S&P’s $8 Trillion Rally Will Be Tested by Tricky Earnings Season

(Bloomberg) — Traders are looking down a range of risks after the stock market’s torrid start to the year, from economic fears to interest rate uncertainty to election jitters. But perhaps the most important variable in determining whether stocks can continue to run is back in the spotlight this week: corporate earnings.

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The S&P 500 is up about 20% in 2024, adding more than $8 trillion to its market capitalization. Gains were largely driven by expectations of easing monetary policy and a resilient profit outlook.

But the tide may be turning as analysts cut their expectations for third-quarter results. Companies in the S&P 500 are expected to report a 4.7 percent rise in quarterly earnings from a year ago, according to data compiled by Bloomberg Intelligence. That is down from forecasts of 7.9 percent on July 12 and would represent the weakest growth in four quarters, BI data showed.

“Earnings season will be more important than normal this time around,” said Adam Parker, founder of Trivariate Research. “We need concrete data from corporations.”

In particular, investors are keen to see if companies are delaying spending, if demand has slowed and if customers are behaving differently due to geopolitical risk and macro uncertainty, Parker said. “Just because there’s a lot going on in the world, earnings and corporate guidance will matter especially now,” he said.

Reports from major companies start coming in this week, with results from Delta Air Lines Inc. that will take place on Thursday and JPMorgan Chase & Co. and Wells Fargo & Co. scheduled for Friday.

“Earnings seasons are usually positive for stocks,” said Binky Chadha, head of U.S. equities and global strategist at Deutsche Bank Securities Inc. “But the strong growth and above-average positioning in (this earnings season) argues for a weak market reaction. .”

Obstacles Abound

The obstacles facing investors right now are no secret. The US presidential election is just a month away, with Democrat Kamala Harris and Republican Donald Trump in a tight and fierce race. The Federal Reserve has just started to cut interest rates, and while there is optimism about a soft economic landing, questions remain about how quickly central bankers will cut borrowing costs. And a deepening conflict in the Middle East is raising concerns about inflation heating up again, with West Texas Intermediate oil prices rising 9% last week, their biggest weekly gain since March 2023.

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“The bottom line is that revisions and guidance are weak, indicating lingering concerns about the economy and reflecting some election-year seasonality,” said Dennis DeBusschere of 22V Research. “This helps set up the reporting season as another uncertainty clearing event.”

Additionally, to make matters more difficult, large institutional investors have little buying power right now and seasonal market trends are mild.

Positioning in systematic trend-following funds is now tilted to the downside, and positioning in the options market shows that traders may not be ready to buy any dips. Commodity trading advisers, or CTAs, are expected to sell U.S. stocks even if the market remains flat over the next month, according to data from Goldman Sachs Group Inc. And volatility control funds, which buy stocks when volatility drops, have no more room to add exposure.

History also seems to be on the side of the pessimists. Since 1945, when the S&P 500 gained 20% in the first nine months of the year, it has fallen 70% of the time, data compiled by Bespoke Investment Research shows. The index is up 21% this year through September.

Bar lowered

Still, there are reasons for optimism, particularly a lowered bar for earnings projections that leaves more room for companies to beat expectations.

“Estimates got a little too optimistic and are now pulling back to more realistic levels,” said Ellen Hazen, chief market strategist at FLPutnam Investment Management. “It will certainly be easier to beat earnings because estimates are lower now.”

In fact, there is plenty of data to suggest that American companies remain fundamentally resilient. A strengthening earnings cycle should continue to offset stubbornly weak economic signals, tipping the balance for stocks in a positive direction, according to Bloomberg Intelligence. Even struggling small-cap stocks, which have outperformed their large-cap peers this year, are expected to see margins improve, BI’s Michael Casper wrote.

Friday’s jobs report, which showed the unemployment rate unexpectedly fell, quelled some concerns about a weak labor market.

Another factor is the Fed’s easing cycle, which has historically been a boon for US stocks. Since 1971, the S&P 500 has returned 15% annually during periods when the central bank cut rates, data compiled by Bloomberg Intelligence show.

These gains were even stronger when rate cut cycles hit during non-recession periods. In these cases, large-caps saw an average annual return of 25%, compared to 11% when there was a recession, while small-caps gained 20% in non-recessionary periods, compared to 17% when there was a recession.

“Unless earnings are a major disappointment, I think the Fed will have more leverage on the markets between now and the end of the year, simply because the earnings have been pretty consistent,” said Tom Essaye, founder and chairman of Sevens Report Research. “Investors expect that to continue.”

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