Pocket Protector Not Included

The S&P 500, Nasdaq Composite and Dow Jones Industrial Average had mixed performance of +0.36%, +0.14%, and
-0.56%, respectively, for the week ending Aug. 14. Market-moving headlines included the continuation of Treasury yield divergence, a financial analysis of one of the artificial intelligence (AI) neoclouds, and economic data releases that lowered near-term rate hike expectations.

Last week saw a significant decrease in rate hike probabilities at the next Federal Open Market Committee meeting, scheduled for Sept. 16, as July’s Consumer Price Index (CPI), Producer Price Index (PPI) and retail sales results surprised to the downside. As of Friday, there is now a 67.5% chance of the Federal Reserve (Fed) holding rates unchanged in September, versus 55.6% a week ago and only 47.6% a month ago. Chances of at least one rate hike in 2026 have slid from 74.1% a month ago to 65.7%, and the likelihood of two or more rate hikes declined from 29.5% to only 21.0%.

While the changing expectations around rate hikes have dampened short-term yields, Friday’s 5.25% closing yield on the 30-year Treasury is moving in the opposite direction. Since early July, the long bond’s yield has remained under pressure and is sitting at levels not seen since mid-2007, when the federal funds rate was held at 5.25% to 5.50% for over a year. Unlike 2007’s flat-to-inverted yield curve, the current bear-steepener regime has benefited financials because of the heightened +82 basis-point spread between the 3-month and 10-year yields (+31 basis points year to date). Specifically, regional banks have quietly outperformed all three major U.S. indexes year to date, posting a +21.7% return amid widening net interest margins and strong debt capital demand (performance: KBW Nasdaq Regional Banking Index).

Switching to economic data from the week, the CPI for July was released Wednesday, with headline and core month-over-month inflation coming in at +0.1% and +0.2%, respectively. An increase in shelter costs (+0.1%) made up roughly two-thirds of last month’s increase, while gasoline (-2.9%) and vehicle insurance (-0.3%) prices subsided relative to June. The following morning, the PPI for July came in unchanged month over month versus a forecasted +0.2%, and core PPI (excluding food and energy prices) registered at +0.2% versus an expected +0.3%. Prices for construction and services climbed +2.2% and +0.2%, respectively, while goods slid -0.7% due to a -3.1% drop in energy month over month. Year over year, PPI increased +4.7%, a decline relative to June’s +5.5% and economists’ forecast of +4.9%.

While researching the factors affecting both CPI and PPI in July, I was surprised to see energy leading declines in both and decided to investigate further. Month over month, the average futures price of both West Texas Intermediate and ICE Brent rose +23.2% and +21.0%, respectively, while retail gas prices fell marginally, -0.4% month over month. Taking into account month-end prices, June ended with Brent at $71.30 a barrel, while July futures settled at $90.12 a barrel, a roughly 26% increase. With my tinfoil hat securely fastened, I confirmed that the Bureau of Labor Statistics uses average monthly gasoline prices for CPI, and PPI sometimes has a few weeks’ lag, but nothing helped me translate how a -0.4% decline in average retail gasoline prices led to a -2.9% CPI line item or how PPI registered an even steeper -3.1% drop in energy inputs month over month.

Retail sales numbers for July were released Friday morning, coming in at -0.6% month over month versus a +0.1% expectation. Sales year over year declined from +6.8% in June to +5.0%. The miss by forecasters was quickly attributed to weakness in non-store (e-commerce) retailer sales, as Amazon’s Prime Day shifted from July to June. Retail sales month over month for June were only +0.2%, but strong non-store sales of +1.9% were offset by a greater -5.3% decrease in gas station sales.

Shifting to notable equity stories from the week, multiple AI neocloud (not a “Matrix” reboot) stocks reported earnings last week, with one of the larger constituents’ shares (I’ll let you figure out which) climbing +15% after reporting a +112% year-over-year jump in revenues. Of the $2.58 billion in revenues generated, depreciation and interest expenses made up about $2.0 billion, or 78.9% of revenues. On the earnings call, the company’s CEO mentioned multiple times how its operating leverage was beginning to materialize, yet its +112% top-line growth (inclusive of deferred revenue, remaining performance obligations and estimated amounts of future contracts subject to delivery/availability) was dwarfed by a +120% increase in real, actual, recordable expenses.

Further, net income (loss) also showed the wrong type of leverage, nearly doubling year over year from -$0.60 a share to -$1.14 a share, even with the positive dilution effects of a +4.55% expansion of shares outstanding sequentially and +13.1% year over year. Holding share count constant, the company’s quarterly loss would have increased to -$1.28 a share, or -113% from its second quarter of 2025.

Cash from operations of +$679 million included $790 million in deferred (contingent) revenues and $165 million of stock-based compensation.

Last, its balance sheet detailed a not-so-modest debt load, increasing sequentially from last quarter by +$10 billion and totaling a whopping $35 billion. The firm’s debt-to-equity ratio equals 7x and equity-to-assets ratio of 6.5%.

Wow.

The namesake for this week’s recap refers to the disregard for basic financial analysis paired with excessive corporate and fiscal spending seen historically during prolonged periods of market strength. The second quarter’s strong earnings are mired with negative cash flows, unrealized investment gains reported as income, and outsized stock and debt issuance, all of which have gone largely unnoticed by the investing masses. AI will no doubt revolutionize the world as we know it, but not without the same creative destruction that has plagued every technological invention before it.

What to Watch This Week: In a light week for economic updates, the Federal Open Market Committee will release its minutes for July on Wednesday, and the S&P Purchasing Managers’ Index (PMI) Composite is set to be released Friday. Second-quarter earnings continue this week with big-box retailers including Home Depot, Lowe’s, Target, Walmart, Ross Stores and TJX, along with Deere & Co.

Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Market Commentary/Market

5846019 Exp. 08/31/2029