Argus

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Jul 01, 2026

Sector(s)

Utilities

Summary

Holding Pattern: Our Monthly Survey of the Economy, Interest Rates, and Stocks Stocks ended the month of June doing something they have not done much of lately, and that is doing not much. The S&P 500 reached its all-time closing high of 7,610 on the second day of June, following an outstanding series of earnings reports across late April and May. The May Producer Price Index (PPI) report set off alarm bells, and by June 10, the index had shed nearly 350 points to bottom at 7,266. Investors tried to push the market to new highs, but the S&P 500 topped out at successively lower highs on June 15 (at 7,554) and June 18 (at 7,501). For most of the past two weeks, the index has drifted near current levels in the 7,350-7,400 range.  Investors are facing a best-of-times and worst-of-times conundrum while trying to figure out which theme will prevail. Corporate earnings are soaring, and the employment economy is growing faster than most folks anticipated heading into 2026. U.S. average gasoline prices are below $4 per gallon, down from a peak of $4.50 in May. Artificial intelligence-driven (AI-driven) investment appears to be accelerating, and that lifted first-quarter gross domestic product (GDP) growth to 2.1%. But the biggest part of GDP, consumer spending, increased by a weak 0.5% in that same GDP report. In the Personal Income and Outlays report for May, the annual change of 3.4% in the Core Personal Consumption Expenditures (PCE) Price Index was the highest in three years. Newly installed Federal Reserve (Fed) Chairman Kevin Warsh, preferring to serve the president's objective of cutting rates, finds himself presiding over the most hawkish Federal Open Market Committee (FOMC) in years, with a majority prepared to raise rates.  Every positive data point from the commercial and industrial economy is met with a 'yeah, but' from the consumer economy or from the inflation reports. Stocks, which have been volatile for most of the past few years, have settled into a drifting pattern. Maybe this is nothing more than normal summer doldrums. The fear is that the longer the stock market drifts sideways, the more sharply it could break either up or down. And after the rally since April, the easier direction may be down in the near term. The Economy, Interest Rates, and Earnings The final (third) GPD report for 1Q26 indicates annualized growth of 2.1%, compared with growth of 1.6% in the preliminary report and 2.0% in the advance release. Growth accelerated from 0.5% in 4Q26, which was impacted by the 43-day federal government shutdown. Some government functions were reduced in 1Q26 by the Department of Homeland Security funding battle in Congress. First-quarter 2026 GDP also captures the effects of one month of the U.S. and Israeli war with Iran. In our view, the 1Q26 report is a much clearer indicator of the underlying economy than was the 4Q25 report.  In broad strokes, the GDP report shows a consumer economy struggling with existing and new inflation and making hard choices on spending. The commercial and industrial economy, on the other hand, appears to be aggressively investing in AI. Despite the yearlong implementation of tariffs at the highest level in decades, imports rose in 1Q26. But they were less subtractive to GDP growth than was estimated in the advance and preliminary reports.  First-quarter 2026 PCE increased 0.5%, down from 1.9% in 4Q25. Total spending on goods rose 0.5% in 1Q26, after rising 0.3% in 4Q25. First-quarter durable goods and nondurable goods spending were up 0.5% and 0.6%, respectively, from 4Q25 levels. On the bottom leg of the K-shaped economy, lower-income consumers are focusing spending on food and gasoline to the detriment of everything else. The largest falloff was in services spending, the biggest part of GDP. After initially being reported as rising 1.8%, spending on services rose by just 0.5% in 1Q26, down from 2.7% in 4Q25.  Altogether, PCE contributed 0.37 percentage point to 1Q26 GDP, after contributing 1.30 points in 4Q25. Consumer spending on services contributed just 0.26 percentage point to 1Q26 GDP, while consumer spending on goods contributed 0.11 percentage point. Nonresidential fixed investment, the proxy for corporate capital spending, rose by 10.6% in 1Q26, up meaningfully from 2.4% growth in 4Q25. The AI boom drove 15.8% growth in equipment spending and 13.8% growth in intellectual property products; corporate spending on structures declined 7.8%. Nonresidential fixed investment contributed 1.42 points to total 1Q26 GDP.   PCE and nonresidential fixed investment normally constitutes 80%-85% of GDP. These two categories contributed 1.79 percentage points to 1Q26 GDP growth after contributing 1.70 points to 4Q25 GDP growth. Residential investment declined 6.2% in 1Q26, much worse than the 1.7% decline in 4Q25. Residential investment was down 7.8% in 2025 and has declined for five consecutive quarters. With Iran war inflation pushing up interest and mortgage rates, relief is not in sight for this category. Net import-exports and private inventories were highly volatile in 2025 as companies sought to optimally position their overseas goods flows around the Liberation Day announcements in April and actual tariff implementation in August. The net export-import contribution to 2025 GDP was a negative 22 basis points (bps).  The Supreme Court in February 2026 struck down the use of the International Emergency Economic Powers Act for tariffs, and the White House used Section 122 of the Trade Act of 1974 to implement blanket 10% tariffs. The tariff situation, which finally seemed settled, remains confusing and is a hindrance to business planning. Exports rose 10.9% in 1Q26 after declining 3.2% in 4Q25. At least some of that growth was in oil exports after the Strait of Hormuz was closed by Iran. Imports rose 11.8% in 1Q26 after contracting 1.0% in 4Q25. The net of exports and imports subtracted 0.37 percentage point from 1Q26 GDP, higher than the 0.22 point subtracted from 4Q25 GDP growth but significantly less than the 1.25 points subtraction indicated in the advance and preliminary reports.  Government spending recovered to 4.4% growth in 1Q26 from a shutdown-impacted 4Q25, when spending contracted by 5.6%. The recovery in government spending added 0.74 percentage point to 1Q26 GDP growth after subtracting 0.99 point in 4Q25. Argus Chief Economist Christopher Graja, CFA, notes that indicators point to further strengthening in gross domestic investment as companies seek to boost productivity and improve return on investment by spending on AI. This in turn raises spending on the equipment and intellectual property accounts in the GDP report. The war with Iran, despite some setbacks in the peace process, seems closer to settlement than at any time since the war started. That has sent oil prices lower, which should provide some relief to strained consumers and could stimulate 2H26 spending for back to school and the holiday season. Chis has raised his GDP forecasts for 2026 and 2027. Employment growth has been stronger than expected, and tax refunds helped many consumers make it through the peak of energy price inflation in April and May. Chris has not made major changes to his forecast for consumer spending, which continues to reflect a bifurcated economy. AI spending, on the other hand, appears to be accelerating. Argus is now forecasting 2026 GDP growth of 2.3%, raised from 2.1%. The Argus GDP forecast for 2027 is for growth of 2.4%, raised from 2.0%. Outside the GDP accounts, the picture is mixed. Based on sentiment surveys and diffusion indexes, the business community is guardedly optimistic due to the AI-related business surge, while consumers remain worried about affordability and new jobs availability.  After multiple years of strength, the U.S. employment economy showed signs of slowing in 2H25. But employment growth has been better than expected across 1H26. May nonfarm payrolls exceeded expectations, with a gain of 172,000, much stronger than consensus estimates of 85,000. April and March were both revised higher, and nonfarm payrolls averaged a monthly gain of 188,000 for March-May, compared with an average gain of 48,000 for February-April. The unemployment rate was 4.3% in May for a third consecutive month.  Average hourly earnings for May grew 3.4% annually, down from 3.6% for April; annual wage growth has mainly been in the 3.5%-4.0% range for the past few years. Over that span, hourly workers could at least count on annual wage growth staying ahead of rising prices. Wage growth and inflation are now running at approximately the same pace. The age of AI has moved beyond the first phase of generative AI, characterized by training of large language models by hyperscalers building AI data centers. The next phase is agentic AI, now rolling out to enterprise and sovereign customers. The U.S. Industrial sector is helping to build the necessary infrastructure to support this transition. New orders for durable goods declined 4.5% in May, reversing from a 7.9% increase for April. Orders excluding defense increased 4.6% in May, still strong though down from 8.1% growth in April. Excluding the highly volatile transportation component, durable goods orders rose 1.3%, compared with 1.1% in April.  Industrial production edged up 0.1% month over month in May, slowing from 0.9% growth in April. Manufacturing output was unchanged in May, compared with an increase of 0.7% in April. Utilities, which in recent months have substantially contributed to overall industrial production, decreased 0.4%, while mining rose 1.3%. Industrial production increased 1.7% over the past 12 months. May capacity utilization rose to a 76.2% rate from 76.1% in April. Capacity utilization is more than 3 percentage points below its long-run (1972-2025) average.  The purchasing managers' reports from the Institute for Supply Management showed the industrial and services economies clearly in expansion territory in May. The Manufacturing Purchasing Managers' Index (PMI) was at 54.0%, and the Services PMI was at 54.5%, both for May - and both comfortably above the 50% cutoff between expansion and contraction for these diffusion indexes. The Services PMI has spent just under two years (23 months) in expansion territory. The Conference Board's Consumer Confidence Index slipped to 93.1% in May from 93.8% in April. Those readings, however, are up from 91.8% in March 2026 and 91.2% in February. The May Expectations index moved higher, in a positive sign. The University of Michigan Consumer Sentiment Index, however, continues to deteriorate. With war-related inflation driving the price of gas higher, consumer sentiment fell to 44.8% in May from 49.8% in April and from 53.3% in March. Actual and diffusion (sentiment) data reflect inflation anxiety in the wartime period. So many peace proposals have been floated that they are now discounted. The situation in Iran seems closer to resolution than at any time since the war began, yet persistent conflict in Lebanon is keeping the Strait of Hormuz mostly closed. At the same time, consumers and companies are wary but mainly continuing to go about their business. Consumers are employed, and businesses are investing in the AI opportunity.   On May 22, 2026, Mr. Warsh was sworn in as the 17th chairman of the Fed. The Stanford University and Harvard Law graduate began his career on Wall Street in the mid-1990s on Morgan Stanley's M&A desk. He became executive secretary of the National Economic Council during the presidency of George W. Bush and in 2006 was nominated to the F's board of governors. Serving as assistant to Fed Chairman Ben Bernanke during the 2008 financial crisis, Warsh was involved in the Lehman Brothers Holdings Inc. bankruptcy, the sale of Bear Stearns Cos. to JPMorgan Chase & Co., and other deals.  During his first stint on the Fe board of governors, Warsh was regarded as an inflation hawk, or someone who prioritizes containing inflation over growing employment and the economy. Mr. Warsh was uncomfortable with Chairman Bernanke's proposed sale of $600 billion in U.S. Treasury securities, because he feared this level of quantitative easing would artificially suppress interest rates and lead to higher inflation.  Warsh is now seen as an inflation dove, or one who prioritizes economic growth and full employment over keeping inflation at a specified level. In hearings preceding his appointment to chair the Fed, Mr. Warsh expressed that he would like to see less transparency from the central bank. He also seems open to using tools beyond adjusting the Fed Funds rate, possibly including leveraging changes in the Fed's balance sheet to attain the desired outcome of lower rates.  Yet the new Fed chair may find his hands tied regardless of his beliefs, given the current economic and inflation environment. At the mid-June 2026 FOMC meeting, nine members of the 12-member board favored at least a quarter-point rate hike in 2026. (Warsh abstained from voting.) The post-meeting statement from the FOMC was about half the size of prior statements, and it attributed resurgent inflation to supply shocks related to the war. Mr. Warsh announced the formation of five task forces he feels will bring the Fed into the modern era. Within the final 1Q26 GDP report, the PCE Price Index was 4.6%, up from 2.9% in 4Q25. Even though the Core PCE Price Index strips out energy along with food, core PCE prices rose 4.4% in 1Q26 after rising 2.7% in 4Q25. In the Personal Income and Outlays report for May, the annual change of 3.4% in the Core PCE Price Index was the highest in three years. Core PCE metrics are monitored by the Fed as part of its rate-setting deliberations. Inflation is percolating across the consumer and business economies. The May all-items Consumer Price Index (CPI) rose by 0.5% on a month-over-month basis and 4.2% on an annual basis. Core CPI for May, excluding food and energy, rose 0.2% monthly and was up 2.9% annually from May 2025. The PPI for May 2026 showed a 1.1% increase, actually moderating from April's 1.4% monthly increase. PPI rose 6.5% on an annual basis in May, the largest annual rise since November 2022. For PPI excluding food, energy, and trade services, the 12-month change through May 2026 was 5.1%, the largest annual change since October 2022.  With inflation flaring, interest rates jumped in March and remained elevated though volatile across the second quarter. The 10-year Treasury yield was 4.51% as of the end of June 2026, compared with 4.45% as of the end of May and 4.14% at year-end 2025. The two-year Treasury yield was 4.25% as of the end of June 2026, versus 3.99% at the end of May and 3.45% as of year-end 2025.  The two-10 slope in the yield curve tightened to 27 bps at the end of June 2026 from 69 bps at year-end 2025. The year-end 2025 two-10 slope was the steepest since 2021, before the Fed began its fight against inflation.  Argus Fixed Income Strategist Kevin Heal now believes there will be no cuts in the Fed Funds rates in 2026. The monetary policy outlook for 2027 is uncertain. The CME FedWatch tool is signaling that by year-end, there is a nearly equal probability that the Fed Funds rate will be higher at 4.0%-4.25% (33% probability) or will be unchanged at 3.75%-4.0% (38% probability). Given the pending midterm elections, we see little chance of any change in monetary policy either up or down before the December 9, 2026, FOMC meeting. Earnings growth for the calendar first quarter of 2026 has reset the outlook for earnings growth for all of 2026. As AI spreads out from hyperscaler data centers to all industries and nations, companies beyond, Information Technology are seeing early benefits from investments made in recent years. Investors and market analysts now anticipate well-above-average earnings growth for 2026 and 2027. Spending on AI has gone from a curiosity three years ago to an imperative now that inference and agentic AI are available at the enterprise level. Managements believe they risk being left behind by competitors if they do not invest immediately. That is benefiting companies (across a range of sectors and industries) who supply the necessary infrastructure, software, and services for the AI revolution. Like earnings growth, spending on AI is also off the charts. And investors appear willing to grant companies a grace period before those investments are expected to lead to monetization. First-quarter 2026 earnings increased in the range of 29%-30% from the year-earlier quarter, according to the major earnings aggregators (Bloomberg, FactSet, and Refinitiv). Earnings growth for 1Q26 was the highest since 4Q21, a period in which economic activity was beginning to accelerate following COVID-19 shutdowns. The reporting period began with aggressive expectations, but actual 1Q26 results exceeded those expectations in multiple ways.  About 85% of companies reported results that were above consensus expectations, meaningfully higher than the long-term range of 75%-80%.The magnitude of the beat against expectations was even more impressive. Companies exceeded calendar 1Q26 EPS expectations in midteen percentages, compared to a historical beat against expectations in the 5%-7% range. Earnings have grown on a year-over-year basis since mid-2023, typically at a high-single-digit-to-low-double-digit pace. The two factors consistently keeping earnings growing so steadily are revenue growth and margin expansion. From a mid-single-digit rate in recent years, annual revenue growth has accelerated, and for the 1Q26 EPS season, sales growth was about 11%.  Margin expansion partly reflects the best earnings growth coming from high-margined sectors such as Information Technology. All companies across all sectors have been through a lot in recent years: the COVID-19 pandemic, the supply chain crisis, inflation at 40-year highs, tariffs, and war and energy shocks. Along the way, companies have learned how to run leaner, source raw materials optimally, and (wherever possible) turn fixed costs into variable costs. We believe the strong margin performance will carry beyond 1Q26. In June 2026, we raised our 2026 forecast for S&P 500 earnings from continuing operations to $340 per share from a prior $315. Our new estimate assumes 24.8% growth in continuing operations earnings from 2025. At that time, we also raised our 2027 forecast for S&P 500 earnings from continuing operations to $390 per share from a prior $363. Our new estimate assumes 14.5% growth in continuing operations earnings from our 2026 estimate. Domestic and Global Markets The performance discussed herein captures the market status as of end of June 2026. This data does not reflect what has happened in the market in recent days. The major indexes shifted away from growth and toward defensive, cyclical, and rate sensitive in 2H25 through 1Q26. Beginning in April, growth leadership reasserted itself, and that trend intensified in May as exceptional earnings across the Information Technology sector sent tech stocks higher. The S&P 500 rose over 10% for April and 5% for May, while the NASDAQ Composite Index ripped more than 20% higher over the two-month span. After a strong start to June for growth stocks, growth sold off in the final weeks on AI profit taking. As of the end of 2Q26, the major indexes were all up for the year-to-date, after all being down for the year at the end of March 2026. But stocks in June did mostly give back some of May's strength. The S&P 500 was up 8.4% year-to-date on a total return basis including dividends as of the end of June. The NASDAQ Composite, which was up 16% at the end of May, ended June up 9.5%. While both the NASDAQ and the S&P 500 declined in June, the Dow Jones Industrial Average rallied in the month and ended 2Q26 up 9.0%. For most of 2026, value and growth have been vying for leadership. At midyear, the FT Wilshire US Large Cap Growth index is up 3% year to date, versus 9% for the FT Wilshire US Large Cap Value index. Small caps continue to relatively outperform, and the Russell 2000 Index was up 22.2% at the end of June - leading the next-closest index by over 1,200 bps. Stock performance has been headline driven. While awaiting a lasting end to hostilities and reduced pressure on inflation from the decline in oil prices, stocks remain positive for the year.  With just a handful of trading days left in June, we can say that sector leadership in 2Q26 diverged sharply from leadership in 1Q26. In the first quarter, Energy was the clear leader, with a 36% gain - and more than half of that gain was rec

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