Coming into earnings season this week, the pace of positive earnings revisions has skewed higher which raises the expectations bar. The market’s performance during earnings season tends to be inversely correlated to the direction of earnings revisions heading into the reporting period. The increased expectations for earnings could turn out to be a headwind for stocks. Wouldn’t it be ironic if great earnings aren’t great enough?
Exceptional earnings growth has been the driver of this bull market. If earnings prove to be a “disappointment” this quarter, what would allow the bull to continue? The economy could be a catalyst as it continues to be solid. In a nutshell, manufacturing has positive momentum, the employment picture remains stable, housing has been sluggish but picking up, and the consumer continues to show significantly more strength than you might expect given the headlines.
The direction of the economy and the stock market don’t always track each other in the short-term. However, they are much more positively correlated in the long-term. Strong economic momentum has usually been followed by strong equity returns.
There is usually unnecessary hype placed on upcoming economic data releases, but the buzz earlier this week about Tuesday’s CPI print may be warranted. Inflation was reported cooler than forecast. There are some notable trends that suggest the report is a sign of relief for the stock market.
The main narrative involves a sharp drop in crude oil prices. After back-to-back monthly declines of more than 15%, WTI (West Texas Intermediate crude oil) lost more than a third of its value in the two months ending in May.
Another driver of inflation is wage growth. The clearest indication of a tightening labor market is accelerating wage growth which is currently benign. As previously mentioned, the current job market is stable (but not tightening) so wage growth will not likely accelerate.
The inflationistas are making a racket about the deteriorating inflation backdrop. But short-term trends are moving the other way. Some investors are raising the odds of a Fed rate hike later this year, but an extended pause may prove to be the ultimate policy path. That would be good news for stocks.
QUESTIONS FOR THE SECOND HALF
As we kick off the second half of 2026, investors face no shortage of questions. Will earnings season live up to expectations? Will inflation cool as expected? Will the Fed raise rates? Will the war in the Middle East continue? Will the AI trade continue to keep the market afloat, or will the underperforming mega-caps stall the rally. We all have our thoughts on these questions, but only time will tell. As events unfold, the market will continue to react with gains and losses. Maybe overreact.
Regardless of what happens in the short-term, long-term investors should consider volatility the price of admission. It has always made sense for investors to invest in the U.S. economy and benefit from its growth and constant innovation. For $1 invested in the S&P 500 in 1928 (when detailed market records started) the value has grown to $10,000 (source: Bespoke Investment Group). If the market generates similar returns over the next 100 years, $10,000 may turn into $100,000,000. Common stocks have been a great way for many investors to accumulate wealth.