Erik@YWR on S&P Earnings: “An Insanely Good” Picture

Delighted to welcome back Erik from Your Weekend Reading for another episode of For the Record. Lots of big brain thinking from him as always…

🏠Housekeeping Note: While some of this episode is free for everyone to watch, the full episode is for paying subscribers only. Thank you as always for your support. If you’d like to pull up a chair, you can join right here.

Per the University of Michigan Consumer survey, “consumer sentiment has never been lower,” said Erik, who dug into the survey in his Killer Charts pack here.

“It’s negative about people’s current prospects, negative about how they feel a year from now, negative about how they feel about their job outlook,” he said.

He also flagged what the survey says about one year forward price expectations. Back in the 70s, when the survey began, it was up at 12-14%, and bond yields were high. “And then interestingly, consumer price expectations dropped relatively rapidly in the early 80s to 3-4%,” Erik said. “That number stayed roughly in the 3-4% range for 40 years, until 2020.” While expectations came down pretty quickly in the 80s, Erik pointed out that it the bond market moved more slowly - “It took several years to come down to 5-6%,” he said.

So, then in 2021 we saw a sharp jump in consumer inflation expectations with COVID. “They are now making a new all time high and the consumer is expecting 8% inflation,” Erik said. And if the bond market follows the same pattern, “it’s suggesting that we should imminently have a high move up in the 10-year, to 5-6%.”

What Erik thinks is “the biggest disconnect in the market right now” is that, the chart is saying “bond yields are going up,” while the Fed is signaling that inflation is going to decline.

He compared the situation to Zimbabwe, where there was very high nominal inflation and the stock market going through the roof, while the central bank didn’t react. In the US, if the Fed keeps saying everything’s under control and the bond market agrees with it, that would mean “equity investors having our cake and eating it too.” Other reasons he thinks the Fed may be slow to react is, Trump doesn’t want rate hikes, and the Fed is trying to get through to the midterms.

💡The risk that Erik is keeping an eye on is that the 10-year doesn’t buy what the Fed’s selling, and say “hey, wait a second here. 4.5% isn’t the right number here. This should be closer to 6%.”

Note: This conversation was recorded the morning of the Fed meeting on July 27 - there was no rate change.

If you step back and look at the S&P at the meta level, “the index level earnings are insanely good,” Erik said. “The estimates for next year are another 17% growth. And that’s with energy supposed to decline next year. The analysts have heard the bubble story, and yet they are going back to their model and having to raise numbers quarter after quarter after quarter. And now we’re looking at $400 a share EPS estimate for 2027 on the S&P.

Last year, after the tariff tantrum, Erik made the brave call that the S&P would go to 10,000 by the end of 2027, up 40% from where it was then. “I thought that by the end of 2027, you’d be looking ahead to 2028 earnings and that the 2028 EPS estimate on the S&P could easily be $400. And that $400 estimate that I expected to be happening in 2028 is [now expected to happen] in 2027.”

What’s fueling it is “everything,” Erik said, including government spending, the fact that the bond market is not freaking out about government spending, corporates “are spending their brains out,” and an underappreciated factor, which is that banks are now being pushed to lend and take risk again.

💡”Every lever is pumping,” Erik said. “The government is spending money, the companies are spending money, and the banks are spending money, and that’s also why I have a really hard time buying these credit crisis arguments.”

That’s the end of part 1. Part 2 of the conversation continues for our paid subscribers below, where Erik shares the biggest themes he’s watching now, and why we could be underestimating the AI trend. Thank you for your support.