earnings growth at a whopping 114.7% y/y, followed by Information Technology, Communication Services, and Materials (chart). Energy's expected earnings growth has surged from negative territory earlier this year, while Information Technology's has climbed steadily, reflecting the AI investment boom.

II. Financials in Q3

Q3 earnings season kicks off next week with the big banks. The latest banking data suggest there is plenty to be optimistic about.

Commercial and industrial loans rose 9.7% y/y during the week of September 23, while total bank loans and leases increased a robust 7.6% (chart). Both point to strong bank lending.

Large domestic banks are leading the charge, with loan growth of 7.6% y/y compared with 5.5% at smaller banks (chart). Strong bank lending is another reflection of a resilient economy.

Commercial banks' allowances for loan and lease losses stood at $203 billion during the week of September 23, little changed over the past two years, confirming that banks do not see a deterioration in credit quality.

Meanwhile, new US corporate bond and equity issuance reached a record $3.1 trillion over the 12 months through August (chart). That's good news for investment banking activity and another sign of robust demand for capital across Corporate America.

III. What could go wrong?

All this sounds bullish, and it is! But our worry list remains long, not least because of the ongoing conflict in the Middle East. The bid-ask spread between Washington and Tehran remains wide. The risk of a military re-escalation is increasing. For now, we expect energy prices to remain higher for longer, keeping inflation and bond yields elevated (chart).

Meanwhile, global bond yields keep rising (chart). In the US, stronger nominal GDP growth and a higher neutral rate partly explain the rise. The energy shock, the unwinding yen-carry trade, and mounting concerns about fiscal excesses are adding fuel to the fire. In France, the Bond Vigilantes are pushing yields above nominal GDP growth amid high debt, weak growth, and political gridlock. The risk is contagion across Europe.

Other worries include second-round inflation effects, more aggressive Fed rate hikes, rising US debt-service costs, an AI investment slowdown, post-midterm political gridlock, and mega IPOs draining liquidity from the stock market.

Against this backdrop, we recently moved our 8,400 target for the S&P 500 from the end of this year to the middle of next year. Importantly, we haven't lowered our earnings outlook. S&P 500 forward EPS reached a record $406.45 on October 1, and we still expect it to climb to $425 by year-end (chart). Instead, we reduced our target forward P/E from 19.8 to 18.6 to reflect valuation risks.

I. From The Good To The Bad To The Ugly

The spectrum of explanations for the rise in bond yields worldwide includes relatively benign ones to downright dangerous ones (chart). On the good side of the spectrum, better-than-expected economic growth has driven US bond yields up to levels that are back to normal. On the ugly side, soaring bond yields in France are signaling a looming debt crisis. In between are bad scenarios that explain the synchronized rise in global bond yields. These include the inflationary energy shock attributable to the war in the Middle East and the unwinding of the yen-carry trade.

Let's have a closer look at the good, the bad, and the ugly:

(1) R-star rising. R-star, or the neutral interest rate, is the real interest rate consistent with low unemployment and price stability. It balances the supply of savings with demand for investment. Three forces are pushing it higher.

First, demand for capital is booming along with AI-related capital spending. Hyperscaler capex is expected to reach $750-$800 billion this year and $1.2 trillion next. Total US corporate bond issuance over the past 12 months through August was a record $3.0 trillion, including $1.4 trillion and $1.6 trillion issued by nonfinancial and financial corporations, respectively (chart).

At the same time, US Treasury borrowing totaled $2.1 trillion over the past 12 months through September, including $1.3 trillion in notes and bonds (chart).

Second, national savings faces demographic headwinds as retiring Baby Boomers stop saving and draw down their net worth (chart).

Third, stronger productivity growth may be raising the return on capital and the economy’s sustainable growth rate (chart).

The Fed's 175bps cuts in the federal funds rate since September 2024 have been completely offset by a comparable increase in the 10-year Treasury bond yield since then. Even at the start of this year, most Fed officials believed that the FFR was modestly restrictive, i.e., that it exceeded the neutral rate. In September, they acknowledged their error by hiking the FFR by 25 basis points, as Fed Chair Kevin Warsh said they had removed a "dose of accommodation," implying that the FFR is actually below the neutral rate!

(2) Energy shock. Moving toward the middle of the spectrum are higher-for-longer oil prices. With US-Iran talks stalled and the US increasing its military assets, the risk of renewed escalation remains high. The longer energy costs stay elevated, the greater the risk they'll boost core inflation, forcing a more aggressive Fed response. If crude oil prices fall because more oil is getting through the Strait of Hormuz, diesel prices might remain elevated (chart).

(3) Unwinding yen-carry trade. The yen-carry trade was based on ultra-low Japanese interest rates and a stable or weak yen. Now the BOJ is raising interest rates and the yen may be bottoming (charts). This is forcing traders to liquidate bond holdings previously financed with cheap Japanese money.

(4) Debt crisis. At the far end of the spectrum is the "Revenge of the Bond Vigilantes." Between the Great Financial Crisis and the Great Virus Crisis, major central banks' ultra-easy policies enabled governments to run large deficits. The Bond Vigilantes were powerless. But now they are more powerful than ever because government debt is at record highs. Central banks have been forced to raise their policy rates as inflation has been more troublesome in recent years. Bond yields have soared this year worldwide as inflation rebounded and fiscal-risk premiums have risen.

The danger is a self-reinforcing debt spiral: Higher yields raise interest costs, widen deficits, require more borrowing, and push yields higher still (chart). And, of course, higher yields increase the risk of causing a recession, which would exacerbate any debt crisis.

In our view, the US should remain in the higher R-star end of the spectrum. We would start to worry about the debt-crisis danger zone if the US bond yield rises above nominal GDP growth (chart).

In France, on the other hand, the Bond Vigilantes are pushing the 10-year government bond yield well above nominal GDP growth (chart). The French could be toast if yields continue to soar.

II. The Fed Minutes

The latest Fed minutes paint a familiar picture: a resilient economy, a firm labor market, and inflation that remains too high. We drew three key takeaways from the minutes of the Fed’s September 15-16 meeting.

(1) Restrictiveness. Several participants said the current policy rate was not restrictive or only mildly restrictive, while a couple explicitly raised their estimates of the neutral federal funds rate. That fits neatly with our R-star story.

(2) Macro backdrop. The Fed saw a resilient economy: real GDP is expanding at a solid pace, consumer spending has firmed, AI investment remains robust, and the labor market is close to maximum employment. At the same time, inflation remains elevated and risks were still skewed to the upside.

(3) Rate outlook. All participants backed September’s 25bps hike, and most judged that another increase would likely be appropriate by year-end.

I. Blue skies ahead for earnings?

We are now seven years into our Roaring 2020s thesis, which remains our base case for the rest of the decade, and it has played out very well so far. When we first introduced the idea in August 2020, the prospect of another Roaring '20s sounded a bit delusional. We argued that, as in the 1920s, rapidly proliferating technologies would drive a productivity boom that would support stronger economic growth while containing inflation, boosting real wages, widening profit margins, and lifting corporate earnings.

Since the beginning of the current decade, the economy's resilience has repeatedly defied the naysayers, as productivity growth has increased and corporate earnings have continued to climb. With only three full years left in the decade, one of the clearest manifestations of our Roaring 2020s thesis has been what we call FEMO, or Fabulous Earnings Momentum.

FEMO is clearly visible in industry analysts' earnings expectations. They currently expect S&P 500 operating earnings per share to rise to about $364 per share in 2026 and $419 in 2027, implying growth of roughly 15% in both years (chart). Toward the end of Q3 each year, we add another year to our Earnings Squiggles framework. This year’s addition is 2028, with earnings projected to rise another 17% that year to about $489 per share.

For now, the analysts are more bullish than we are about earnings prospects over the remainder of the decade. We are projecting $450 per share in 2028, $475 in 2029, and $500 in 2030. If they are right, our S&P 500 target of 10,000 will be achieved well before the end of 2029!

The extended earnings boom is driven by strong revenue growth expectations. Industry analysts expect S&P 500 revenues per share to rise 12.7% in 2026, 9.2% in 2027, and another 8.3% in 2028 (chart). Those expectations seem too exuberant to us.

Profit margins provide the other driver of the earnings story. Analysts expect the S&P 500 profit margin to rise from 13.2% in 2025 to 15.7% this year, 16.8% in 2027, and a record 18.1% in 2028 (chart). That is what we would expect in our Roaring 2020s scenario, with stronger productivity growth widening profit margins.

The earnings outlook is strong beyond the S&P 500 as well. Industry analysts expect S&P 400 MidCap operating earnings per share to rise roughly 19% in 2026, 14% in 2027, and 13% in 2028 (chart).

S&P 600 SmallCap earnings are expected to increase about 21% this year, 16% in 2027, and 15% in 2028 (chart). That suggests FEMO is broad-based.

II. Blue skies ahead for the economy?

(1) Consumer spending. The latest Redbook data provide yet another sign of continued strength in consumer spending. Redbook same-store sales rose 8.3% y/y during the week of October 2, well above the 5.8% average for 2025 and underscoring the consumer’s continued resilience (chart).

(2) Labor market. ADP estimates that private-sector payrolls rose 23,750 in the week through September 19, up from an upwardly revised 22,500 the prior week and marking the fifth consecutive acceleration in weekly job gains (chart). It was also the strongest weekly increase in three months. The ADP numbers for private industry payrolls make more sense to us than the Bureau of Labor Statistics’ payroll employment data.

(3) Trade balance. The latest US trade data point to still strong US and global economic growth. US imports rose 4.3% m/m and 23.6% y/y in August, accelerating from July, while US exports increased 1.4% m/m and 12.3% y/y. Imports reached a $3.36 trillion annualized rate, versus $2.03 trillion for exports, leaving a merchandise trade deficit of $1.33 trillion annualized (chart). The gap reflects exceptionally strong US demand for imported goods.

Nominal and real US merchandise exports plus imports rose 23.1% y/y and 7.1%, respectively, in August (chart). That suggests global trade remains firmly in expansion territory and is consistent with strong global economic growth.

Selected technology imports reached a record $56.6 billion in August (chart). The AI buildout is highly import-intensive and requires large volumes of semiconductors, servers, networking equipment, and other hardware produced overseas.

I. Profits, Cash Flow & Capital Spending

Corporate profits are the economy's lifeblood. As Dr. Ed explains in his 2021 book, In Praise of Profits, profits are not merely a reward for economic success; they also drive the economy. Strong profits give businesses both the incentive and the financial means to expand, generating the cash flow needed to invest in capital, hire workers, and pursue new opportunities. At the same time, profits reward successful businesses and encourage entrepreneurs to take risks, innovate, and direct capital toward its most productive uses. Consumers benefit from employment gains and from better goods and services.

Let’s examine how Corporate America is turning record profits into record cash flow and putting that money to work:

(1) Profits. Corporate America is highly profitable. Pre-tax profits from current production rose to a record $4.7 trillion (saar) during Q2, while after-tax profits reached a record $3.9 trillion (chart). That leaves businesses with a large pool of earnings to distribute, retain, and reinvest.

Profits earned abroad by US corporations rose to a record $1.2 trillion in Q2, confirming that the global economy is also doing well alongside the US economy (chart). After subtracting $651 billion in profits earned in the US by foreign corporations, net rest-of-world profits totaled $546 billion (chart).

(2) Profit margins. Economy-wide and S&P 500 profit margins both rose to record highs during Q2 (chart). The S&P 500 forward margin jumped to 18.0% in Q2, partly reflecting mark-to-market investment gains at Alphabet and Amazon. The economy-wide GDP growth measure excludes such capital gains and still rose to a record 11.9%.

Unit profits have risen sharply too, meaning that selling prices have outpaced labor costs per unit of output (chart).

The S&P 500 forward profit margin rose to a record 16.7% in early October, well above the S&P 400’s 8.9% and S&P 600’s 7.6% (chart). The gap largely reflects the greater scale, pricing power, and productivity of large-cap companies.

(3) Retained profits & cash flow. After-tax corporate profits have surged in recent years, but dividend payments have risen much less rapidly. As a result, undistributed profits rose to a record $1.7 trillion (saar) in Q2 (chart). That leaves businesses with plenty of internally generated funds to pursue today’s abundant investment opportunities, not least of all those presented by the AI boom.

Corporate cash flow, which combines undistributed profits with tax-reported depreciation allowances, rose to a record $4.6 trillion in Q2 (chart). Those depreciation allowances have been boosted this year by generous expensing provisions, including the OBBBA’s 100% write-off for qualifying investment, which lowers current tax liabilities and boosts near-term cash flow.

(4) Capital spending. As corporate cash flow has climbed to a record high, businesses have been putting that money to work. Nonresidential fixed investment has risen in lockstep and reached a record $4.7 trillion (saar) in Q2 (chart).

Increasingly, that spending is being directed toward high-tech investments. High-tech capital spending surged 16.8% y/y in Q2, far outpacing the 2.0% gain in low-tech investment (chart).

Indeed, high-tech investment now accounts for a record 54.8% of total nominal capital spending (chart).

Most of the current nonresidential investment boom is tied to AI-related spending, particularly on software, information-processing equipment, and R&D (chart). That is where much of the cash generated by record profits and elevated retained earnings is now being deployed.

Profits increasingly have outpaced private sector employment (chart). This aligns with rising productivity, especially in high-tech industries, where businesses generate more revenue and earnings without a proportional increase in employment. This can help offset labor shortages caused by population aging and slower immigration.

The same shift is visible in the distribution of national income. Employee compensation fell to 59.7% of national income in Q2, while corporate profits rose to a record 17.2% (chart). Put differently, a growing share of income is accruing to capital rather than labor. However, keep in mind that profits are funding dividends and driving the stock market higher, thus boosting the incomes and the net worth of many households.

II. US Economy

As Corporate America mints money and reinvests it in today’s remarkable investment opportunities, the US economy continues to expand at a solid pace.

The latest evidence comes from the September ISM NM-PMI. The headline index rose to 54.9 in September, while business activity, new orders, and employment all remained in expansion territory (chart). New orders were especially strong at 59.8, suggesting continued momentum in the service sector.

The bigger concern is prices. September's NM-PMI prices-paid index climbed to its highest level since 2022 (chart). Historically, it has been a useful leading indicator of core PCED inflation, the Fed’s preferred measure of underlying inflation.

Last week was relatively quiet on the economic data front, but the indicators released pointed to continued economic strength. ADP weekly payroll gains increased for the fifth consecutive week, reaching a three-month high, while jobless claims fell to multi-year lows. The ISM NM-PMI remained solid at 54.9 in September, though its prices paid component jumped to 74.0, the highest since July 2022. Redbook same-store sales rose 8.3% y/y during the week of October 2, signaling continued strength in consumer spending, while the New York Fed's consumer survey showed expected spending growth and one-year-ahead inflation expectations both reaching three-year highs.

The data suggest that the Fed has good reason to be hawkish. Accordingly, September's FOMC meeting minutes showed that most policymakers favored another rate hike by year-end, with several judging monetary policy to be barely restrictive, if at all. We agree that further tightening is warranted. However, recent comments by New York Fed President John Williams, Fed Vice Chair Philip Jefferson, and Governor Christopher Waller suggest flexibility on the timing. The markets assign a 17.2% probability to an October hike and a 71.6% probability of a December hike.

This week's inflation reports could change those odds. A hotter-than-expected CPI reading on Wednesday could prompt the markets to price in an October hike, pressuring the Fed after September's unanimous 25bps increase, which Fed Chair Kevin Warsh described as removing "a dose of accommodation." An in-line or cooler CPI reading would support patience. Warsh speaks Thursday evening at the IMF and World Bank annual meetings in Bangkok.

Here's more:

(1) Inflation. The September CPI and PPI reports will be released on Wednesday and Thursday, respectively. The Cleveland Fed’s Inflation Nowcast model projects a hot 0.53% m/m increase in headline CPI, while core CPI is expected to rise a more modest 0.2%. That would put headline and core CPI inflation at 3.6% and 2.4% y/y, respectively. September is expected to mark the 67th consecutive month of CPI inflation exceeding 2.0% y/y, underscoring the persistence of inflationary pressures (chart).

Adding to inflation concerns, the averages of the prices-paid and prices-received indexes of five regional Fed banks’ business surveys rose to their highest levels since 2022 in September (chart). Both have historically tracked headline CPI inflation closely.

The same indicators have also closely tracked PPI final demand inflation, which was already running hot at 5.4% y/y in August (chart).

(2) Monthly Treasury statement. The federal budget deficit totaled $1.77 trillion over the 12 months through August, while outstanding marketable Treasury securities increased by $2.12 trillion over the 12 months through September (chart). The recent slowdown in Treasury borrowing suggests that the deficit may have narrowed somewhat. Tuesday's report will reveal the final budget deficit for fiscal 2026, which ended on September 30.

(3) Consumer spending. Thursday's September retail sales report will provide the first official reading on consumer spending for the month. We expect another solid increase, as Redbook same-store sales rose 8.3% y/y in September, well above the 2025 average of 5.8%. Redbook sales historically have tracked official retail sales closely, suggesting that consumer spending maintained strong momentum through the end of Q3 (chart).

(4) Manufacturing. The week will also provide important insights into the manufacturing sector, with the October New York and Philadelphia Fed banks’ business surveys due Thursday, followed by September's industrial production and capacity utilization reports on Friday.

Manufacturing aggregate weekly hours rose to 84.4 in September, the highest since August 2023, continuing their recent upward trend (chart). Immediate expensing under the OBBBA, reshoring, and the AI buildout are helping to reinvigorate manufacturing activity. With skilled labor in short supply, manufacturers appear to be meeting stronger demand partly by increasing the hours worked by existing employees. The rise in aggregate hours worked suggests that manufacturing production expanded at a healthy pace in September.

The New York and Philadelphia Fed manufacturing surveys provide another reason for optimism. Their average manufacturing PMI rose to 22.7 in September, the highest since 2021 (chart). Historically, the average has closely tracked manufacturing production growth, suggesting that factory output could accelerate further in the months ahead.