Bankshot

So far, so good on my buy-the-market call from last week. Bond yields have stalled out. Netflix has rallied on the massive termination payment from the Paramount deal and cost-cut announcements. And with the onset of earnings season, there is renewed focus on the resilience of the U.S. consumer. This week's reaction to bank earnings is critical to the overall market health. Money center bank reports have been a pivot point in the past, and given the rotational nature of the market correction that we have seen so far, they remain a key indicator to watch. This trendline must hold, or further downside is likely.

S&P Bank ETF

Despite the existential nature of the various threats posed by the failed Iran gambit and AI hacks, the stock market has expressed little macro-based fear. Even the Midterms, with Trump's non-trivial threats to orderly transfers of power, are likely to come and go without any lasting market impacts. I believe any overt attempt on his part to thwart the results could mark the end of the MAGA dominance of the GOP. The knives are sharpening in the backrooms of Congress, and a soon-to-be-lame-duck President is an easy target once the 2028 race begins Nov. 4th.

As for predicting any AI guardrails, your guess is as good as mine. Self-regulation is the buzzword now. But unless an AI equivalent of the Hippocratic oath - "do no harm" - is widely and immediately adopted, there will be more negative headlines. Any slowdown in AI adoption due to these fears should dampen AI-related investment and hamper capex growth in the short term. That is a win-win for the inflation/bond story. Less crowding at the Treasury auction window from Hyperscalers and lower inflation premiums on long bonds.

I believe inflation will soon recede as the pass-through of higher energy costs in the CPI runs its course. It will take a few more reports of $100/bbl-infused CPI, but demand destruction in discretionary spending is a huge offset. Look at the chart below to see the steady downtrend in non-food and non-energy prices. Real wages aren't keeping up either, further dampening inflation expectations.

Powell was right after all; it's transitory! I stick by my out-of-consensus call for Fed easing by next year.

Sticky Inflation

And more fuel is coming for the mid-cycle rotation from Growth to Quality factors in stock selection. As the highly overbought Semis start a fresh downleg, the rest of the market has survived the bond market's hissy fit. Bond volatility has peaked, in my view, as real rates have returned to normal levels after years of Fed repression. This has happened without the feared contagion to the S&P 500 despite abnormally high AI concentration. Breadth and Correlation measures have started to bottom out. Opportunities are plentiful in many non-AI-related companies. Starting with an oversold bounce in the banks and interest-sensitive utilities, many quality large-cap stocks are ready to assume leadership. Visa, MasterCard, and Apple have just broken out and look higher.

Bond Volatility

A side benefit of a reversal of expectations on Fed hikes could filter through to hard assets, at some point. The US dollar has been pushed from direct investment into the AI boom and the flight-to-quality trade as the Fed hiked rates. The BofA Fund Manager Survey this morning revealed that a crowded trade has developed in 'long dollar".

Keep some protection trades on, though. The self-fulfilling sell-off due to Semi weakness would be worrisome if it becomes systemic. I'm optimistic we can navigate the AI investment slowdown without a left-tail event, but I've seen too many of those to completely dismiss the bear camp.

That's why this bankshot matters so much.

Risk Model: 5/5 - Risk On

The lack of correlation in the market has actually worked in its favour. Despite the mini-bear in Financials, the broad market hasn't exhibited any volatility. Stocks have held firm in the face of rising bond yields despite the macro threats, partially because earnings have been higher than at any time in the past 30 years - outside of recession recoveries. That has reduced the overvaluation fears enough for now, but those earnings had better keep coming!

3 Month Volatility

S&P 500 Earnings YOY