Summary
Earnings Obliterate Inflation Concerns: Our Monthly Survey of the Economy, Interest Rates, and Stocks In our base case 2026 economic and market outlook issued in December 2025, Argus forecast monthly nonfarm payrolls growth in the 50,000 range, S&P 500 continuing operations earnings growth in low-double-digit percentages, and headline inflation moderating to the 2.5% range by year-end. Based on those forecasts, we set a base case for gross domestic product (GDP) growth in the mid-2% range and stock market appreciation of 5%-10%. With midyear 2026 not far off, the general parameters of our base case forecast — GDP growth and stock market appreciation — are intact. Beneath the surface, the underpinnings of our forecast have changed meaningfully. The jobs economy is proving not just resilient but appears to be gaining momentum. Inflation surged due to the energy shocks from the war with Iran and may not yet be at peak levels. Normally, inflation is the one sure-fire bull market killer, as it proved in 2022. But astonishing earnings growth for giant U.S. Information Technology companies has obliterated inflation concerns, at least in the view of unabashedly bullish stock investors. The S&P 500 concluded May with its eighth consecutive week of gains, its longest winning streak since December 2023, and ended the month at new all-time highs. It’s not just tech companies that are reporting stunning earnings growth. The artificial intelligence (AI) revolution has broadened from its narrow focus on generative AI (GenAI) and training large language models (LLMs) by hyperscalers to the infinitely larger market for agentic AI enabled by inference. Agentic AI enables enterprises and nations to bring new levels of digital sophistication to their operations, and this transition is impacting revenue and earnings for every sector and industry worldwide. This level of enthusiasm (OK, call it mania) rarely ends well. But the broadening of the AI trade from its narrow beginning in the hyperscale data center to every company worldwide may actually be a case of ‘It’s different this time.’ The Economy, Interest Rates, and Earnings The preliminary (second) GDP report for 1Q26 indicated annualized growth of 1.6%, down from 2.0% in the advance 1Q26 GDP report but up from 0.5% in 4Q25. Although some government functions were shut down or truncated in 1Q26 by the Department of Homeland Security funding battle in Congress, the 1Q26 report is a much clearer indicator of the underlying economy than was the 4Q25 report. First-quarter 2026 GDP also captures the effects of one month of the U.S. and Israeli war with Iran. In broad strokes, the GDP report shows a consumer economy struggling with existing and new inflation but still spending and a commercial and industrial economy that is all-in on investing in AI. And despite the yearlong implementation of tariffs at the highest level in decades, imports soared in 1Q26 and were meaningfully subtractive to GDP growth. First-quarter 2026 Personal Consumption Expenditures (PCE) increased 1.4%, down from 1.9% in 4Q25. Total spending on goods rose 0.4% in 1Q26, after rising 0.3% in 4Q25. First-quarter durable goods and nondurable goods spending were up 0.4% and 0.5%, respectively, and down from 4Q25 levels. Tepid consumer spending on goods reflects pressures on the bottom leg of the K-shaped economy, as lower-income consumers focus spending on food and gasoline to the detriment of everything else. Services spending, the biggest part of GDP, rose by 1.8% in 1Q26, down from 2.7% in 4Q25. Altogether, PCE contributed 0.95 percentage point to 1Q26 GDP, after contributing 1.30 points in 4Q25. Consumer spending on services contributed 0.86 percentage point to 1Q26 GDP, while consumer spending on goods contributed 0.09 percentage point. Nonresidential fixed investment, the proxy for corporate capital spending, rose by 10.1% in 1Q26, jumping meaningfully from 2.4% growth in 4Q25. The AI boom drove a 17.2% surge in equipment spending and 11.6% growth in intellectual property products; corporate spending on structures declined 6.2%. Nonresidential fixed investment contributed 1.35 percentage points to total 1Q26 GDP. PCE and nonresidential fixed investment normally constitute 80%-85% of GDP. These two categories contributed 2.30 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 2.1% 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 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. Those tariffs expire or must be renewed by Congress by July 2026, and the situation remains confusing for business planners. Exports rose 13.1% 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. But imports jumped an even heartier 21.1% in 1Q26 after contracting 1.0% in 4Q25. The net of exports and imports subtracted 1.25 percentage points from 1Q26 GDP, much higher than the 0.22 point subtracted from 4Q25 GDP growth. Government spending recovered to 4.4% growth in 1Q6 from a shutdown-impacted 4Q25, when spending contracted by 5.6%. The recovery in government spending added 0.73 point to 1Q26 GDP growth after subtracting 0.99 point in 4Q25. Argus Chief Economist Chris Graja, CFA, is forecasting 2026 GDP growth of 2.1%. The Argus preliminary GDP forecast for 2027 is for growth of 2.0%. Outside the GDP accounts, the picture is mixed. After multiple years of strength, the U.S. employment economy showed signs of slowing in the third and fourth quarters of 2025. Employment has been better than expected but erratic in 2026 to date, with nonfarm payrolls missing consensus expectations both to the upside and downside in alternating months. April 2026 nonfarm payrolls exceeded expectations with a gain of 115,000, compared with consensus estimates of 62,000. Nonfarm payrolls averaged a monthly gain of 48,000 for February-April, compared with an average gain of 68,000 for the January-March period. Once the negative February tally rolls off, the three-month average could move back into six figures. The April unemployment rate was 4.3%, consistent with March. Average hourly earnings for April grew 3.6% annually, nudging up from 3.5% for March though down from January (3.7%) and February (3.8%) annual growth. For at least three years, hourly workers could count on annual wage growth staying ahead of inflation. Given the oil-induced surge in inflation, that may no longer be true. Although AI was in development for years and even decades, the AI era in the U.S. economy and stock market started in November 2022, with general availability of OpenAI’s ChatGPT. This first phase of GenAI, beyond the fascination of asking ChatGPT questions, was characterized by training of LLMs by hyperscalers building AI data centers with graphics processing unit clusters. The next phase of inference-enabling agentic AI is even more compute intensive and coincides with AI rolling out to enterprise, neocloud, and sovereign customers. No part of the economy is untouched by these developments, and the U.S. industrial sector is helping to build the necessary infrastructure to support this transition. New orders for durable goods rose 7.9% in April, accelerating from a 1.3% increase for March. Orders excluding defense were even stronger, rising 8.1% in April. Excluding transportation, durable goods orders rose 1.1% in April. Industrial production rose 0.7% month over month in April after a 0.3% drop in March. Manufacturing output rose 0.6%, breaking a multimonth string of weak or negative readings. Utilities were up in the 2% range as weather normalized, and mining ticked down as the war in Iran slowed shipping. Industrial production increased 1.4% over the past 12 months, including 3% annual growth for 1Q26. April capacity utilization rose to a 76.1% rate from 75.7% in April but is more than 3 percentage points below its long-run (1975-2025) average. 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 jobs availability. The Institute for Supply Management’s (ISM’s) Manufacturing Purchasing Managers’ Index (PMI) remained at 52.7% in April after reaching that level in March. Even with energy prices continuing to climb, April marked four consecutive months for the Manufacturing PMI in expansion territory, meaning above 50.0%. The ISM’s Services PMI slipped to 53.6% for April from 54.0% for March. The Services PMI has spent nearly two straight years (22 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 and 91.2% in February. The May Expectations Index moved higher, in a positive sign. The University of Michigan Index of Consumer Sentiment, however, continues to deteriorate. With war-related inflation driving gas prices 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. At the same time, consumers and companies are wary but mainly continuing to go about their business. Consumers are employed, and businesses are investigating the AI opportunity. The situation in Iran remains in a ‘no war, no peace, no oil’ phase, with both sides seemingly willing to wait out the other side. If the logjam in the Strait of Hormuz is not resolved, consumers and businesses may feel differently this summer. West Texas Intermediate (WTI) and Brent crude oil benchmarks, along with gasoline, diesel fuel, and aviation fuel, all moved 40%-50% higher in March 2026. Crude and refined product prices bobbed around peak levels in April and most of May before heading lower at the end of May on what appears to be the best chance yet to end or at least pause the war. Neither side wants to blink, prolonging the truce process. Stasis in which the strait remains closed is not a healthy condition, as global stocks of petroleum products continue to work steadily lower. Even before the war with Iran began, the Federal Reserve (Fed) was in a tough spot trying to honor its dual mandate of keeping the workforce fully employed and holding inflation near its 2% target range. Energy inflation is fully revived, and transportation and food inflation are likely soon to follow. The double-digit shock in energy prices resulting from the war and closure of the Strait of Hormuz has sent market rates of interest higher on now actualized fears of renewed inflation. The Federal Reserve board conducted a momentous Federal Open Market Committee (FOMC) meeting in May, the final one in which Jerome Powell served as Fed chair. As expected, the FOMC held rates steady in May. Not long after the meeting, Congress approved Kevin Warsh as the new chair of the Fed. Mr. Powell announced he would remain a board member, and Trump appointee Stephen Miran stepped down to make room for Warsh. Besides the Powell-to-Warsh transition, the May meeting was notable for four dissents on the official Fed policy statement. Mr. Miran voted in favor of a rate cut. The other three dissents, however, sought to remove language in the statement indicating that further easing was appropriate. These three members, along with the very real change in the inflation environment, may complicate Kevin Warsh’s stated goal of lowering rates. Within the preliminary 1Q26 GDP report, the PCE Price Index rose 4.5%, up from 2.9% in 4Q25. Even though the Core PCE Price Index strips out energy along with food, Core PCE prices rose 4.3% in 1Q26 after rising 2.7% in 4Q25. This metric is monitored by the Fed as part of its rate-setting deliberations. Inflation is percolating across the consumer and business economies. The April all-items Consumer Price Index (CPI) rose by 0.6% on a month-over-month basis and 3.8% on an annual basis. Core CPI for April, excluding food and energy, rose 0.4% monthly and was up 2.8% annually from April 2025. While the CPI was about in line with expectations, the Producer Price Index (PPI) stunned investors and sent interest rates soaring. The PPI for April 2026 showed a 1.4% increase from March and a 6.0% increase on an annual basis – the largest 12-month advance since December 2022. For PPI excluding food, energy, and trade services, the 12-month change through March 2026 was 5.2%, much higher than the 4.3% consensus call. PPI captures ‘pipeline’ prices, with lags that can be weeks or months before reaching consumer prices. The ripple effect is still ahead, as this April wave of higher prices reaches consumers in June or July. Even after normal shipping resumes in the Middle East and oil and other goods begin to flow, the time required for supply to normalize and for prices to begin to come down will be measured in months rather than weeks. With inflation flaring, interest rates jumped in March and remained elevated in April and May. The peak in rates came in mid-May in the wake of the PPI report. Rates have since come off peak but not by much. The 10-year Treasury yield was 4.45% as of the end of May, compared with 4.39% as of the end of April and 4.14% at year-end 2025. The two-year Treasury yield was 3.99% as of the end of May, versus 3.88% as of the end of April and 3.45% as of year-end 2025. The two-10 slope in the yield curve tightened to 46 bps at the end of May 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 continues to model one quarter-point rate cut in the second half of 2026 and one in 2027, but additional inflation might begin to erode that forecast. We are cognizant that the war has created a dynamic situation in which expectations for monetary policy can change rapidly. Conversely, we see a low possibility of a rate hike. Earnings season for the calendar 1Q26 is now largely over and can formally and officially be declared ‘a doozy.’ With more than 95% of S&P 500 constituent companies having reported results, 1Q26 earnings are up in the range of 29%-30% from the year-earlier quarter. That range of estimates is based on the average of data reported by the major earnings aggregators (Bloomberg, FactSet, and Refinitiv) and reflects slightly different baselines and recording conventions. Earnings growth is typically calculated on a blended basis that captures both actual numbers for companies that have reported, as well as estimates for companies yet to report. With just a handful of retailers and technology companies yet to report, the current tally is likely be the final tally. Earnings growth for 1Q26 was the highest since 4Q21, a period in which economic activity was beginning to accelerate following COVID-19 shutdowns. Earnings expectations were healthy heading into the 1Q26 EPS season, running in the 13% range as of the beginning of April. But actual results have exceeded expectations in multiple ways. Of the companies reporting positive earnings growth for the quarter, about 85% have reported results that were above consensus expectations. That is meaningfully higher than the long-term range of 75%-80%. The biggest outlier in this earnings season is the magnitude of the beat against expectations. Companies that exceeded calendar 1Q26 EPS expectations did so in midteen percentages, compared to a historical beat against expectations in the 5%-7% range. The earnings beat was influenced by Magnificent 7 earnings. Three companies – Amazon.com Inc., Alphabet Inc., and Meta Platforms Inc. – experienced huge onetime gains totaling $65 billion. These three companies offer only GAAP results. Nvidia Corp. posted non-GAAP results that included a $15.9 billion onetime unrealized gain from nonmarketable equity securities, bringing the Mag 7 contribution from onetime gains to more than $80 billion. Including the Mag 7 contribution, S&P 500 earnings topped expectations by a far-above-average 16%-plus. But even backing out that contribution, the EPS beat was well above average. 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. 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 (whenever possible) turn fixed costs into variable costs. We believe the strong margin performance will carry beyond the first quarter of 2026. We have raised our forecast for S&P 500 earnings from continuing operations to $340 per share for 2026 from a prior $315. Our new estimate assumes 24.8% growth in continuing operations earnings from 2025. We have 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 the end of May 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 more than 10% for April and 5% for May, while the Nasdaq Composite ripped more than 20% higher over the two-month span. As of the end of May 2026, the major indexes were all up for the year-to-date in another stunning V-shaped recovery, after all being down for the year at the end of March 2026. The S&P 500 was up 11.3% year-to-date on a total return basis including dividends as of the end of May. The Dow Jones Industrial Average was up 6.9% including dividends. The Nasdaq, which in mid-March was on the edge of correction territory, ended May up 16.3%, for an 8-percentage-point one-month swing. For most of 2026, value had been beating growth, but now growth is back in front. The FT Wilshire US Large Cap Growth index is up 9% year to date, versus 8.5% for the FT Wilshire US Large Cap Value index. Small caps continue to relatively outperform, and the Russell 2000 Index was up 18.3% at the end of May – leading the next-closest index by 200 bps. Stock performance has been headline driven. After benefiting in April on talk of a truce, stocks rallied in May on earnings headlines, capped by Dell Technologies Inc. on the final trading day. While awaiting a lasting end to hostilities and a
