When The Good is Bad

"Every rose has its thorn." Friday's May payrolls report was the thorniest of them all. Non-farm payrolls at 172,000, nearly doubling consensus expectations, while unemployment held steady at 4.3%. In any other universe, a resilient economy would be cause for celebration - except, a strong labor market is the ghost that haunts the inflation story - one we've been warning about since January.

The bears, of course, were waiting, sharpening their claws in the corner, ready to pounce the moment the music skips. And the music did skip on Friday. But before one reaches for the panic button, remember - we are in a market where the "Magnificent Few" have been compounding earnings at unprecedented levels, where AI capex programmes are being funded at a scale that makes the dot-com era look like a blip, and where the earnings trajectory, for now, remains unbroken. Without doubt there is froth. IPOs at 94x revenue. Vanishing free cash flows dressed up as visionary disruption. "Concepts", not businesses being capitalized on the strength of a founder's LinkedIn profile and a nice-looking deck. The euphoric crescendo is louder than before. But the critical question, the only question that matters for positioning is -"is the trend broken or merely dented?"

Despite our long-standing concerns on inflation, excessive valuations and the tell-tale signs of exuberance, there is not enough evidence to call for a clear trend-reversal. While early-stage indicators suggest need for hedges to protect recent gains, until the earnings trajectory diverges meaningfully from price action Or the latter reverses convincingly, the trend is not broken

S&P – Reversing Underperformance vs. Nasdaq – Rotation at Play

• ‍Equities – Visible signs of rotation towards quality, defensives and value, away from growth and momentum factors. Tech & growth sectors remain outperformers, but trend is decelerating. Priced to perfection, any miss on earnings/ guidance invites exponential negative reactions. US equities preferred vs. ROW. Tactically reduce delta/ beta especially to growth biased portfolios, but stay invested, especially in AI infrastructure (upstream) with high visibility on demand and earnings.  

• Fixed Income – With inflationary concerns to the fore, we remain underweight fixed income. Both basis risk (higher treasury yields) and spread risk (currently near record lows) make the asset class unattractive top-down. Quality and bias towards short to medium term durations recommended for fixed income biased portfolios.

• Oil & Oil Equities– The elusive “deal” in the Middle East continues to keep oil in an elevated tight range – any resolution will likely see sharp sell-offs. While we are not bullish oil prices, oil equities are likely to see an extended period of super-normal profits.

• Gold & Silver – Despite a positive fundamental outlook, neither gold nor silver are trading positively. Risk of higher rates remains a dampener for long positions. Elevated volatility for both gold & silver support the case for derivatives/ structured products to accumulate positions in what remains the best dollar diversifier (gold).

• The Dollar Remains Resilient – While we expect the FED to remain on an extended pause, even as other central banks are likely to raise rates (ECB notably), higher treasury yields and a “flight to growth and safety” are likely to keep the Dollar Index supported.  

• Alternatives – Macro strategies have struggled thus far in 2026 while long-biased strategies have delivered. Long/Short strategies appear best positioned alongside strong macro managers.

Macro – Better Or Worse?

Proprietary EconomicNowcaster – Trends Are Worsening

The market may have been spooked by a “strong” payroll number, but the fact is that payrolls were down vs. previous readings. No doubt the labor market remains relatively resilient in a “low hire, low fire” environment – BUT, there is broad based deterioration as inflation bites into consumer confidence with implications for future spending.

• The payrolls double-take. 172,000 new jobs in May, on a consensus of 85,000 - and April was revised up to 179,000. Stronger job-openings, further support the resilient labor market narrative.

• Inflationary threats – Headline PPI at 6% and CPI at 3.8% have worsened materially and we remain of the view that an easing in Middle-East tensions will unlikely result in an immediate pullback in inflationary threats. In an insular world, with elevated commodity prices and fiscal profligacy in the western world, inflation is likely to remain a thorny issue.

• The FED in a bind – From multiple cuts to none to now a 62% probability of a December hike – is how futures are pricing in the inflationary threat. While the mid-Jun FOMC is unlikely to see a rate change, commentary and dot plots will give an insight into how the Kevin Warsh FED is thinking. Given supply side heavy inflation drivers, we expect an extended pause rather than a hike.

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Rate Hike Expectations- Rising

• CPI (10 Jun) - the moment of truth. A forecast of 4.20% against a previous 3.80% is already an admission that inflation is re-accelerating. If the print comes in at or above forecast, expect a violent repricing of rate expectations heading into the June 17 FOMC. A surprise to the upside can potentially force the market to price a July hike as a base case, rather than a tail risk. A downside surprise would offer temporary relief but would not, in our view, change the structural inflation narrative we have maintained since January.

• Core CPI (10 Jun) - the Fed's real compass. At 2.80% previously and 2.90% forecast, core is still elevated but not yet running away. The Fed's 2% target feels increasingly theoretical. Watch whether core surprises to the upside - that, more than the headline, will dictate the dot-plot language on June 17.

• PPI (11 Jun) - the dog that already barked. Previous reading of 6.00% year-on-year, with a forecast of 6.80%. This is not a number you dismiss. PPI is the upstream pressure that feeds into consumer prices with a 2–3 month lag. We have been flagging this since Q1. The market is now catching up. An upside surprise here, coming one day after CPI, would be the one-two punch that extinguishes any remaining rate-cut optimism.

• Retail Sales (17 Jun) - the consumer's confession. Forecast of 4.00%against a previous 4.90% suggests the consumer is beginning to crack under the weight of elevated prices and higher-for-longer borrowing costs. This is consistent with our proprietary Nowcaster's "broad-based deterioration" signal. A sharp miss here on the same day as the FOMC decision would create a genuinely stagflationary narrative - good for gold, bad for nearly everything else.

EARNINGS DRIVE VALUATIONS

Rising EarningsExpectations – Do Valuations Matter?

• ‍Broadcom - The Icarus trade. Revenue of $22.2bn beat the $22.1bn consensus, and EPS of $2.44 topped the $2.39 estimate. By any conventional standard, this was a good quarter. AI semiconductor revenue surged 143% year-over-year, the 13th consecutive quarter of AI-centric growth. And yet, the company did not raise the full-year AI semiconductor target of $100bn+, and Q3 AI chip guidance of $16bn came in below the $17.2bn analyst consensus. In a market priced for exponential acceleration, "merely excellent" is a capital offence. The -12% single-day move is the starkest illustration yet of our core thesis - at these valuations, the margin for disappointment is zero.

• Upcoming - Oracle & Adobe. Both report this week. Oracle's cloud growth trajectory and any commentary on AI workloads will be closely watched, as will Adobe's AI-integration narrative in its creative suite. Any guidance caution will be punished severely given the current mood.

Earnings Outlook & Valuations – Following a blockbuster 1Q, earnings expectations remain elevated at 23% for 2026 and c16%for 2027. While equities are overvalued on most metrics, and they have been for a while, valuations are driven by earnings – as long as the earnings trajectory is supported, valuations will matter less in deciphering near-term returns for equities.