Parabol/Parabola

Celebrate this chance to be alive and breathing
A chance to be alive and breathing

“Parabol/Parabola”, Tool

 

One of our favorite things about Tool is how the band imbues its lyrics, song structures, album art, music videos, and live shows with deep symbolism, but leaves the interpretation of those symbols up to the fans instead of explicitly articulating the meaning. This creates the room for the fans to relate to songs in their own unique way, based on their own unique experiences.

For example, we’re pretty sure that Maynard James Keenan did not write the two-part “Parabol/Parabola” with the equity and bond markets in mind, but that does not mean that we, as equity and bond market participants, can’t find meaning and message in the song, mostly as some markets, like yields, “went parabolic” this week.

To us, one message of “Parabol/Parabola” is about remaining grounded and present even in times of distress, with the calm knowing that pain, like all things, is temporary (“this body holding me reminds me of my own mortality; embrace this moment, remember we are eternal, all this pain is an illusion”).

This ascension from suffering is, of course, far easier said than done, but today’s market seems to be doing a mighty job at trying to embody this wisdom.

Consider all of the things that have been thrown at the market during this holiday-shortened week alone: Brent oil prices +7% to over $100/barrel, diesel above $6/gallon for the first time ever, the 2 Year Treasury yield up nearly 30 bps to 4.6%, the 10 Year Treasury yield up nearly 20 bps to 4.96%, the odds of a September rate hike from 60% to 89%, and the pricing of Fed hikes in 2026 from 1.4 to 2 (oh, and not to mention AI apocalypse doomersim). And for all of these potential wrenches, the S&P 500 was down a whopping -0.22% on the week. For the S&P 500 this week, macro pain really has been an illusion.

This resilience is even more impressive in the context of a tough seasonal backdrop and signs of complacency in both positioning and sentiment going into this tougher seasonal stretch (these complacent signs include low volatility, low demand for downside protection, overweight consolidated positioning, stretched futures positioning, bullish sentiment readings, and more). 

And yet, this equity market seems to ascend from any macro suffering and remain relatively calm… on the surface.

Despite the index currently being down just 2.2% from its all-time highs, we have seen a larger deterioration underneath the surface of the S&P 500. After the close on Thursday, when the index was down just 3% from highs, a mere 17% of names in the index were trading above their 20-day moving average and only 33% were trading above their 50-day moving average (this latter reading is down from 70% just one month ago). These metrics are far closer to an internal “wash out” than would normally be expected with such a mild price drop in the index.

The S&P 500 can thank its 34% weight to the Magnificent 7 cohort for its overall resilience. As the “average” stock, as measured by the equal weight index and captured in those breadth statistics, has struggled over the last month, the Mag 7 has rebounded from its June-swoon and provided a ballast for the overall market. Effectively, the 12% rally in the Mag 7 since the start of August has made up for more broad-based softness in the rest of the market.

The other underlying source of market resilience is, of course, earnings (as is very well appreciated by market participants). 

The constant and continuous climb in 2026 and 2027 EPS estimates for the S&P 500 has allowed the market to absorb many macro shocks that are putting downward pressure on equity valuations. Both 2026 and 2027 EPS estimates are up 16% YTD, pricing in 32% growth this year and 14% growth next year. This growth has allowed the S&P 500 to tolerate a 13% decline in its forward PE multiple and still deliver a 12% YTD return. To use a Maynard line, earnings have been the “holy gift” for this market.

This 13% drop in the S&P 500’s PE multiple is worth a note, as we see it coming from multiple sources. First, higher rates are pressuring valuations, as we have been flagging for months that the low in rates in 2025 coincided with the peak in valuations. A further lift in yields, as we saw this week, is likely to put further downward pressure on valuations. 

Second, we see a deterioration in earnings quality weighing on valuations, mostly for the Mag 7. The Mag 7 cohort has seen its forward PE multiple drop by 30% since last October and is now at the lowest level since 2025’s Liberation Day lows and even close to the 2022 tech bear market lows. We see some of this de-rating as capturing the now-poor cash generation and higher capital intensity of these businesses. Given the weight of Mag 7 in the index, an important question is if there is much more downside to Mag 7 valuations from here, or if the reset has already occurred, effectively allowing these stocks to resume their prior powerful returns.

Third, we see lower valuations reflecting peak earnings growth rates and an increasing probability that some segments of the market “over earning” or pulling forward earnings power from the future to today. We expect that 2Q26 was the peak quarterly growth rate (at over 50%) and 2026 will be the peak annual growth rate (at 32%), with a sharp deceleration in 2027. The equity market’s forward-looking tendencies sniffs out this peak growth rate and typically ascribes a lower valuation multiple. 

This last point raises the question about how much longer we can count on huge positive earnings revisions to dampen and dull any pain that macro dynamics cause to valuation multiples. 

With 2027 EPS estimates already at $416/sh, implying 14% growth on top of the stellar growth (read: tough comparisons) from 2026, we are not sure how much more realistic upside there is to 2027 estimates. 

Of course, taking the under on earnings estimates has been precisely wrong all of this year, which is why analysts are hesitant to trim forecasts and are inclined to keep raising forecasts until clear evidence challenges this bullish growth outlook. This is why we think estimates could continue to rise into year end, even if they might be challenged by reality in 2027 (one-time gains not repeating, tough YoY growth comparisons, less upside to hyperscaler capex forecasts, and more).

Overall, the ability to shake off these macro tribulations is thanks to an earnings backdrop that has allowed the market to absorb valuation compression with minimal top line damage. 

We still see potential for further volatility as we move through the remainder of the month and into October. Seasonal headwinds remain, while positioning and sentiment suggests that investors are not already bracing for higher seasonal volatility. 

The earnings backdrop provides a strong fundamental underpinning for this market, but rate dynamics cannot be ignored, as a further climb (and a resulting potential tightening of financial conditions) could begin to weigh on not just the valuation outlook but the earnings growth outlook as well. We also are watching 2027 estimates closely for any signs that the powerful revision upcycle that has bolstered this market in 2026 is beginning to slow. 

Clearly, this equity bull market has taken Maynard’s advice to “celebrate this chance to be alive and breathing”, even amidst acute macro pain. 

 

 

IMPORTANT DISCLOSURES