A Lot Will Be Learned In The Next Eight Days
We have a critical eight-day stretch staring us in the face. I don’t see a reason to take a decisive position on anything at the moment, with equities at or near all-time highs, gold at all-time highs, and bonds trying to find their footing. On the earnings front, we have five of the Magnificent Seven members reporting – Alphabet (Tuesday), Meta and Microsoft (Wednesday), and Amazon and Apple (Thursday). Sticking with earnings for a moment, so far, roughly 35% of S&P 500 companies have reported third-quarter results, and according to FactSet, about 75% of them have beaten Wall Street profit expectations, compared with the five-year average of 77%. This week is the busiest week for Q3 results (see graphic below), where AI/ mega-cap Tech is taking center stage, and investors will be focused on AI monetization metrics and forward capex guidance. Recall that Tech CEOs have repeatedly stated that the biggest risk is underinvesting in AI capex.
One thing to keep in mind about the Mag7 is that their year-over-year earnings (blue bars in below chart) have been declining since Q4 2024 and you can see from the chart that, while still growing, they are not forecast to accelerate in a meaningful way through 2025. This is perhaps why we’ve seen breadth broaden out as the rest of the S&P 500 (white bars) while still growing slower than the Mag7 is seeing earnings growth accelerate into the back-half of next year.
The following table from BofA Merrill Lynch’s quant team provides a good visual for where analysts are penciling in EPS growth through 2025. Q3 2024 looks like the trough quarter for earnings growth. For sure, these numbers are not etched in stone and highly susceptible to ongoing revisions, but if they were to play out as penciled in then it helps to make sense of why investors are willing to pay a 22x forward P/E on the S&P 500.
Beyond earnings, we have a heavy slate of economic reports coming out this week. On Tuesday, we will get the Case-Shiller home price index for August, we also get one of Chair Powell’s favorite employment metrics, the JOLTS survey for September, and the Conference Board’s measure of consumer confidence for October. Wednesday, we’ll get the ADP employment numbers for October and the first stab at Q3 real GDP. Then, on Thursday, we will be on the receiving end of the PCE deflator numbers for September. Friday caps off the week with October nonfarm payrolls (which will be skewed lower by the hurricane and Boeing/East Coast port strikes) and the ISM manufacturing PMI index.
As I said at the start of this note, given the avalanche of earnings and data set to be released, not to mention next week’s election outcome, what’s the upside in making any significant portfolio shifts or capital commitments in front of the release of this important information. Equities are already priced for best-case scenarios where in-line releases only confirm current trends and are unlikely to disrupt them. Otherwise, if the data as a whole is disappointing, then it is likely markets need to reprice to the downside. Ergo, expect a lot of volatility across the equity and bond markets. It’s worth mentioning that options markets are showing an investment community that is abundantly hedged up for next week's election results. Outside of a significant surprise (meaning a delay because of a vote count or some form of contested outcome), it’s likely we will see a bounce in the equity market just with the unwinding of out-of-the-money hedges and the removal of election uncertainty.
Last week’s market action was mixed depending on one's vantage point. The Dow fell by 2.7%, the S&P 500 lost nearly 1.0%, and the small-cap Russell 2000 gave up a hefty -3.0%. The Nasdaq hit a record high Friday, eking out a meager +0.2% gain for the week as Tesla, Nvidia, and some other mega-cap names masked what was otherwise very weak breadth. This week looks like it's set to kick off with a risk-on mood as oil prices are plunging -6% on the news that Israel did not go further than it did in Saturday’s retaliatory strike, and Iran’s verbal response appears more muted than expected.
Bonds continue to sell off, with the yield on the 10-year Treasury back up to 4.25%. I think higher yields will start to bite the equity market as the 10-year closes in on 4.50%. With inflation expectations well anchored around 2.5 – 2.7% at that yield level, you’re looking at a 10-year T-note providing a real yield closing in on 200 basis points. It’s also a yield that becomes competitive with an earnings yield on the S&P 500 of 4.7% and forward equity market returns of mid-single digits when trading at a 22x forward P/E multiple.
Otherwise, I don’t have much else to discuss this week. I really think the best thing to do at the moment is sit back, wait, watch, and analyze incoming data and events leading up to next week’s election.
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