Get Mike Santoli’s Market Memo in your inbox first. Subscribe here
Three weeks after a spirited recovery that pushed stock prices to new records, it’s time for the market to prove that the blessed relief has given way to genuine belief.
The recovery since late July, when the S&P 500 rose more than 6% in 12 trading days, is what I call an “all fear removed” rally.
A few weeks ago, these concerns weighed on the index. Concerns that major technology platforms will be further punished for their escalating AI investments. The frenzy of semiconductor buying turned into a bursting bubble. And the Federal Reserve will have to pursue inflation with higher interest rates.
Strong growth in cloud services, as evidenced by hyperscalers’ earnings, was met with a decline in stock valuations, driving a rise in detente at magnitude 7. Semiconductor companies responded to the washout technical conditions, recovering just under half of the 30% plunge in five weeks. And market expectations for Fed rate hikes are dampened by positive inflation indicators and uncertainty about payrolls and retail sales.
Therefore, there is a rush for peace of mind and added equity risk with both personal and professional funds.
John Kolovos, head of technical research at Macro Risk Advisors, whose Sentiment Gauge is featured below, has been wary of the possibility of a market collapse last month. But he points out that Big Tech earnings gave the index a “kick save” a few weeks ago. He now predicts the S&P 500 index could “stretch the needle” to 8,300 (up 6-7%) by early next year, with some declines in late summer. Kolovos believes momentum stocks have the potential to extend tactical gains, and Chinese stocks are a buy for those looking to make that leap.
Is the rapid increase in profits real?
Analysts and strategists are currently gushing incessantly about reports of a geyser of corporate profits that beat second-quarter expectations, leaving bulls feeling very virtuous being redeemed by fundamentals.
Pretty good; it does support tape, everything else is the same.
However, there is no escape from the troubling possibility that this jackpot could result in companies making too much money. It’s not just that the results were flattered by gains in the tech giant’s stocks for OpenAI and Anthropic, companies that need far more capital to meet all the spending commitments that are inflating the AI infrastructure companies’ orders.
That gaudy number also represents recorded revenue for data center construction, funded by the hyperscaler’s past revenue and now lost free cash flow, against which expenses will only be recognized in future quarters. Add to that the fact that the energy sector’s profits temporarily surged due to wartime supply disruptions, and that many companies are reporting difficult results due to the disruption of “Liberation Day” in the second quarter of 2025.
Of course, current profit estimates continue to rise, so the moment of earnings is likely not here. Still, I’d like to proceed with the assumption that we’ve seen a peak in index valuation, if not a peak in index levels.
Last October, S&P posted 23 times expected earnings, buoyed by blanket optimism fueled by AI, lower U.S. Treasury yields and the dominance of large-cap stocks. This P/E ratio also reflects that the market expects earnings to accelerate since then.
Currently, the P/E ratio is around 20, but given the perceived zero-sum aspect of the AI race, the predictable lack of much tech free cash flow, and the new “asset-focused” nature of the business, it may be difficult for the P/E ratio to rise significantly.
Oh, and the S&P Industrials already trades at a P/E of 25x, far higher than at any time this century except when profits collapsed during the coronavirus pandemic, making it a bit tough to ask for any further upside help there.
What stage of bull is it in?
These asterisks don’t erase all positive elements, nor do they negate solid tape action itself. The S&P 500 continues to break out to new highs, with software firming up on the back of harmonious sector rotation, moderate market breadth, local bank stocks hitting new highs and reports that private capital is sniffing out some bellwether names.
Scott Rabner, head of equity and equity derivatives strategy at Citadel Securities, released his widely researched August flows report, detailing what he sees as a convergence of several sources of demand and a constructive setup at this time. Individual traders are rebuilding their exposure after selling heavily at the late July lows, systematic funds are keying off subdued volatility numbers, and corporate stock buybacks.
“The market, which has spent much of the year absorbing selling pressure, could begin to rebuild purchasing power over this month,” he concluded. “September could be a different story. There could be more seasonality and better positioning. If August becomes a chase, some of today’s buying power will have already been used up.”
Warren Paiz, co-founder of ThreeFourteen Research, lowered the stock’s weight to neutral in his recommendation model last week. He moved to an overweight position in mid-April, just in time for the S&P 500 to rise 10% in four months. He currently believes market prices are too low for a potential Fed rate hike.
Such alarm may be premature. It is inherently difficult to distinguish between mid-cycle meandering and late-cycle sputtering. And as Dr. Fay Miller said of Don Draper from “Mad Men,” I’ll admit that when it comes to recovering market recoveries, I’m temperamentally “only in love with the beginning of things.”
Still, it never hurts to follow this reliable creed. “Stay involved, but keep your expectations in check.”
market thermometer
This index from John Kolobos of Macro Risk Advisors uses several data points to reflect both what investors say and what they do.
Commenting on his latest view, Kolovos said: “From a sentiment perspective, we haven’t had such a capitulation sell-off, but the overly bullish sentiment that dominated the market heading into June has been neutralized and this is enough to push the market higher.”
around the street
—For years, I have noted the unusual frequency of declines in the S&P 500 index, stopping short of losing a full 20% on a closing price basis: the simple definition of a bull market. As noted in an informative post on LinkedIn by Mike Taylor of Pie Funds, counting a 19% decline (or at least a 20% decline on an intraday basis) cuts some of the longest bull markets in history into shorter ones.
Still, it’s hard to draw conclusions about how much is left in the current car, which will be 4 years old in a few months. No matter how much data the market has produced over the decades, there haven’t been enough cycles to get a truly reliable statistical sample.
— Major League Baseball’s annual Field of Dreams game, held last week at the Iowa cornfield diamond used in the 1989 movie, is an interesting new tradition and a rare example of MLB creating a clever and popular in-season marketing opportunity.
This is also an opportunity for me to air some of my less popular works. “Field of Dreams” is not a top five baseball movie.
A sentimental favorite for sure, but too syrupy to warm the heart. Having read the novel it is based on, WP Kinsella’s Shoeless Joe, as a teenager, I never got over how it turned the father-son relationship into an excuse to justify cultural clashes and other dissent between boomers and their parents.
My top five baseball movies: “Eight Men Out,” “The Natural,” “Bull Durham,” “Major League” and “Bang the Drum Slowly.”
Kinsella also wrote a truly bizarre, fascinating, and somewhat magical realist novel, “Iowa Baseball Federation,” which is well worth your time. There’s no doubt that it was at least a partial inspiration for the critically acclaimed indie baseball movie “Ephus” that was released last year.
market is closed
Why is socialism on the rise?: If, as I suggested earlier, it is possible that corporate America is “making too much money,” it has been building in that direction for a long time.
Overall corporate profit margins have risen sustainably for a quarter of a century, reaching levels once thought impossible. Tax cuts, borrowing relief and technological efficiency all come into play. However, labor’s share of national income is also rapidly declining.
This graph from BCA Research perfectly illustrates the dominance of capital over labor. It directly affects stock valuations and perhaps also the current political rise in democratic socialism.
The data comes from a thorough and provocative new report by Martin Burns, BCA’s long-time chief economist (now semi-retired). It depicts a once-unthinkable decades-long surge in federal borrowing, dominance of the dollar, and expansion of corporate profitability.
His conclusion: “Soaring federal debt, a resilient dollar, and record profit margins are unsustainable. Within the next five years, we expect to see a resurgence of bond vigilantes, a sharp decline in the dollar, and the bursting of an AI-driven profit margin bubble. The latter may occur within the next year.”
Subscribe to Mike Santori’s Market Memos here
