Global Market and Economic Overview
Equity Performance and Rate Expectations
Global stock growth slowed in the past month compared to the previous three months. U.S. equities gained ground on international peers, though global capital flows remain tilted toward diversification as Trump’s tariff policies continue to temper enthusiasm for U.S. exceptionalism.
Markets have also priced in the near certainty of an interest rate cut at the September FOMC meeting. Small caps responded strongly, with the Russell 2000 gaining nearly 15% over the past three months on a total return basis. Combined with a 1.51% rise in the Small Business Optimism Index, sentiment in the small-cap space is improving. Small caps have now outpaced the S&P 500 over the 1, 3, and 6-month periods, marking an important divergence from their prolonged underperformance. Meanwhile, Treasury yields shifted lower across the curve, apart from the 30-year, as markets positioned for a September rate cut.
Signs of Stagflation
Recent economic data has raised concerns about stagflation. The unemployment rate ticked up to 4.2%, inflation (measured by CPI) edged higher, and job additions missed estimates for the third straight month as of July. Yet U.S. personal spending remains in line with long-term averages, suggesting consumers are still supporting growth even as the labor market softens.
Producer prices rose sharply in July (+3.29%) after a decline in June, while U.S. factory activity contracted for the sixth straight month, pointing to the drag from higher import duties. However, there were some positive surprises: the ISM gauge of new bookings jumped 4.3 points to 51.4, its largest increase of the year, while raw material prices fell to 63.7, the lowest since February, though still elevated.
These developments highlight the conflicting pressures facing producers. On the one hand, they face higher costs due to levy hikes and ongoing supply chain disruptions. On the other hand, they benefit from solid business investment and resilient household demand. The durability of this balance remains uncertain as tariff effects ripple through the economy.
Credit and Currency Dynamics
Credit markets paint a cautiously constructive picture. High-yield spreads are trading roughly 2% below their long-term average and well below levels typically seen ahead of recessions, except for the sharp but short-lived spike during the COVID-19 pandemic. Lending standards also remain relatively loose, suggesting confidence in the repayment capacity of riskier borrowers, lending support to the “stagflation-lite” narrative: slower-than-trend growth paired with persistent inflation pressures.
Meanwhile, the U.S. dollar has weakened this year as capital has flowed out of U.S.-denominated assets and into global markets. Heavy tech sector valuations and tariff-related uncertainty have contributed to this rotation, resulting in relative depreciation against major trading partners. The inverse effect has been stronger performance for non-U.S. assets and commodities. As the world’s reserve currency loses ground, investors diversify regionally, while traditional safe-haven assets such as gold benefit from heightened volatility
Earnings Risks
Looking ahead, S&P 500 earnings are projected to grow roughly 10% in 2026, well above the historical average of 6–7%. The driving force behind these expectations is artificial intelligence. Investors are effectively betting that AI will deliver a significant boost to corporate profits over the next several years.
This optimism is reflected in valuations. The tech sector trades at a lower price-to-earnings-growth (PEG) ratio than more traditional areas such as consumer staples, materials, and industrials. Even AI-focused funds are valued roughly in line with the broader S&P 500. A lower PEG ratio does not imply that tech is cheap; rather, it reflects how much extraordinary growth is already embedded in expectations.
Some may see this as a case for broad exposure through market-cap-weighted indices, on the assumption that AI’s benefits will lift overall earnings. The risk, however, is that if AI-driven profits fall short, the market could face a painful reassessment. With tech representing nearly 36% of the S&P 500, any disappointment has the potential to trigger a meaningful correction.
Where Do We Go From Here?
As rates begin to come down, floating-rate debt instruments currently used as cash proxies with low duration may need to be reconsidered. Equities, in my view, are still overvalued, but appear poised to continue moving higher, albeit with growth likely to be choppier and slower than in recent periods. On the fixed income side, investors may need to extend further out on the yield curve to capture higher returns as rates decline.
All in all, the market is likely to remain uneven as we move into the new year, but both the economy and financial system appear well-equipped to withstand additional short-term shocks.
From The Investments Desk at JSW
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