2026 Q3- 2026 Q4
September 1st 2026
Our quarterly S&P 500 forecast for 2026 Q3 (average price returns) is a 5.4 percent growth over the second quarter of 2026. Our forecast for Q4 is 1.9 percent higher than Q3. Our monthly forecast for September is also higher than August’s average.
Volatility concerning frequent changes in tariff rates and timings, and geopolitical conflicts, cannot be captured in a forecast model. Thus, any uncertainty concerning these issues makes the 95 % confidence interval around the point forecast rather wide.
Market rally loses steam in Q3
Following a 4.81 % drop in 2026 Q1 due to geopolitical tensions and rising oil prices, the S&P 500 had a big turnaround in Q2. After the US and Iran signed an interim framework agreement for a 60-day ceasefire, the S&P 500 index ended Q2 14.9% higher than the end of Q1. This was the best quarterly performance since 2020 Q2.
As Q3 began, the fragile peace in the Middle East ended with renewed hostilities. Traffic in the Straight of Hormuz is severely impeded. Consequently, oil prices have been rising again. The stock markets gave back some of the Q2 gains. Nevertheless, the S&P 500 index ended August at 7686, up 2.6% over the end of July.
Resilient economy, cautious mood
The US economy and labor market remain resilient despite a significantly higher inflation rate than the Fed’s 2% target. The Fed Chairman, Kevin Warsh, continues his hawkish stance after abandoning the Fed’s ‘forward guidance’ policy, i.e., hints of future interest rate changes. Our own analysis agrees that the new Fed Chairman Kevin Warsh’s decision to scrap the ‘forward guidance’ policy is the right decision. It reduces the Fed’s flexibility in reacting to changes in market conditions.
Despite the strong earnings results of Q2, investors remain in a cautious mood as we enter the last month of Q3. The never-ending Middle East conflict, the prospect of a rate hike in September, and lack of ‘forward guidance’ make investors’ optimism rather subdued. Given the big tech’s massive capital expenditure commitments for AI infrastructure, investors are showing more scrutiny and caution in viewing the earnings expectations.
U.S. Q2 GDP growth remains unrevised
US 2026 Q2 gross domestic product (GDP) grew at an annualised rate of 1.5 per cent, down from 2.1 per cent in the first quarter. This was the second estimate for Q2, unchanged from the first advance estimate. The reading was in line with economists’ expectations (Source: Bureau of Economic Analysis (BEA)).
Consumer spending was stronger than the first estimate (3.4% vs 3.2%). Despite the acceleration in consumer spending, the headline growth figure remained the same because imports were revised up and government spending was weaker in Q2.
Although US economic growth appears still respectable, deteriorating inflation prospects stemming from the war threaten household budgets. The strength of consumer spending in Q2 may have something to do with consumers racing to beat higher inflation because of the war in the Middle East.
Consumer spending is related to job creation. Nonfarm payrolls fell 23,000 in July. Economists’ expectations for July were an increase of 85,000.
The unemployment rate edged down to 4.1% in July from 4.2% in June. The drop in the unemployment rate was because of a lower participation rate (61.4%). The decline in payrolls was mainly in the local government, education, and leisure and hospitality sectors. Although the low-hire, low-fire trend persists, the seasonal impact of the aftermath of the World Cup may have affected the hospitality sector.
Retail and home sales dipped in July
Starting with the economic data, retail sales ticked down in July. Home sales had a big drop.
The advance estimate of U.S. retail and food services sales was down 0.6% in July but up 5 percent from July 2025.
The National Association of Realtors’ index of pending home sales fell 2.3 % in July after falling 5.4% in June (m-o-m). The Pending Home Sales Index typically lags existing home sales by one to two months. Higher inflation is likely to keep mortgage rates elevated for some. The latest data show that, with no sign of rate cuts any time soon, the challenges in the housing market are far from over.
The labor market remains resilient
In the week ending August 22, the advance figure for seasonally adjusted initial claims was 203,000, a decrease of 4,000 from the previous week’s revised level. The 4-week moving average was 205,500, an increase of 1,250 from the previous week’s revised average. The advance seasonally adjusted insured unemployment rate was 1.2 percent for the week ending August 15, unchanged from the previous week’s unrevised rate. (Source: US Department of Labor).
Initial jobless claims remain well below the 250,000 mark, extending the labor market’s resilience. The expression ‘low-hire, low-fire’ describes a market where companies are reluctant to lay off workers despite labor-saving AI technology. As the latest job creation numbers are very weak, this hypothesis is currently supported.
So far, the data support the Fed Chair, Kevin Warsh’s statement of the US economy being at full employment. Such resilience of the US labor market gives the Fed the power to fight inflation with a September rate hike before it is too late.
PMI falls below 50, and consumer confidence deteriorates
The Chicago Purchasing Managers’ Index (PMI) fell to 47.1 in August 2026 from 57.6 in July and well below the market forecasts of 58.3. The latest data pointed to a renewed contraction in business activity. The contraction has been the steepest since December 2025. This raised alarm bells as going back to the contraction mode is usually punished by a stock market sell-off.
The Conference Board’s consumer confidence index decreased by 0.8 points to 89.4 (1985=100) in August, down from 90.2 in July. The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—rose by 6.8 points to 121.2, following three months of consecutive decline. The Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—fell by 5.8 points to 68.2. The survey period for this month’s preliminary results was August 3–16. Already in June, US consumers were feeling pessimistic about the prospects of getting a job. This was when the US-Iran ceasefire was in place. The ceasefire violation and the restart of the conflict contributed to the deterioration in consumer sentiment.
Inflation falls to 3.4%
The annual inflation rate in the US fell to 3.4% in July from 3.5% in June 2026. This was in line with market expectations. Declining energy costs, thanks to the ceasefire between the US and Iran was the main reason for the cooling inflation. However, the renewed conflict and the rising energy prices in August indicate that the cooling in US inflation might be short-lived.
Personal consumption expenditures (PCE), a key barometer of inflation and consumer spending, was 3.7% at an annual pace in July, unchanged from June, and 0.1 percentage point above the Dow Jones consensus estimate. Core PCE, which excludes the more volatile food and energy categories, was 3.3% in July, in line with market forecasts.
Being above the target inflation rate (2%) for five years has been a concern for the Fed. After the peace deal between the US and Iran in June, the oil price dipped sharply. At the end of June, the WTI Crude price was hovering around $70. However, the renewed atrocities in the Middle East changed the energy price outlook. At the end of August, crude oil benchmarks closed higher, driven by persistent Middle East supply disruption risks and tight inventory conditions (Brent Crude: $88.37 / barrel, and WTI Crude: $86.42 / barrel). If a peace deal is reached in September, given the lagged effects, production costs and consumer inflation may remain elevated in Q4. We expect the inflation picture to worsen before it gets better.
A rate hike in September?
Since the cut in December 2025, the federal funds rate’s range has been 3.5 % to 3.75%. The Fed held the rates unchanged for a fourth straight meeting on July 29. The next Fed meeting is on September 16. We believe a 25bp rate hike is likely. Given that inflation is sticky, the US labor market is resilient, and the economy is at full employment, the appropriate course of action for the Fed would be to increase interest rates.
Fed Chairman Kevin Warsh stated during his speech at the Jackson Hole symposium , “We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job, our mandate and our charge to keep.” Warsh’s commitment to lowering inflation to the central bank’s 2% target would lose its credibility if the Fed holds the rates unchanged in September. Warsh’s hawkish tone, persistent underlying PCE inflation, and rising energy costs increase the probability of a September rate hike.
A sharp rise in US Treasury yields
US Treasury yields have been rising since June (see Graph below). At the end of August, the 10 Year Treasury yield was 4.73%, the highest since January 2025. Strong economic data, resilient labor markets on one side, and the latest surge in inflation expectations with rising energy prices were driving the increase. Fed Chairman Warsh argues that the sharp rise in U.S. Treasury yields delivers some monetary tightening, typically associated with higher interest rates. Following President Donald Trump’s threat of additional attacks on Iran, rising oil prices caused a sell-off in the Treasury bond market, raising yields.
When the 10 Year Treasury yield increases, the cost of capital rises across the bond market spectrum. Currently, tech companies are using the bond market to fund investment in data centers, power infrastructure, and hardware. The magnitude of this spending is about $7.6 trillion over the next 5 years. There has been a massive long-dated bond issuance by companies such as Amazon, Meta, Alphabet, and Microsoft. As the timing of higher spreads corresponds to widening spreads in corporate bonds due to increased supply, risks to the financial system are also increasing. If these AI companies cannot convert their tremendous investments into even higher earnings, the systemic risk may require the US state to take stakes in these companies.
Q2 corporate earnings were very strong
US corporate earnings with inventory valuation and capital consumption adjustments (domestic industries) were up 9.9 percent in 2026 Q2 from the previous quarter. Earnings were up a whopping 22.7 percent over 2025 Q2. The AI boom is the main driver of this jump, followed by companies in Consumer Discretionary sectors such as Autos, which benefited from tariff refunds and improving supply chains. In addition, US consumer spending is strong by historical standards.
Our consumer sentiment indicators are based on our ‘keyword’ algorithm related to ‘Google Trends’. Accordingly, these indicators are among the explanatory variables that predict US corporate profits. In 2026 Q3, we expect the company’s earnings to be 9.2% higher than in 2026 Q2 and 29.4% higher than in 2025 Q3. US corporate earnings encompass a broader range of companies than the S&P 500. That said, lately the AI boom has made the earnings impact of the ‘Magnificent 7’ more dominant. This inevitably blurs the more representative picture of the health of the US economy. That said, the productivity gains from AI have been giving a cost-saving boost to a wider range of sectors such as Business Services.
The historical data from August 31st 2025
The S&P 500 is no longer over-valued
According to FactSet Insights from August 28, the forward 12-month P/E ratio for the S&P 500 is 19.6. This P/E ratio is below the 5-year average (19.9) but above the 10-year average (19.0). For Q2 2026, the blended (year-over-year) earnings growth rate for the S&P 500 is 52.0%. If 52.0% is the actual growth rate for the quarter, it will mark the highest earnings growth rate reported by the index since Q2 2021 (91.6%). Overall, the index is close to fair valuation, owing to high earnings forecasts, driven by the AI boom.
For Q2 2026 (with 97% of S&P 500 companies reporting actual results), 86% of S&P 500 companies have reported a positive EPS surprise, and 77% of S&P 500 companies have reported a positive revenue surprise. It remains to be seen if higher inflation and rising Treasury yields will challenge the earnings of these companies and push their forward P/E ratios into overvalued territory.