Hi everyone,
In this letter, we want to dive into the current market situation and potential risks and levels we think the market may need to reach to reprice today’s valuations. We spoke about this many times in our past letters. We’ll also go into detail on how we’re planning to structure our portfolios over the next few months.
Let’s begin!
On Wednesday the Fed raised rates to 3.75%–4.00%. First hike since July 2023. As we wrote in our morning prep that day, everyone expected a hike and it wasn’t a surprise.
But what is then new? The 10-year Treasury yield hit 5.04%, the highest since 2007. Oil is above $100. Diesel just set a record at $6.49 a gallon. Nine months ago oil was near $60 and markets still expected rate cuts.
A whole regime changed in just nine months.
Bonds moved before the Fed did
Normally the 10-year yield barely moves in the year before the first hike. This time it jumped about a full percentage point first. The bond market forced the Fed’s hand.
After a first hike, history says the 10-year often keeps rising. From 5%, that path points toward 6% by next spring and maybe 6.4% at the peak, a level last seen around 2000. In the 1970s it rose even more.
People assume this is inflation fear. It isn’t. The market’s long-run inflation forecast (the “breakeven”) is still about 2.3%. It has barely moved since last winter. Yields went up because investors want more pay to lock money up for 10 or 30 years, a higher real rate and a fatter risk premium on Treasuries. That is the quiet risk.
It also decides the dollar. And the dollar decides almost everything else.
The Fed is not done and the White House hates that.
In three months the Fed raised its forecasts for growth and inflation and cut its forecast for unemployment. Stronger economy, hotter prices, tighter jobs market. Nothing in that table says “pause.”
Officials now see rates at 4.1% at the end of 2026 and still 4.1% in 2027. Sixteen of eighteen expect another hike this year. Inflation does not get back to 2% until 2029.
After you subtract inflation, the real policy rate is only about +0.5%.
The political problem is the other side of the table. About two weeks before the meeting, President Trump threatened to cut off trade with countries that run a surplus against the U.S. if the Fed did not cut. After the hike he said rates should be 1% or less.
We have seen this movie.
In the 1970s, under pressure, the Fed kept real rates negative. Inflation came back at 13%. The dollar fell about 17%. Then Volcker pushed real rates very high. Inflation collapsed, the dollar soared, and stocks eventually boomed.
Real rates and the dollar move together. Half a point of real rate, with a president demanding 1%, is not a strong-dollar setup. That is the fork in the road: 1994 (yields up, dollar down) or 2022 (yields up, dollar up).
Profits are fine. The price tag is not.
Company earnings are roaring. Second-quarter S&P 500 profits were up 51% from a year earlier. Over the last four quarters they are up 26%. A lot of that is AI spending — the big tech firms may spend about $800 billion this year.
But the market is paying less for those earnings. The forward P/E dropped from 23 times last year to about 19 times now. At Friday’s close of 7,650, that implies about $400 of forward earnings.
In late 2018, earnings were strong, the P/E shrank hard, and from September to December the S&P fell about 20% and the Nasdaq about 24%. In 2022 the S&P lost 18% (including dividends) and the Nasdaq 33%. Both times, yields and the dollar were rising. Record profits did not save anyone.
Bonds did not help either. In 2022 the main U.S. bond index lost 13%, its worst year on record. When inflation is above about 3%, stocks and bonds often fall together. Inflation is 3.7% now. Do not count on bonds as a shield.
Three different ways of looking at the same market land in the same zone:
A 2018-style squeeze (earnings still growing, multiple down to 16x) → about 7,400
A typical high-inflation hiking cycle (stocks down ~7.5% in four months) → about 7,100
The lowest year-end target among Wall Street strategists (Bank of America) → 7,100
Call that cluster 7,100 to 7,400.
That is not a crash call. If oil falls back below $100 and this stays a slow, “one more hike then hold” cycle, 8,000+ is still possible. If oil stays high, the next four months are the rough ones.
One more 2022 lesson: energy stocks rose 66% that year while the S&P fell 18%. In this kind of cycle, oil is a hedge.
The S&P is still up 58% from the April 2025 low and 21% from the March 2026 low. That pre-hike rally is normal. The hard part starts after the first hike.
Why the multiple is falling
At 19 times earnings, stocks yield about 5.3%. The 10-year Treasury yields 5.0%. You are barely paid extra to own stocks instead of a government bond. On some measures that gap is already gone. Last time it was this thin was around 2000.
That is why a profit boom is not lifting the index. Higher yields ate the valuation.
Gold follows the dollar, not the Fed
After past first hikes, gold usually wobbles, then firms, unless the dollar surges.
When the dollar was flat or weak (2004, 2015), gold rose. When the dollar ripped higher (2022), gold fell 13%. The Fed hike does not write gold’s next six months. The dollar does.
Central banks also changed the game. They bought more than 1,000 tonnes of gold a year from 2022 through 2024. Buying slowed to 863 tonnes in 2025, but they are still net buyers. That bid does not care about real yields the way hedge funds do.
So gold is really a dollar forecast: 2015 rerun, or 2022 rerun.
Three different methods point to the same area on the S&P 500: about 7,100 to 7,400.
If investors pay less for earnings (a lower P/E), the index lands near 7,400
If this hike cycle looks like past high-inflation cycles, the index can fall toward 7,100 in the first few months.
The most cautious Wall Street year-end target is 7,100.
One method would be easy to ignore. Three landing in the same place is a level to plan for.
That is not a forecast that the S&P will go there. It is the zone where stocks would start to look reasonably priced again versus bonds. Right now they barely pay you extra for the extra risk.
To get from today’s 7,650 down into that zone, several things would have to stay uncomfortable: another Fed hike still on the table, long-term yields already high, a policy rate that is not tight enough to send the dollar sharply higher but is high enough to keep pressure on stock valuations, and a White House pushing for 1% rates.
What actually decides the path:
Oil. Below $100, the market can drift toward 7,900+. Above $100, the next few months are usually the hardest.
The dollar. A weaker dollar helps gold. A much stronger dollar does not.
Bond yields. If investors keep demanding more yield to hold long Treasuries, 5% on the 10-year is the start of the move. If they stop, 5% can be the high.
Watch those three. The next Fed statement will mostly explain what they already did.
So how do we prepare and position for this? See TMAD detailed plan.
We treat 7,100–7,400 as a planning zone. We prepare by deciding now what we will own, what we will buy, and what we will not use as a hedge. Best is to act only when the evidence picks a path.
This is not a financial advice. Position size around your time horizon, tax situation, and whether you need this money in the next 1–3 years.
TMAD PLAN:
Hold
