My commentary last quarter pointed out that wars don’t necessarily affect the stock market that much. The Iran war and the Ukraine war have droned on (pun only slightly intended) and yet the S&P500 has risen 15.2% in the second quarter and 10.2% for the first half of the year. The MSCI EAFE index of developed markets outside the US also rose a respectable 9.4% for the first half. The MSCI Emerging Markets index was the big winner, up 23.9% for the first half.

(From Kwanti, Green is S&P 500 Total Return index, Blue is MSCI EAFE index, and Orange is MSCI emerging markets index)

My clients expect me to pay attention to the economy and the markets. I do not believe in timing the markets, but I do think the US markets may struggle to go higher from here and I will explain why.

What is the basis for stock prices? A share of stock is a slice of ownership of a company that is hopefully making profits. Those profits are distributed to shareholders through a combination of dividends, stock buybacks, or reinvested to help increase future returns and the value of the business.

The market sometimes values stocks higher as a percentage of their profits and sometimes lower. This is called the P/E (price-earnings ratio) multiple. Here is a nice chart which shows the P/E multiple over time as well as the S&P index price level.

You can see that the P/E multiple is high, but it has certainly been higher in the past just before a significant pullback. The market can maintain a high P/E multiple for some time before it pulls back.

I also want to look at earnings themselves. The S&P500 earnings have been increasing at a rapid rate. In 2026 the increase has been 24% according to JP Morgan but includes 13.7% of increased profit margin and only 10% is because of revenues increasing. Profit margin is the profit companies make per amount of revenue. It is a form of efficiency and in this case the S&P500 index earnings are overly influenced by the efficiency of the largest companies which recently have been software companies. There are reasons to believe profit margins might not increase as much in the future or might even decrease. That’s because the mix of the largest companies in the S&P500 is changing with chip companies becoming more prominent and they are reliant on much more fixed infrastructure. It’s also because costs are rising for all these companies and their abilities to raise prices are decreasing.

So, we have a combination of an expensive S&P500 on a P/E basis combined with profit margins that are probably stretched in the US. It doesn’t mean stocks can’t go up, but it might mean it’s better to look at areas of the market which are cheaper on a P/E basis and that still have room to increase profit margin and revenues. International stocks are definitely still cheaper than US stocks overall. The Eurozone P/E is 14.9x vs. the US at 20.4x. Japan is at 16.1x. Emerging markets are at 13.4% in spite of their excellent first half stock performance. There is also reason to believe the dollar might go lower moving forward which will improve international returns when measured in dollars.

The Economy

Consumer sentiment is terrible at the moment, so if you have been feeling gloomy, you are not alone. But, if you are like many Americans, you are continuing to spend even though you feel extremely gloomy.

The truth is that employment has been holding up pretty well with the exception of certain sectors like software, but our big problem continues to be inflation. In May the Consumer Price Index was up 4.2%, although the core reading which excludes food and energy was up 2.9%. This is too high and everyone is feeling it. Energy is the part of the picture most in the news, but food inflation and services inflation are both real.

In Summary

The stock market is bouncing around its highs and really has been for about a month. But the leadership of the AI companies and the semiconductor manufacturers have pulled back. It would not surprise me to see a pullback, but that does not mean we will have a significant longer-term downturn. A pullback in an overextended market is healthy. Inflation is running hot and isn’t accelerating (today’s release of CPI was slightly lower than forecast). I do think the Fed will have to raise rates, but they will be very reluctant to do it before the November election because they don’t want to be accused of political interference. After that some rate hikes will probably be necessary which may cause stocks to go down. In the long run, we still have a very robust economy, so I expect longer term we will be just fine.

As always, a diversified portfolio which includes significant international exposure as well as bonds and commodities works best.

If we are not managing your investments, we would be happy to chat with you about doing so. Check out our website at www.cereusfinancial.com for disclosures and more information including other blog articles.

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