This is a ‘Goldilocks backdrop’ for the economy, strategist says

Key Concepts

• Jobless Prosperity
• AI and Job Displacement
• Conventional Wisdom vs. Reality (Unemployment and Stock Market)
• Earnings Season
• Small Cap Stocks (S&P 600 vs. Russell 2000)
• Goldilocks Backdrop
• Federal Reserve Policy and Market Impact

AI and the Job Market: A Glacial Pace

Charles opens the discussion by highlighting the pervasive news about Artificial Intelligence (AI) and robots taking jobs at a "blistering pace." He questions the concept of "jobless prosperity," where the disappearance of consumers might offset productivity gains. Michael Kantowic, Chief Investment Strategist at Piper Sandler, counters this by stating that AI replacing employment is not a "broadly systemic problem for markets" in the near term, suggesting it's happening at a "glacial pace." He believes this is not a significant concern for 2026 but could be a factor "down the road."

Challenging Conventional Wisdom: Unemployment and Stocks

The conversation then delves into challenging conventional Wall Street wisdom regarding the relationship between unemployment and the stock market. Charles presents the traditional view: rising unemployment leads to falling stocks, a recession, and a decline in housing and the overall economy.

Kantowic argues that this is "not necessarily true" and "not all of the time." He cites historical data, starting from the 1990s recession and looking at the six prior recessions. In five out of those six periods, higher unemployment actually helped the stock market go up. This occurred because rising unemployment allowed interest rates to come down, which in turn lifted the market. This scenario is presented as being "similar today" in its potential implications.

Earnings Season and Market Outlook

The discussion shifts to the current earnings season. Kantowic reports that earnings season "looks good so far," with approximately half of companies having reported. He notes that while more "beats" (companies exceeding earnings expectations) tend to occur early in the season, and expectations might adjust downwards in later weeks, the overall backdrop remains "pretty solid."

Crucially, Kantowic highlights that for the past three months, there has been the "broadest improvement in earnings expectations since 2021." This is coupled with "green shoots" in both housing and other macroeconomic data. This positive trend leads to the expectation that earnings breadth will continue to improve into 2026.

Small Cap Stocks: A Shift in Optimism

A specific chart showing "largest small cap calendar year earnings estimates even for 2027" making a "nice move higher" is discussed. Charles questions the confidence in projecting estimates that far out. Kantowic explains that markets don't typically look that far ahead, and these estimates are often an "extrapolation of what markets and investors know today and expect in the future." If the current economic backdrop remains healthy, future projections will likely reflect that.

Kantowic confirms the use of the S&P 600 index for small-cap analysis, preferring it over the Russell 2000. He explains that the S&P 600 is a "more conservative" and "higher-quality benchmark" because the Russell 2000 is heavily weighted towards biotech and unprofitable companies, leading to "funky data" in aggregate. The S&P 600 provides "cleaner" and more comparable data.

Regarding investment strategy, Kantowic reveals that Piper Sandler had been "relatively bearish on the small caps up until about four or five weeks ago." Now, looking into 2026, he believes investors should "broaden out beyond the Mag7" (referring to the seven largest technology companies). This is due to a "better macro backdrop," "better earnings breadth," and a "soft employment and lower interest rates" environment, which he terms a "Goldilocks backdrop."

Federal Reserve Policy and Economic Tailwinds

In the final segment, Charles brings up the Federal Reserve and its policies. He references Nancy Lazar's discussions about "the big beautiful bill" and its potential to provide "additional sort of tailwinds for that not just the economy but possibly for the market next year too."

Kantowic agrees, stating that markets reflect policy changes in the Fed Funds rate in two ways: when expectations change and the Fed acts, and then approximately a year to 15 months later, when the "variable lag" impacts economic and earnings data. He concludes by reiterating that they "see a lot of green shoots into the momentum of the economy looking out."

Synthesis/Conclusion

The discussion debunks the simplistic notion that rising unemployment is always detrimental to the stock market, presenting historical evidence to the contrary. The current economic environment is characterized by positive earnings momentum, particularly in small-cap stocks, and a favorable "Goldilocks backdrop" of soft employment and lower interest rates. Federal Reserve policy is also seen as a potential tailwind for both the economy and the market. While AI's long-term impact on jobs remains a consideration, it is not perceived as an immediate systemic threat to markets. The overall sentiment is cautiously optimistic, with a focus on broadening investment beyond mega-cap tech stocks.