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Introduction

Remember our Charles Dickens reference two weeks ago? "It was the worst of times, it was the best of times." Last week, the "best of times" returned with a vengeance, sending the S&P 500 to fresh all-time highs. It's remarkable how quickly sentiment can change.

Just two weeks ago, the doomsayers were calling for the end of the bull market, driven by the unwind of an overly euphoric AI infrastructure trade. Ironically, the semiconductor index—the epicenter of both the panic and the recovery—is still roughly 15% below its June highs. After suffering an almost 30% correction, the group has merely retraced about half of that decline, underscoring just how quickly investor psychology has swung from despair back to optimism.

Rotational flows have become an increasingly important driver of the market, as leadership continues to broaden beyond the narrow group of technology names that carried much of the rally over the past year. We have highlighted this shift for weeks as one of the primary reasons to resist becoming overly bearish, despite the severe correction in the leading semiconductor stocks. A healthy bull market ultimately requires participation to broaden, and that is exactly what has been unfolding beneath the surface.

Obscuring that improvement has been the conflict with Iran, which sent oil prices sharply higher, reignited inflation concerns, and weighed on many economically sensitive sectors. While there is still little visibility into a lasting resolution, markets are discounting mechanisms. Rather than waiting for perfect clarity, investors appear to have been pricing in a more favorable outcome for months.

The relationship between oil and the Equal Weight S&P 500 (SPW) makes this especially clear. Oil prices peaked in early April, almost precisely when the equal-weight index bottomed. Since then, as energy prices have steadily retreated, the SPW has ground higher, reflecting improving participation across the broader market rather than continued reliance on a handful of mega-cap technology stocks.

We've shown this chart several times before, but it deserves another look. Since the start of the third quarter, sector leadership has shifted decisively toward cyclical areas of the market, reinforcing our long-held view that participation is broadening beneath the surface.

Looking through the ETF lens tells a similar story. Technology (XLK), the market's primary leadership group for much of the past year, has been bringing up the rear for most of the third quarter, only finding a meaningful low on July 29 before beginning its recovery. Meanwhile, Energy (XLE) led the field through much of the quarter before recently surrendering the top spot to Internet (FDN), with Financials (XLF) close behind. The message is clear: leadership is broadening rather than narrowing.

In a previous report, we warned that the S&P 500 could be forced to "catch down" if technology failed to stabilize. That scenario never materialized. Instead, technology carved out what appears to be an important low in late July, with the reversal accompanied by exceptionally strong volume—a classic hallmark of institutional accumulation and, often, the beginning of a durable tradable bottom.

Interestingly, in our July 29 report, we called for a rebound in the market, specifically highlighting the Nasdaq 100 and Semiconductor Index (SMH) as likely beneficiaries. While we had no way of knowing how far the rally would extend, we did recommend adding back long exposure. As key resistance levels were reclaimed, we continued to increase exposure, culminating in the follow-through days (FTDs) that confirmed institutional buying. The entire process was documented in last week's report, Green Means Go!

To be clear, we were never ringing the bell at the exact lows or advocating an "all-in" approach. We were, however, encouraging investors to progressively increase exposure as the evidence improved. Just as importantly, we were not bearish when much of the market had become convinced the bull market was over.

If you've followed our work for any length of time, you know we don't become aggressively bullish simply because the market stages a bounce. Our process requires multiple independent factors to align before we make that call. Ironically, that alignment never fully materialized during the correction because the market's underlying internals never deteriorated enough to generate the type of high-conviction setup we typically look for. As a result, our approach remained tactical rather than aggressive. The bottom line is that we have no intention of abandoning a disciplined, rules-based process simply because it feels like the market should move higher.

That discipline has now been rewarded. The S&P 500 finished the week at fresh all-time highs while posting its strongest weekly advance since April. New all-time highs are inherently bullish, and that should remain the starting point for any assessment of the current market backdrop.

A surprise decline in U.S. payrolls renewed concerns about the labor market, suggesting employers are becoming increasingly cautious amid lingering inflation pressures and the economic uncertainty created by the Iran conflict.

While that may sound counterintuitive, if the recent softness in payrolls is, at least in part, a function of uncertainty surrounding the Iran conflict, then a durable resolution could reverse much of that caution. Couple that with easing inflation pressures and a moderation in the Fed's hawkish rhetoric, and you have a potentially powerful backdrop for higher equity prices.

This was a welcome surprise, although another rate hike cannot yet be ruled out, as the persistent rise in Treasury yields continues to complicate the macro backdrop during Trump's second term.

The next major catalyst with the potential to alter the trajectory of yields is this week's inflation data. Consensus estimates call for CPI to edge modestly higher, but inflation is still expected to remain relatively contained. More importantly, the report should begin to reflect a moderation in the energy-driven price pressures that intensified following the onset of the U.S.-Iran conflict at the end of February. If that proves to be the case, it should help keep Treasury yields in check and reinforce the market's growing belief that the inflation shock from the conflict is beginning to fade.

As always, however, inflation reports have a history of surprising markets. A meaningful upside or downside deviation from expectations could quickly alter the interest-rate outlook and, by extension, drive significant moves across risk assets.

Earnings season is beginning to wind down as we move beyond the busiest three-week reporting window. Results have been exceptionally strong, with approximately 85% of companies exceeding consensus expectations—the highest beat rate since 2021. For all the concern surrounding geopolitics, inflation, and interest rates, corporate America continues to deliver.

Looking ahead, earnings estimates for next year continue to move higher, with consensus now forecasting roughly 12% earnings growth. It's difficult to maintain a structurally bearish outlook when forward earnings expectations are still trending higher.

Should the Iran conflict de-escalate, the current consensus forecast of roughly 12% earnings growth may ultimately prove too conservative. Lower energy prices, easing inflation pressures, and improving business confidence would all provide additional tailwinds for corporate profits. Until we see evidence of a meaningful re-escalation, we continue to believe the weight of the evidence favors the bulls.

In our last report, we argued that the prerequisites for becoming more aggressive on the long side had finally fallen into place.

Let's see if the charts continue to validate that thesis.