Our autonomic nervous system (the part that works automatically, not under our conscious control) consists of two balanced parts: The sympathetic nervous system that controls flight-or-flight (associated hormones: adrenaline and cortisol) and the parasympathetic nervous system that controls rest-and-digest (associated hormones: acetylcholine and melatonin). We need our sympathetic nervous system’s rapid response to survive in an emergency. But we also need to relax and digest to remain healthy.
The markets have been hit with several high-stress pieces of information in the past few weeks. Rising inflation. A new Federal Reserve chair who has declared that “prices will be stabilized” (no mention of employment - which implies higher interest rates) and that the Fed will set up five task forces to reorganize critical Fed functions. A growing realization that the AI hyperscalers are taking on too much debt for the business to be profitable in the reasonably near term. Growing public push-back against AI data centers. A murky on-again-off-again war against Iran. Strait of Hormuz mined and opened to a trickle of traffic.
Last week, the markets seemed to move into a “rest and digest” phase.
SPX and NAZ fell but that was probably noise. Traders moved from risky stocks into Treasury bonds and USD. (Possibly end of 2Q26 book-keeping.) The trade was risk-off as both SPX and junk bond prices fell relative to the 10 year Treasury price. But the stock market is still in a historic bubble with 40% of the SPX concentrated in the tech hyperscalers.
The Equity Risk Premium (ERP) is the yield above the safe Treasury yield that stock investors should get for the risk inherent in stocks relative to bonds. With interest rates rising and stock returns falling (as the index rises) the ERP is at the lowest point since the dot-com bubble burst.
Oh, what a coincidence! The lowest since the LAST bubble burst! It took years for corporate earnings to actually catch up to those bloated multiples after the bubble burst in 2000.
Growth stocks are, by definition, investments that are expected to pay off in the long term so it makes most sense to compare their return with the 10 Year Treasury.
The 10 year Treasury yield is 4.37%. The earnings yield of the SPX is 3.16%. The ERP for the SPX is negative -1.22%. Investors are betting 100% sure that the earnings yield of the SPX will be higher than the Treasury yield over a 10 year time frame. The earnings yield of the Vanguard Growth ETF is approximately 3.0%. VUG allocates over 45% of its total capital to just five massive growth names: NVIDIA, Apple, Microsoft, Alphabet, and Amazon. The lower earnings yields of these individual mega-caps directly drag down the aggregate fund average.
The SpaceX IPO may be a turning point in the gradual decline of stock shares in the marketplace. Goldman Sachs estimates that up to $675 billion in new equity supply will hit the market this year alone. This will compete with existing shares, especially of speculative growth businesses.
Patrick Boyle made an excellent video about this. It’s similar to the wave of new tech IPOs and secondary share offerings which flooded the market in the late-1990s and in aggregate broke the back of the dot-com boom.
The Fear and Greed Index was in Extreme Fear despite the lack of a sudden emergency. VIX fell a little. Also, The Chicago Fed’s National Financial Conditions Index (NFCI), which provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems, loosened so there was plenty of easy money around. So I think the stock indexes will continue their rising trends. Last week was noise.
The Treasury yield curve flattened. Short-term T-bill yields rose since the bond market expects inflation to be sticky. But the long-term bond yields didn’t rise. The 5-Year, 5-Year Forward Inflation Expectation Rate is only 2.1%, showing that traders believe the inflation rate will be lower in the medium term. Given high government deficits that feed into Consumer Price Inflation I don’t believe that, but the market does.
The only way to prevent sticky inflation is dramatic cuts in government spending (especially Medicare and Social Security) and/ or a recession caused by high interest rates.
John Mauldin wrote a very good “Thoughts from the Frontline” showing the effects of inflation on households. At 2% inflation $100 you started with shrinks to $82.03 in 10 years and $67.30 in 20 years. Our household expenses, such as food and insurance, are rising much faster than 2%.
The economy is growing at a solid, sustainable rate. The Atlanta Fed’s Latest GDPNow Estimate for 2026:Q2, Updated: June 25, 2026, was 2.5%. This is similar to the “Blue Chip Consensus of Economists.”
As a result of high inflation, strong economy and Fed Chair Warsh’s hawkish opinions, the options market is predicting a 60% probability of a fed funds hike by September. Warsh would lose all credibility if he tried to cut rates. He will need ear plugs to ignore the insults and rage from President Trump but it’s too late now. Warsh is in like Flynn and Trump himself told Warsh to be independent when Warsh was sworn in.
The price of gasoline is falling along with oil but both are much higher than the 2025 price. Natgas is rising. Gold, silver and bitcoin bubbles have popped.
Next week will be the 250th anniversary of the signing of the Declaration of Independence. I remember the Bicentennial (1976) as an inspiring event as my father took the family into New York Harbor on his cabin cruiser to watch the awe-inspiring international parade of Tall Ships.
The markets will be closed part of the week and many traders will be on vacation.
The METAR for next week is sunny. But with thin trading there may be some volatility.
Wendy
https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html