Rochdale Speedometers^SM

As we move into September, there’s still plenty for investors to worry about. We have geopolitical risk, volatile interest rates, a difficult fiscal backdrop and midterm elections getting closer. But when we look past the headlines and focus on the economic data, the picture has actually improved.

Growth has strengthened, corporate earnings have been exceptionally good, business investment remains strong and the recent inflation data have become more encouraging. That combination led us to make several changes to the Speedometers this month.

Dial 1: Business Outlook Spending/Surveys, 0:50— The most significant change was an upgrade to our Business Outlook and Spending Surveys Speedometer, which moved into the green.

We have been watching corporate investment closely because so much of the current expansion is tied to technology spending, particularly artificial intelligence and data-center development. The question has been whether that investment would stay concentrated in a relatively small group of companies or start to benefit the broader economy. So far, we think the answer is clear: It’s spreading well beyond the technology sector.

Capital spending remains very strong, manufacturing surveys have improved considerably and businesses are becoming more constructive about future investment. Federal Reserve districts are also reporting increased manufacturing activity and growth in data centers, defense and construction.

This reinforces the view that the AI investment cycle is beginning to reach well beyond the technology companies themselves. It is supporting manufacturing, construction, power infrastructure and an expanding network of industries connected to that buildout.

Corporate profits provide additional support. Second-quarter earnings grew more than 30%, margins remained extremely strong and earnings estimates have continued to move higher. That's unusual. Analysts typically reduce estimates as the year progresses, but so far, we're seeing the opposite.

So, the reason for the upgrade is fairly straightforward: Strong corporate investment is increasingly translating into broader economic activity.

Dial 2: Inflation, 2:14— Our second change was to inflation, which we upgraded by one notch.

That does not mean inflation is back to the Fed's 2% target, and there are still risks. But compared with where we were several months ago, we think the probability of another significant inflation breakout has declined.

Some of the year-over-year inflation readings remain elevated because they still include the earlier effects of higher energy prices and geopolitical disruptions. The more recent data has been better. Core inflation is trending lower and wage growth has continued to cool. While prices in some areas are still rising, particularly for energy, transportation and raw materials, there are few indications of broad overheating. Some companies are actually finding it difficult to pass higher costs along because their customers have become more price sensitive.

So, while inflation remains above the Fed's target, today's environment looks very different from 2022. Fiscal stimulus is not flooding into household balance sheets, the Federal Reserve isn't plowing stimulus into the economy and many of the supply problems that contributed to the earlier inflation surge have normalized.

Energy and geopolitics remain the major swing factors, so we are not dismissing the risk. We simply think the inflation outlook has improved enough to justify moving that Speedometer to neutral.

Dial 3: Yield Curve, 3:31— That leads naturally into the Yield Curve Speedometer, which we moved slightly lower.

This change reflects the pressure we've seen in longer-term interest rates. There has been a lot of discussion recently about the term premium, which is simply the additional return investors want for committing money to a longer-term Treasury bond. That premium has increased as markets price in uncertainty surrounding inflation, government borrowing, Treasury supply, global interest rates and the future path of Federal Reserve policy. We agree that those factors matter, particularly the fiscal outlook. But there is another reason long-term yields can rise: Stronger economic growth.

Nominal economic activity has accelerated and when the economy is growing faster, investors generally demand a higher return to own long-duration bonds. So, we don't interpret every move higher in Treasury yields as evidence that the bond market is signaling economic trouble.

The challenge is that the Federal Reserve has much more influence over short-term rates than it does over the long end of the curve. Even if the Fed eventually eases policy, longer-term yields can remain elevated if growth is strong or investors continue to demand additional compensation for uncertainty. For that reason, we think the longer end of the Treasury market warrants a little more caution.   

Dial 4: Political Environment, 4:45— Our final change this month was a downgrade to the Political Environment Speedometer.

This is not an election forecast, and it is not a judgment about either political party. We are simply getting closer to the midterm elections and historically that means policy uncertainty begins to increase.

A number of economically important issues are becoming part of the political debate, including taxes, trade, energy policy, government spending and the rapid development of AI infrastructure. As that debate becomes more intense, companies have less clarity about the rules they may be operating under next year.

We think that uncertainty is worth flagging as we move toward year-end. Once the elections are behind us and there is greater visibility around policy, there is a reasonable path for that Speedometer to improve again.

Putting all of this together, our economic outlook remains positive.

The U.S. economy is growing and corporate spending is providing an important tailwind while earnings and market multiples continue to support equity markets. Consumer spending has also remained resilient, and going into the jobs number tomorrow, the labor market looks stable. At the same time, we recognize that the risks have not gone away. Geopolitics, government debt, long-term interest rates and political uncertainty all have the potential to create volatility.

September itself can also be a difficult month for markets. But our central view is that the underlying economy is stronger than many of the headlines suggest. As long as growth continues to support corporate earnings, we believe that remains a favorable backdrop for investors.