SUMMARY
Consumer price pressure remains elevated but lacks the breadth and momentum of past episodes. Profit margins are expanding across most S&P 500 sectors, supporting our constructive view on U.S. equities.
KEY TAKEAWAYS:
Inflation is elevated but looks unlike the 1970s or 2021-23 episodes
Profit margins are expanding across 10 of 11 S&P 500 sectors, led by Tech
Mega-IPOs are coming soon, but initial index weights will likely be modest
Profitability historically drives post-IPO returns; largest IPOs tend to lag
Principal risks lie in valuation and profitability, not market disruption
Selectivity on fundamentals more prudent than chasing IPO headlines
High inflation but profits light the path
The April Personal Consumption Expenditure (PCE) prices report showed still-elevated inflation, with headline inflation readings coming in at 3.8% and core readings at 3.3% year-over-year.
We take a broader view of price growth, looking at the breadth of underlying measures experiencing rapid price gains and momentum.
Even if today's inflation is high, its breadth remains lower than the 1970s and 1980s and the COVID inflation surge.
Today's reading tells a different story.
Inflation is elevated, but it sits well to the left of those danger zones, which means the increases stay concentrated in a few areas rather than spreading through the whole economy.
We find this view compelling because breadth, not the headline number alone, is what has historically separated a passing bout of inflation from one that digs in and proves hard to reverse.
On momentum, we flag periods when one-month inflation outpaces three-month, three-month outpaces 12-month, and yearly inflation growth tops 3%.
That signal triggered in the summer of 2021, when many still described high inflation as transitory.
It is not triggering now.
High inflation does weigh on household income, and real disposable income growth has dipped negative.
While cautionary, we do not view this as a signal to change our outlook.
Tax refunds offer temporary support, and we see the labor market as the key, with weekly job growth averaging 36,000 the past month and jobless claims staying low.
We view profits as the North Star guiding our economic outlook.
We now have a fuller picture, compared to the 40% of total profits represented by S&P 500 companies, and whole-economy profits for the quarter are picking up.
Companies appear to be hiring and investing as profit margins widen, and this is not just a Tech story. Ten of 11 S&P 500 sectors1 expanded profit margins in the first quarter from a year ago.
Bottom line: Though inflation is high and rising, this is occurring without the breadth or momentum that defined past episodes.
Nonetheless, elevated inflation risk supports our preference to remain underweight duration.
Meanwhile, strong profit growth that is broad based but led by Tech argues for maintaining exposure to high-quality, large-cap U.S. equities.
Mega-IPOs arrive, but mechanics may stage the impact
This year looks poised to feature some of the largest IPOs in history, with the biggest expected listings running an estimated two-to-three times larger than any prior deal.
The two largest, one in aerospace and defense and the other in transformative AI, carry anticipated proceeds of roughly $75 billion and $50 billion, respectively.
Those figures dwarf prior records set by Alibaba, near $25 billion, and Saudi Aramco, near $29 billion.
We view index inclusion as a two-speed process.
The Nasdaq 100 has fast-tracked eligible listings for index inclusion roughly 15 days after IPO, following recent methodology changes, and has no profitability or free float requirements.
On the other hand, the S&P 500 requires a 12-month seasoning period and a full-year of profitability.
Those rules would delay inclusion meaningfully, especially for an AI listing with an unclear timeline to profitability.
Despite their enormous valuations, we expect initial index weightings to be small.
Index providers weight inclusion on free floats (publicly tradable shares), rather than total market cap, and we expect these listings to debut with very low initial free floats, likely under 10%.
We also see the risk of significant, market-disrupting selling of existing large-cap index constituents by passive investors as contained.
Because initial free float is low, the passive buying that inclusion requires should be manageable, and our analysis suggests the resulting selling pressure on existing constituents would represent a small fraction of their total market capitalization.
In our view, index compositional changes unfold gradually over several years rather than in a single event.
The risk materializes through a series of rebalancing events tied to milestones such as lock-up expirations, typically around 180 days post-IPO, and subsequent secondary offerings.
Each event concentrates buying and selling on a specific rebalance day, which can create periodic episodes of market pressure rather than one disruptive moment.
Bottom line: These IPOs loom large in headlines, but the mechanics of index composition appear likely to limit risk of market-disruptive passive selling from inclusion alone.
Profitability and incentives, not headlines, have driven IPO returns
History shows a distinct pattern, and profitability has driven how IPOs perform after listing.
We see this as a critical consideration when evaluating the current wave of mega-IPOs.
In the short term, IPOs often post a positive return on their first day of trading.
The average first-day return for 2026 listings has been 15%.
Over a longer horizon of roughly one to three years, IPOs have historically underperformed their industry peers.
The early pop has not reliably carried through.
We see profitability as paramount.
Companies with negative net income have historically seen their shares lag their industry group peers significantly for years after listing.
The largest listings now in focus report large revenues, yet their net income remains negative as they come to market, which we view as a key risk factor.
Incentives to sell are another factor determining performance for the 12 months following the IPO.
The largest IPOs (by market cap at time of listing) historically underperform the smaller companies that list.
These mega-listings are driven by founders and early investors looking to cash out and capitalize on huge valuations.
This is yet another angle to monitor.
Investing in IPOs entails higher risk than established companies, as limited operating history and financial data can increase volatility.
We see additional risks in valuation, profitability, and insider incentives.
The timing of these listings warrants particular attention, since it raises the question about whether the moment companies choose to come to market is also the best moment to purchase their shares.
We weigh these considerations alongside the index mechanics rather than in place of them.
Bottom line: We see the principal risks in valuation, profitability, and insider incentives rather than in market mechanics.
In our view, staying selective on fundamentals is more prudent than chasing headlines.
1The S&P 500 is divided into 11 sectors according to the Global Industry Classification Standard (GICS), each representing a distinct segment of the U.S. economy. The 11 sectors of the S&P 500 are: Information Technology, Financials, Communication Services, Consumer Discretionary, Health Care, Industrials, Consumer Staples, Energy, Utilities, Materials, Real Estate.
