The Regime Letter: From Wall Street to Main Street
The war paid the people who owned the bottleneck. Phase two gets graded on everyone else.
Howdy everyone!
Hope you’re all enjoying the part of the cycle where everyone’s portfolio looks smart and nobody’s paycheck does. That pretty much captures the tension we’ve been watching build all year.
The war did what wars tend to do to markets. It scared everyone for a quarter, repriced anything connected to scarcity or security, and then started writing checks to the companies that owned the bottleneck. Defense budgets expanded, energy trades worked, grid equipment re-rated, and anything that hummed, pumped, transported fuel, or transformed voltage suddenly became indispensable.
If you owned the bottleneck, you ate well. If you owned a mortgage, a grocery bill, and a car payment, you mostly watched.
That’s not a moral judgment, and it’s not a criticism of the market, it’s simply the way the sequencing worked. The money flowed into backlogs, margins, multiples, infrastructure, defense capacity, and energy security long before it showed up in wages, credit availability, or household confidence.
Phase one rewarded Wall Street. Phase two has to prove it can reach Main Street.
The Scoreboard, Honestly
Let’s mark our own homework for a minute. We’ve earned a little credit, but we should be clear about what we actually got right.
Our base case coming into this year was 7,400 on the S&P, with upside beyond that level if three things happened: the tax package began flowing through the economy, the banking system moved toward deregulation, and the Wall Street-to-Main Street push evolved from a political slogan into an actual transmission mechanism.
The index is sitting around 7,500 as I write this, with recent highs in the low 7,600s. The base case didn’t merely hold, it was taken out to the upside.
The oil normalization we said was a condition of the bull case rather than a bonus has also largely shown up. WTI is back in the low 70s, and Brent briefly pushed toward $80 during the latest exchange with Iran before rolling back over.
That doesn’t mean the geopolitical risk has disappeared, and it certainly doesn’t mean the underlying defense, grid, and energy-security cycles are finished. Those are multiyear capital cycles, and the physical buildout still has a long way to go. What it does mean is that the market is assigning a higher probability to containment than the headlines might suggest. That matters as the first market repricing now looks mature even though the underlying investment cycle is nowhere near complete.
The broad sequence worked:
Fragility
Spark
Shock
Repricing
Normalization.
Here’s the uncomfortable part, though. That first phase was a Wall Street phase almost by definition. War spending doesn’t show up in your neighbor’s paycheck, it shows up in order books, backlog growth, pricing power, margin expansion, and valuation multiples. The energy trade, the defense trade, and the grid trade were ownership trades. You had to own the assets to get paid, and most households didn’t own enough of them to feel the benefit directly.
Main Street didn’t own the bottleneck but it does hold the gas bill.
The Regime Beneath It
The current regime is strange, but it isn’t especially hostile.
Monetary policy remains restrictive, yet financial conditions are still relatively loose. Credit spreads are calm, the banking system is functioning, and the labor market is cooling without yet breaking. Inflation is still uncomfortable, but domestic nominal growth remains alive. That leaves us in an environment that is neither cleanly risk-on nor obviously defensive.
The distinction matters. We no longer have the kind of excess liquidity that lifts everything regardless of valuation, but we do have enough liquidity, credit availability, and underlying economic activity to support the right parts of the market. This is a selective regime rather than a broad one, and selective regimes reward knowing exactly where the next dollar of capital is headed.
Why Phase Two Is Different
Phase two isn’t really a trade in the traditional sense. It’s a transmission mechanism.
The question for the next twelve months isn’t what is scarce. We already know what is scarce: power, grid equipment, defense capacity, pipelines, skilled labor. The question is whether tax relief, deregulation, bank capital, housing reform, and political urgency can actually make their way into hiring, wages, lending, mortgages, business investment, and household spending.
Three channels matter most:
1. The Tax Package Has to Hit Paychecks, Not Just Filings
The small-business deduction is permanent, full expensing is back for equipment and expansion, and Opportunity Zones have been extended. All of that is real and potentially useful.
But tax relief is a slow-release drug. The test isn’t whether the legislation passed or whether the administration can hold a press conference about it. The test is whether hiring, wages, capital spending, and business formation at the small and midsize level begin appearing in the data by year-end.
We should be watching the NFIB surveys, hiring plans, capital-expenditure intentions, compensation trends, and actual business behavior rather than taking Washington’s victory lap at face value. A tax package that improves after-tax income on paper but fails to change real-world behavior is not transmission, it’s accounting.
2. The Banks Have the Capital. Now They Have to Lend It.
The largest U.S. banks are sitting on substantial capital above their binding regulatory requirements. Stress testing is being recalibrated, reputation risk has been removed from the supervisory framework, capital rules are being tailored, and the regulatory apparatus is being rewired in real time.
That creates a genuine possibility that more capital flows into commercial lending, construction finance, mortgages, and small-business credit. It also creates the possibility of an enormous buyback cycle. That’s the fork in the road. Excess capital plus deregulation can produce loan growth, or it can produce the most tax-efficient capital-return cycle in years. One reaches Main Street while the other is simply phase one wearing a different suit.
This is why the bank earnings matter so much. We care less about whether the quarter beats consensus by a few cents and more about what management teams say regarding commercial and industrial loan demand, construction lending, credit-card performance, deposit costs, mortgage activity, capital return, investment-banking pipelines, and small-business borrowing.
The question is not whether the banks are healthy. They are. The question is what they do with that health.
3. The Mortgage Channel Is the One to Watch
The March executive order on mortgage credit may be the most direct Wall Street-to-Main Street plumbing we’ve seen so far. Streamlined documentation, modernized appraisals, e-notes, digital closings, more flexibility for community-bank construction lending, and targeted liquidity for entry-level housing all affect the way credit reaches the household.
None of those measures changes the funds rate, but they can change the spread. With long-term Treasury yields still elevated, every basis point of spread compression is doing work the Federal Reserve may not do for us.
Let’s be honest, the Fed is not riding to the rescue. The conversation has shifted from cuts toward whether inflation forces another hike later in the year. Growth remains firm, the AI buildout remains inflationary before it becomes disinflationary, and oil is still one headline away from causing trouble.
If Main Street gets relief this cycle, it comes through tighter spreads, deregulation, better credit transmission, and targeted housing reform rather than a dramatic collapse in the policy rate. That makes the mortgage channel one of the most important things to watch. Not because housing is suddenly cheap, because it isn’t, but because affordability can improve at the margin before the Fed ever moves.
The Consumer Is Still Grumpy, But the Behavior Is Changing
The consumer is not healthy everywhere, and there is no reason to pretend otherwise. Lower-income households remain under pressure, the labor market is slowing, housing affordability is poor, and inflation is still taking a meaningful bite out of purchasing power.
But consumers don’t need to feel wonderful for discretionary activity to improve. They only need to feel a little less nervous about tomorrow.
What we’re seeing is not a return to the stimulus-fueled spending binge of 2021. This version is more selective, more price-conscious, and much more deliberate. Consumers are trading down where the details don’t matter and preserving the things that do. They may take the earlier flight, skip the better room, use points, wait for a promotion, and complain that dinner costs twice what it should. BUT, they’re still going.
That distinction matters, and two of our consumer themes are now moving.
The first is Discretionary Beta, our shorthand for the consumer’s willingness to spend on wants rather than simply needs. That theme has turned back up and is beginning to attract early institutional accumulation.
The second is the Experience Economy. Thats travel, restaurants, entertainment, leisure, and the parts of consumption tied to getting out and doing something. That theme is graduating from early evidence to institutional confirmation in our theme lifecycle, which is the difference between a thesis and a trade.
This is not yet a recovery in financial comfort, but it may be the beginning of a recovery in the willingness to participate. That’s a narrower claim and a more investable one.
The Risk Nobody’s Pricing
Here’s my correlation-versus-causation moment, because you know I need one.
The deregulation momentum is real, but so far it disproportionately favors scale. Community banks are supposed to serve as the transmission mechanism between policy and the local economy. They know the borrower, finance the contractor, fund the developer, and recycle local deposits into local activity. The problem is that they are also being lapped by the largest banks and fintechs in technology, funding costs, compliance scale, and customer acquisition.
If phase two simply consolidates lending into a handful of national balance sheets, we can get better loan-growth statistics without meaningfully improving Main Street outcomes. The aggregate number rises, the banking system looks healthy, and the town without a bank branch still has no bank branch. That’s the causation problem.
There is also a clock on all of it. The midterms are in November, and a meaningful portion of the transmission agenda depends on regulatory and executive action. If political control changes, extending or deepening the framework becomes more difficult, and markets will not wait until Election Day to discount that risk. They’ll begin doing it in September.
Phase two does not have four years to prove itself, it has a few quarters to start showing up in the data.
What We’re Doing About It
We remain long the bottleneck. Power, grid equipment, LNG infrastructure, natural-gas pipelines, and the physical layer do not stop working simply because the phase changes. The buildout is measured in years, the lead times remain long, and the underlying scarcity has not disappeared.
But we are adding phase-two exposure at the margin. That’s regional and community banks positioned to benefit from the supervisory reset, financial-infrastructure businesses that benefit from higher transaction activity, the housing supply chain if mortgage spreads begin compressing, consumer companies tied to take-home pay rather than asset prices, experience businesses that consumers are reluctant to cancel, small and mid-cap companies with real domestic revenue exposure, and select industrials positioned to benefit when capital moves from announcements into actual projects.
The Russell has been the sleepy corner of this market for two years. If the transmission mechanism begins working, it stops being sleepy.
If it doesn’t work and if the capital goes to buybacks, mortgage reform fails to lower costs, loan growth never materializes, and consumer confidence stalls — then phase two fails quietly, the market narrows again, and next year we will be writing about how the recovery was real but nobody invited the guest of honor.
What Would Confirm It
The next few months will give us a clean set of tests.
Bank lending is the first one. Commercial and industrial loan growth needs to improve, construction lending needs to stabilize, and small-business borrowing needs to turn. If banks remain healthy but unwilling to extend credit, the transmission mechanism is not working.
Mortgage spreads are the second. We need to see evidence that reform is reducing friction and compressing borrowing costs at the margin. The funds rate can stay elevated while affordability improves through tighter spreads, lower fees, faster processing, and more competition.
Small-business behavior is another important confirmation point. NFIB hiring plans, compensation intentions, capital-spending expectations, and actual business formation should begin improving. Press releases do not hire people, businesses do.
Consumer confidence also needs to build on the early improvement we are seeing. One better month is a signal. Several better months begin to resemble a trend.
Market breadth should confirm the story as well. If Main Street is beginning to participate, we should see improving relative strength from small and mid caps, financials, homebuilders, consumer discretionary, domestic industrials, transportation, and financial infrastructure. If the index continues rising while those groups deteriorate, phase two is not arriving.
Finally, watch Washington’s message before the policy itself. If the administration begins talking more aggressively about affordability, mortgage costs, household tax relief, retail investing, energy prices, homeownership, and domestic employment, that will tell us the political machine has identified the same transmission problem we are flagging. The messaging usually arrives before the mechanism.
What Breaks It
There are three primary risks.
The first is inflation. If inflation accelerates materially, long-term yields move higher, real household income comes under more pressure, and the Fed’s tightening bias becomes more credible. That would hit housing, small caps, consumer discretionary, and domestic banks first.
The second is the labor market. This thesis can tolerate slow hiring, but it cannot tolerate a genuine firing cycle. If layoffs rise materially and unemployment begins climbing because people are losing jobs rather than simply leaving the labor force, willingness to spend will reverse quickly.
The third is geopolitics. The thesis assumes the Iran conflict gradually moves toward containment, even if the path remains ugly and uneven. If escalation becomes the dominant path again, oil and inflation risk move back to the center of the regime and phase two gets delayed.
Those risks don’t necessarily kill the long-term themes, but they do kill the timing.
Closing
We were right about the fragility, right about the spark being war, and right about oil normalization being a condition of the bull case. We should still hold the trophy loosely, though. Being right about sequencing is not the same thing as being right about transmission.
Correlation got us here. Causation, whether policy actually causes paychecks to catch portfolios, is the part nobody can model cleanly, including us.
The first phase rewarded ownership. The next phase has to prove transmission.
If it does, this bull market gets a second act with broader shoulders and if it doesn’t, we may discover that phase one was never a phase at all.
It was the whole show.
Luke Perry
Portfolio Manager, Whalen Financial