Pivotal Week for Earnings and Data

Last week, the equity market stumbled a bit and trading was sloppy on many fronts. This is not surprising as a mild consolidation was entirely expected, given the proximity to all time highs and limited levels of liquidity. This week marks probably the most decisive 5-day period of the quarter, with high profile corporates reporting Q3 Earnings and a slew of critical economic releases. Could the current correction turn into a more meaningful drawdown, or will the bulls take charge once again? Let’s review the key events on the calendar:

• Tuesday: AMD, Chipotle and Visa are set to report, while JOLTs Job Openings are expected to come in at 7.99M;

• Wednesday: Meta, Microsoft, Eli Lilly and Caterpillar report, while the first estimate for Q3 GDP Growth is expected at 3.0% MoM

• Thursday: Apple, Amazon.com and Mastercard report, while Core PCE Price data as well as Personal Income and Spending will be released;

• Friday: Exxon Mobil and Chevron report, while Non Farm Payrolls and the Unemployment Rate will be released;

Each of these events could be major catalysts on their own, but when occurring together in the same week, it becomes hard to overstate their potential impact. Furthermore, these will be the last days when investors can position ahead of the U.S. Presidential Elections. Active and very short term traders may want to sit this one out or at least reduce position sizes in anticipation of high levels of volatility. It’s more important to gauge where the market stands at the end of the week than attempt to trade in between these dates.

Technically, SPY should be well supported at the 50-DMA, as we’ve seen more liquidity and bids coming in as the benchmark ETF has consolidated. While no longer overbought and on a short term SELL signal, we view corrective action as a buy-the-dip opportunity for an end of year rally.

Recently, SentimenTrader made an interesting observation, aligning with our interpretation that the current advance could continue for a while longer and defy more skeptical expectations:

“The S&P 500 has closed 242 consecutive sessions above its 200-day moving average. While nothing is critical about this particular number of days, it just happened to be an observation I made over the weekend: consistent momentum of this type has historically led to further upside in the world’s most benchmarked index. The previous signal occurred in June 2021, and the S&P 500 gained 10.7% over six months. 

The S&P 500 delivers an annualized return of 9.8% when the win streak count surpasses 242 sessions. Conversely, when the streak resides below 242 days, the index yields an annualized return of 8.1%.”

The S&P 500 is now at winning day number 253 by this analysis, so more upside can be expected.

Another quote lifted straight from SentimenTrader sums up our view almost perfectly:

“Stock indexes continue to grind higher, fueled by improving market breadth and consistent price momentum. In such environments, where nearly all indicators align-whether through expanding new highs, stocks trading above key moving averages, or bullish leadership in cyclical groups-it’s tempting to believe that the market can’t go any higher. Yet, history shows that markets often defy these expectations, pushing higher for longer than most investors anticipate. While a consolidation around the election is possible, the big picture heading into the most seasonally strong period of the year suggests investors continue to give the market the benefit of the doubt.”

This tendency for the market to move up fueled by its own momentum aligns with our findings as well. Fundamentally, there are three forces at work that may boost returns by year-end.
First of all, analysts have already lowered the bar for Q3 EPS by around 10% versus their original estimations. Lowering expectations will inevitably lead to a high “beat rate”. We are already seeing this — Per FactSet:

With 37% of S&P 500 companies reporting actual results, 75% of S&P 500 companies have reported a positive EPS surprise and 59% of S&P 500 companies have reported a positive revenue surprise.

That beat rate, as impressive as it is, has so far been unable to catalyze the market any higher. Instead, a lot of volatility in individual stocks has been recorded. Q3 has seen the largest moves by stocks on earnings day than at any other point in the last 15 years.

Secondly, according to Morningstar, during the first half of 2024, only 18.2% of actively managed mutual and exchange-traded funds outperformed the cap-weighted S&P 500 index. A “performance chase” is bound to happen into the end of the year, as managers scramble to get the right stocks in their portfolios for end of quarter reporting. In this sense, a factor like Momentum (MTUM) is expected to outperform in the next period.

Finally, the corporate share buyback windows will reopen in November and December as companies exit their earnings “blackout period.” Historically, the last two months of the year represent the best period for buyback executions. As Goldman Sachs notes:

“The VWAP machines will be lining up to buy $6bn worth of equities daily during November and December.”

Bids of $6BN per trading day will not only limit downside, but help lift the entire market into year-end.

While the outlook seems rosy, we have to be aware of a couple of potential risks that could cause a sharp reversal. The first issue the market will have to overcome is the potential of a contested Presidential Election. If both parties claim victory after election day, and especially because Vice-President Harris will have to certify the election results, we could see an extended deadlock. Lawsuits will certainly be filed in key battleground constituencies.

Given the deep national divisions, regardless of who wins, we could see riots, looting, or more violent protests. In turn, these could weigh on market sentiment.

The Fed also needs to align with market expectations. The next FOMC meeting will be held after the election. If the Fed pauses rate cuts or suggests future rate reductions may be less than anticipated, this could disappoint markets.

A cyclical observation regarding sentiment is that we haven’t really had pessimistic conditions in a while. While current sentiment is nowhere near “exuberant”, the last time “Extreme Greed” was recorded by our indicator was in April 2024. That’s a longer than normal time to not have a true “Fear Event” (and no, the drawdown in early August was not quite large enough).

Our Trading Strategy

As we are trading in the seasonally strong period of the year, it does make sense to pursue a risk-on allocation from an equity standpoint. We believe two types of companies will benefit in the following months:

• Large caps, liquid names, with generous buybacks programs in place;

• Momentum-correlated names that should do well just by virtue of performance chasing;

As always, we strive to avoid emotionally driven mistakes by using our risk-control measures and Portfolio Management tools. Increased volatility, especially at the single-stock level is expected, and we would avoid excessive trading during this period. We may do some reshuffling on Wednesday, during the regular rebalancing review, but our portfolio is already well positioned for year-end.

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