Stocks are about to test a central tenet of the investment world, one hard learned by traders over decades: "Don't fight the Fed."
Wall Street's dare-famous investor Martin Zweig coined the phrase in 1970-comes as the Federal Reserve maps out its inflation fight and bond markets sound the alarm over myriad interest-rate risks.
The principle will be challenged by the relentless optimism of the AI investment race, a healthy rotation into non-tech stocks, and a stunningly solid run of corporate profits.
And the market is about to do so just as the central bank seeks to establish its inflation bona fides under new Chairman Kevin Warsh.
"We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed," Warsh told the Kansas City Fed's Jackson Hole central bank symposium on Friday. "Otherwise, we have work to do."
Who wins this battle, of course, will dictate the path of stocks into September, traditionally the market's worst month of the year, as well as early next year.
And right now, it has to be said, stocks are winning.
The S&P 500 is on pace to book solid August gains of 2.8%, a startling advance for a month that has had an average decline of 0.5% over the past 35 years. The benchmark also notched a record high-it's first since early June-and is just a few ticks from booking a 13% gain since the start of the year.
Stocks are cheaper than they were in late 2025, with the forward price-to-earnings multiple of the S&P 5oo down to 20 times from 22 times, while earnings forecasts for the market's biggest stocks are on fire.
And those gains, while juiced by a series of solid outlooks from the tech sector tied the AI investment boom, are showing a healthy broadening as well.
In fact, no tech-influenced sector has recorded any gains over the past three months: Healthcare, financial, energy and materials stocks have paced the market's advance since the end of May.
That could make markets more susceptible to a Fed rate hike, given that those sectors are historically more influenced by higher borrowing costs than tech. That hasn't played out yet, though.
That's even in the face of rising Treasury yields, where long bonds touched their highest levels since 2007 and the 10-year note is trading at 4.76% for the first time in nearly two years.
But some investors are suggesting that's because the Fed, while suddenly sounding hawkish onrates, has met the market halfway by recommitting to its inflation fight but not undercutting the economy's solid fundamentals.
"A hike (or maybe two) in September and/or before year-end is unlikely to hurt economic growth (the economy is on solid footing 50 basis points shouldn't change that)," said Tom Essaye, founder and president of the Seven's Report.
"But they [hikes] could re-establish Fed credibility on inflation, which should push 10-year and 30-year Treasury yields lower, creating a tailwind on stocks," he added. "That's the positive scenario and it's reasonable."
Underscoring that view is the earnings forecast, which sees 30% year-over-year gains for collective S&P 500 profits over 2026's final two quarters. That projection follows a massive 34.5% advance over the three months ending in June.
Added to that is the market's broader resilience to geopolitical shocks and the surge in global and domestic energy prices, which has taken crude nearly 14% higher since the Iran war started on Feb. 28. Yet, the turmoil has barely put a dent in broader equity market performance.
Apollo Global's Torsten Sløk suggests that the current market narrative tied to the bond market, where both fiscal and inflationary concerns are driving rates higher, could ultimately be unwound by the AI trade.
"If AI succeeds and tech companies generate trillions in revenue, it will be massively deflationary and push rates lower," he said. "If it does not, and the 'bubble bursts' as investors rotate out of equities into Treasuries, long rates will fall dramatically."
But that doesn't mean investors should be blind to the warning signs flashed by the bond market, or indeed evident in both the rise in global energy costs and softening labor and consumer trends.
Nor should they discount the stresses in the tech sector, tied to the AI investment race, which have weakened balance sheets and increased corporate borrowing costs.
"Across major credit stress cycles since the 1990s, the first half of the move in spreads from trough to peak took six times longer than the second half," said Bank of America analysts led by Savita Subramanian. "And the second half was always accompanied by negative S&P 500 returns."
Thomas Matthews, head of Asia Pacific markets at Capital Economics, also notes that the stock market is approaching valuations similar to the dot-com crash of 2000 by one measure of earnings growth-the so-called CAPE ratio developed by Nobel economist Robert Shiller.
"The eye-watering level of Shiller's CAPE partly reflects that earnings have grown very rapidly lately, far outpacing the slow-moving trend measure of earnings it takes as an input," Matthews said. "So whether it is flashing a genuine warning sign depends, in part, on how long the current earnings boom ultimately lasts."
Higher Treasury yields, a modestly hawkish Fed, and lingering inflation won't be powerful enough to stop the stock market juggernaut, which could take the S&P 500 past 8000 by the time the bull market's fourth anniversary in early October.
But it will raise questions for stock market performance into next year, and that's what investors need to be thinking about heading into the home stretch of a challenging year.
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