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We’ll start with the bad news first. CPI inflation came in roughly in line with expectations. But those expectations were for a modest reacceleration of the Fed’s preferred gauge, core CPI. Core inflation (which excludes volatile food & energy prices) came in at a six-month high, which pushed the year-over-year growth rate to 3.0% (up from 2.9% last month), while, total CPI remained at 2.7%.
 

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Transportation, medical care, and used cars & trucks were the biggest gainers for the month. Food prices were unchanged, while energy prices fell 1.1%. Shelter inflation continues to be the “stickiest” of the core components, up 0.2% for the month and up +3.7% over the last 12 months.
 

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There is no better picture that summarizes the effects of inflation than the real retail sales chart. While both total retail sales and core retails sales charts are making record highs, when we adjust for the effects of inflation, we can see clearly that demand has remained the same for the last four years. Real retail sales remain below its April 2021 highs. Consumers are paying more for the same amount of goods.
 

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Consumers are feeling the effects of inflation and the slowing economy. If we look at real consumer spending (which includes goods and services) for the first half of 2025, we can see that real spending is negative for the first half, and the third worst first half of a year since 2008. The only worse starts came in 2009 (in the depths of the GFC) and in 2020 (COVID-19).

Much was made from the latest jobs report which showed negative revisions of 250,000+ jobs for the prior two months. I hear people brushing this off, but I wouldn’t be so quick to dismiss it. I think those revised numbers are closer to the truth.

If we look at the ISM reports on Services and Manufacturing, we can see that the employment subindex for both has remained below the 50 level (which signals contraction) for much of the year, while the ADP measure of private payrolls has been weak as well. And, of course, there is the real spending data we just looked at.

There is no doubt the economy is slowing by a noticeable amount. At the same time, inflation is holding steady above the Fed’s target. That's the definition of stagflation, even though its nothing like what we experienced in the 1970’s.
 

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Now on to the good news. Earnings growth for S&P 500 companies has been stellar. Analysts were expecting only 5.8% growth in Q2, at the beginning of the quarter. Now that about 92% of S&P 500 companies have reported results, the Q2 growth rate has shot up to 12.9%.

This is a result of 80% of the companies beating their earnings estimates (a seven-quarter high), with every sector but real estate beating their earnings expectations. Earnings growth has been led by the technology and communications sectors (as demonstrated by Google and Meta).

AI-related capital spending is keeping earnings growth steady for large-cap US companies, even while the broader economy weakens.

Next week we’ll get a handful of retail earnings (Home Depot, Target, Lowe’s, Walmart) to digest. While there won’t be much economic data next week, we will have the Fed’s Jackson Hole event at the end of the week to look forward to.
 

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The S&P 500 is up 1.74% in August so far, and 9.66% year-to-date. This is slightly above the historical average annual return of 9.06% (6414 – as shown by the red dotted line at the top of chart), but well below the 17% average return for years that end positive.

The market is up over 34% off the April lows, which has led many to say the move is overextended. But if we look at it in historical context, we are still below the average annual return for positive years, and lagging behind the rest of the world's equity market returns.
 

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The gains in the market cap weighted index have clearly been led by Nvidia and Microsoft. The equal weighted index is still attempting its break out, lagging behind the market cap weighted index (up 24% from the April lows compared to the 34% market cap weighted return), but it's not showing any meaningful bearish divergence so far.
 

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The US dollar continues to get rejected at the 2024 lows (shown by the blue dotted line), down about 12% for the year. This has helped multinational earnings, along with foreign stocks priced in US dollars.
 

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The 10-year treasury rate continues to hold the 4.2% area as we await more clarity on future interest rate policies and tariff-related effects on inflation.

Summary

It’s clearly a mixed bag. Earnings are stellar, mainly thanks to AI spending and excitement, while the real economy slows. Stock valuations remain quite expensive by every metric, but as long as earnings continue to outperform by a wide margin, it won’t matter. Eventually, it will.

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