ECONOMIC REVIEW – July 2026

Brian Goodstadt, CFA
Chief Investment Officer

Economy Still on Solid Ground Despite Record Low Consumer Sentiment

The University of Michigan’s Consumer Sentiment indicator, which dates back to 1952, recently fell to the lowest reading on record. Yet consumers keep spending, and the economy is growing moderately, with real GDP projected to rise 2.1% for 2026. The index increasingly reflects politics rather than economic conditions, which makes it less useful as a gauge than it once was, when sentiment and economic conditions were highly correlated. A shift in how the survey collects responses has drawn more Democratic respondents, and much of the recent decline has come from Independents, while sentiment among Republicans and Democrats has held relatively steady. 

Source: Goldman Sachs Global Investment Research, University of Michigan

Inflation Rising While Labor Market Improving

The recent rise in inflation has slowed the economy only slightly, with the current 2.1% GDP projection down marginally from the 2.3% expected three months ago. Inflation has been driven partly by higher oil prices, and partly by other structural factors such as the AI-driven rise in the cost of hardware, which recently led Apple to raise prices on its iPhones. This has the market now pricing in Federal Reserve rate hikes later this year, a reversal from the rate cuts expected only a few months ago. That puts the Fed chair in a bind, and new chairs are typically tested by the economy or markets within their first year. For now, we expect the Fed to hold rates steady. The pickup in inflation is illustrated below.

Note: Three- and six-month annualized change uses seasonally adjusted figures.
Source: Labor Department
Source:WSJ

One reason the economy has weathered higher inflation is that the labor market has improved in the last two months, as shown below. After several months of weak job growth, payrolls picked up recently, driven mostly by gains in the healthcare and leisure/hospitality sectors. And as we discussed last quarter, there is still no real evidence of AI taking jobs.

Earnings Estimates Soaring

Despite GDP projections declining slightly in the second quarter, corporate earnings and forward estimates have risen sharply in the past three months. As shown below, 2026 S&P 500 earnings projections have risen from 17.1% at the end of the first quarter to 23.2% at the end of the second quarter. Small cap companies have also seen earnings increases, along with most international countries, especially emerging markets, which we added to our client portfolios in the first quarter.

This disconnect between earnings and GDP highlights the significant differences between S&P 500 companies and the broad economy. One difference is that GDP is reported after inflation, while earnings include it. A second is profit margin expansion, which does nothing for the broader economy and can even weigh on it if wider margins come from fewer, more productive employees. Margins have in fact soared to all-time highs, lifting return on equity to a record of 22%, compared with a 40-year average of 14%. A third is that about 40% of S&P 500 revenues come from abroad, which does not feed into GDP, a purely domestic measure.

The largest single driver of the recent surge in earnings is the accounting treatment of unrealized gains on investments in private companies whose valuations have risen. This effect has been concentrated among large technology companies. 

Long-term earnings projections (next 5 years) have also risen to new heights in recent months. According to LSEG, long-term earnings growth is now expected at 24% annually, which is about twice the historical average of 12.8% since 1985. This projection is probably overly optimistic, as it surpasses the dotcom peak projection of 18.6% in 2000.

Current Economic Outlook and Summary

The U.S. economy is still likely to avoid recession this year, with GDP projected for moderate growth despite record low consumer sentiment. The economists’ consensus puts the chance of recession over the next 12 months at 25%, and slightly higher in Europe at 27.5%. Inflation has picked up but could recede as the war in Iran subsides. Consensus projections are 3.5% for CPI this year, and core PCE (personal consumption expenditures) of 3.2%. The labor market has improved after several lackluster months, and continued improvement could be key to further economic growth. Corporate earnings estimates, meanwhile, have surged on a combination of higher revenues and wider profit margins.