August Market Update

 

 

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Portfolio Management Comment

The following is from Jurrien Timmer; Director of Global Macro at Fidelity

Jurrien Timmer - Report July 30

Nothing stops this train.

The global bull market continued last week, with new all-time highs being recorded on a daily basis. With trade deals in place with Japan and now the EU, it appears that the tariff tantrum has crested, just as the fiscal impulse from the Big Beautiful Bill is getting started. This is of course good news for earnings and margins (and animal spirits), as uncertainty gives way to better visibility.

Equity valuations, which always anticipate earnings, have already priced this in, with the S&P 500 index now trading at 24.1x expected earnings. With momentum returning to the more speculative corners of the market, it makes you wonder if we are entering another melt-up phase, not unlike 2021, 1999, and 1968. A melt-up would require ample liquidity, which there is, plus an accommodative Fed, which we don’t have (yet).

With the White House continuing to exert pressure on the Fed to lower rates, we can’t help but wonder what a post-Powell Fed will look like. That milestone is only a year away and the markets appear to be declaring that the Fed will become easy and loose. If so, that would create an era of Fiscal Dominance in the purest sense, with expansive fiscal policy accommodated by loose monetary policy and yield curve control (YCC).

The fate of the Fed’s role as the US and global central bank is about as existential as it gets with regards to interest rates, inflation, equities, and the dollar. It seems outlandish to think that the Fed might lose the independence that it gained in 1951, but if there is one thing we have learned in 2025, it’s to take seriously the words that come out of Washington, even if they seem hard to believe.

If the Fed ends up turning a blind eye to the Taylor Rule by lowering short rates beyond what its dual mandate justifies, the bond vigilantes would immediately bear-steepen the curve and create as many (or more) problems than lower short rates would solve. That suggests that the Fed would have to do a pre-emptive one-two punch of lower rates and YCC.

There is no free lunch, of course, so the escape valve for such a fiscal-monetary combo would either be higher inflation or a weaker dollar, or both. As my friend Lyn Alden (lynalden.com) has been saying: nothing stops this train. Gold and Bitcoin have been telling us this for some time now. Welcome to fiscal dominance.

Global bull

Per the MSCI All- Country World Index below, 72% of global equities are now in uptrends. Not bad, considering we seemed to be staring into the abyss just a few months ago.

Cyclical bull

The S&P 500 index continues to make new highs in both nominal and real terms, and the inflation-adjusted index is back on its cyclical trendline.

Earnings

With 167 companies reporting (and 83% beating estimates by an average of 689 bps), Q2 earnings season is performing on par with its historical tendency. The growth rate has already bounced from 2.5% to 4.5%, with more likely in the coming weeks.

GDP forecasts

The recovery in earnings estimates is on par with the improvement in GDP forecasts following the growth scare in April. The tariff tantrum has crested and the incoming fiscal impulse from the OBBB is being priced in.

Valuation

This improvement has already been anticipated by valuations, which are now up 10% year-over-year. Earnings and valuations are going up in tandem, which is the stuff that robust rallies are made of.

 

The question always is what price we should be willing to pay for each dollar of earnings. The S&P 500 index is now trading at 24.1x forward earnings, which is definitely not cheap. What remains ‘cheap’ however are international equities.

 

Avoiding a debt spiral

Valuations are affected by earnings growth and payouts (the numerator in the discounted cash flow model), and interest rates and risk premia (the denominator). With trade fears subsiding while another $5 trillion fiscal impulse gets underway (the second in 5 years), perhaps the denominator will now become the next big thing to worry about.

The federal debt has grown $13 trillion since COVID, begging the question of who is going to mop up all that Treasury supply. During COVID it was the Fed, but it has been shedding Treasuries since 2022. That leaves an almost $11 trillion gap between the supply of Treasuries and the demand, at least from price insensitive buyers.

 

 

Lessons from Japan

The US government is now spending $1.2 trillion, up from $500 billion before COVID. The only way to avoid a crowding out effect on the budget (other than cutting spending) is to continue to run deficits. That vicious cycle can eventually become a debt spiral.

 

When Japan reached burdensome levels of debt service a decade ago, it resorted to fixing rates via zero (and negative) rates and yield curve control (YCC). As a result, Japan was able to cap its interest expense at around 4% of GDP. The US is getting to that point now, which raises the possibility that a combination of low short rates and YCC lies in store for 2026 when the new Fed leadership takes over.

Currency is the escape valve

Of course, there is no such thing as a free lunch, and for Japan the price to be paid for years of financial repression was a much weaker Yen. Most countries would prefer a weaker currency, but there are limits.

 

 

The US dollar remains the dominant reserve currency despite losing share over the years. Its status as reserve currency has earned the US many privileges, including lower risk premia for both equities and debt. If the US enters another era of fiscal dominance, in which both fiscal policy and monetary policy are very loose, it could bring us back to the 1940’s period (WWII) as well as the late 1960’s (guns & butter).

Triple Mandate?

If the US is going to grow its way out of debt, it will need either a growing labor force or a productivity boom to lift the speed limit for the economy (potential GDP). With immigration policy under pressure, it will have to come down to productivity. Barring this (or regardless), borrowing costs will need to come down, which will put pressure on the Fed to look past its dual mandate of price stability and full employment and lower rates even when it might not be justified.

 

 

This is of course where the tension is coming from between the White House and the Fed. With Chair Powell’s term ending in less than 12 months, it will be interesting to see how independent the Fed will remain in 2026 and beyond.

Can the Fed bend the curve?

If the Fed becomes more politicized in 2026 and lowers rates beyond what deems justified by the Taylor Rule, the yield curve could well bear-steepen unless the Fed engages in yield curve control.

 

 

That would restart the QE engines, which is something that both gold and Bitcoin appear to have been anticipating. The Fed’s balance sheet is only 23% of GDP, which is a far cry from the BoJ’s 117%.

 

1940’s Fiscal Dominance

During WWII the Fed engaged in financial repression to facilitate the Treasury’s debt financing of the war. Given that the US and the world were on the gold standard, there were limits to the degree of debt monetization. When the war ended, fiscal discipline returned, and the money supply stopped expanding. That allowed for the inflation spike to be transitory. When the Fed ended its policy of capping rates in the 1950’s, there was no shock in the bond market or equity markets.

 

 

1960’s Guns & Butter

During the second half of the 1960’s there was no overt policy of financial repression, but it was still a period of fiscal dominance. This was the guns & butter era in which the focus was on full employment and social programs. Fiscal policy was chronically loose, to the point that President Nixon had to end the gold standard. Monetary policy was also chronically loose, even though the GDP output gap (the difference between actual growth and potential growth) was positive (grey bars below). That combination of loose fiscal, loose monetary policy, and an economy growing beyond its speed limit, was enough to create a secular inflation problem.

 

 

Decades later, during the GFC era, the US endured another long period of loose fiscal and loose monetary policy, but this time the output gap was persistently negative and it was the fear of deflation that kept policy makers on edge. Currently we have a positive output gap, loose fiscal policy, and a modestly restrictive monetary policy. If the Fed becomes dovish in 2026, we could have the same trifecta as the late 1960’s. That suggests higher inflation and a weaker dollar in the coming years.

Melt-up?

If another wave of fiscal dominance lies ahead once the Fed changes leadership in 2026, then I’m guessing we will get lower short rates and a Japan-style yield curve control from the Fed. That could make the bond market significantly less interesting (and influential) in the coming years as the term premium gets capped and the stocks/bonds correlation goes to zero. The dollar would likely fall, and the risk is that inflation will rise, barring a productivity miracle from the AI boom.

That leaves equities. How will they do in such a regime? During the late 1960’s, the secular bull market ended with a speculative blow-off in 1968, at which point inflation started to depress valuations. Following the LTCM debacle in 1998, an easy Fed facilitated a bubble in 1999 (which burst in 2000), and in 2021 the Fed’s monetization of the COVID-induced fiscal impulse fueled another valuation bubble (which burst in 2022).

Perhaps the “next Fed” will facilitate another melt-up, until it’s slayed by inflation or excessive valuation. Until then, the secular roadmap below allows for a few more innings before the secular tide turns a few years from now.

 

 

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We are fundamental investors that use technical analysis to manage short-term market risks. We believe that risk management is not a choice, but a necessity. While we cannot control how much downside the market provides during a correction, we can control how much of the downside your account receives. We aim to avoid 60% or more of the decline in any significant downturn. Without our process, there is a good chance you will experience 100% of the downside from the market. We will help you navigate the risks and rewards of the market so that you can stop worrying about your money and start living your life.

 

Transactions

The following is a chronological list of our trades in July:

Sold our final position in Lundin Gold for a large profit. Bought at $18.598 sold for $69.358.

 

Bought a full position in Hudbay Mineral at $14.82 and $13.97. Well managed copper story breaking out of a 14-year base.

 

Added to Thermo Fisher Scientific at the bottom of its trading range.

 

Added to TCE Energy at the bottom of its trading range.

 

Added to The Travellers.

Our CIBC NVCC 2.01% 21Jul25 bond was called and replaced with a Sunlife FF-2031 5.12% 15MAY36 at 105.99 for a yield of 4.01%

Returns on our 60/40, 70/30 & 80/20 Portfolios, before fees:

Interesting Charts

 

 

 

 

Technical Comments

Market Overview: S&P 500 Emini Futures

The market formed a S&P 500 Emini 4-bar bull microchannel on the monthly chart. The bulls expect at least a small second leg sideways to up after any pullback. The bears must create strong bear bars to show they are back in control.

S&P500 Emini futures

The MONTHLY Emini Chart

• The July monthly Emini candlestick was a bull bar closing in its upper half with a prominent tail above.
• Last month, we said traders would see if the bulls could create a strong breakout above the December 6 high, or if the market would trade higher, but close with a long tail above or a bear body instead.
• The market traded sideways to up for most of the month, followed by a small pullback in the last few days of July. The August candlestick gapped lower at the open.
• The bulls got a breakout above the prior all-time high (Dec 6) in July.
• They want the broad bull channel to resume.
• The move up (from Apr 7 low) is in the form of a 4-bar bull microchannel. They may be buyers below the first pullback.
• Because of the strong move up, the bulls expect at least a small second leg sideways to up after any pullback.
• The bears see the current move as a buy vacuum retest of the prior all-time high (Dec 6).
• They want a higher high major trend reversal and a double top (Dec 6 and Jul 31)
• They want a failed breakout above the December 6 high.
• The bears must create strong bear bars to show they are back in control.
• So far, the move up from the April 7 low is strong, in the form of a 4-bar bull microchannel and consecutive bull bars closing near their highs.
• The market is Always In Long.
• The move covered 32% from low to high (Apr 7 to July 31) over 4 months without any significant pullback.
• While the move is strong, it is slightly climactic and overbought.
• The market may form a pullback to alleviate the overbought condition before the trend resumes.
• If a pullback forms, it could last 1 to 2 months.
• The 4-bar bull microchannel increases the odds that the first pullback may only be minor, followed by a retest of the recent leg extreme high (Jul 31 ) after the pullback.
• For now, traders will see if the bears can create strong bear bars to show they are back in control.
• Or will the pullback lack follow-through selling, forming a long tail or a bull body in August instead?

Millennial Minute

Ashley's summer of camping continues and she'll be back next month with a new article!

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...the goals of high-net-worth (HNW) women are often more aligned with the latter than men’s tend to be. It’s important for your advisor to appreciate these differences because it could influence how they develop your retirement plan...

 

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