Bulls return on earnings optimism, though challenges persist

Thoughts

• Equity markets continued to demonstrate tremendous resiliency, with a recovery from the sluggishness in September bringing the S&P 500^® Index to within 2% of a fresh record high. The S&P 500 delivered its best week in nearly three months on encouraging earnings data and despite continued pressure on a number of fronts, including supply chain, inflation and commodity pressures. Technical indicators are improving, with the S&P 500 back above the 50-day moving average and sentiment and breadth indicators improving. The seasonality headwind that has been in place since August now fades, with mid-October through December a historically strong period for equity returns.
• The yield curve is flattening, with long-term rates stable and short-term rates jumping on a reset of FOMC expectations following the minutes from the recent FOMC meeting. A “bearish flattening” occurs when long rates are stable on an uncertain outlook while short-term rates rise on the prospect for tightening monetary policy. Low global rates have been a governor on domestic rates, but global rates have recently began moving higher, driven by comments from BOE Governor Bailey saying that monetary officials need to prevent higher inflation expectations.
• The tone of the news remains nerve-racking, but investors interpretation of the news is more optimistic, and buy-the-dip has returned.

News

• Third-quarter earnings season launched last week with mostly optimistic results and commentary. Last week was dominated by large bank results, providing an optimistic outlook for consumer spending. Citi reported credit card spending up 24% from a year ago and well above pre-pandemic levels, with credit and debit card spending up 26% at JPMorgan and 21% at Bank of America. Earnings season accelerates this week, with nearly 15% of companies reporting. Consolidated earnings growth is now forecast to grow 30%, better than the 24% expected at the end of September, but slower than the 87% recorded in the second quarter.
• Supply chain pressures persist, with 4.3 million workers missing from the labor force compared with pre-pandemic levels, with the labor force participation level at 61.6% versus 63.3%. This has driven the gap between job openings (10.4 million) and unemployed individuals (7.7 million) to a record level, while a record 4.3 million workers (2.9% of total) quit their jobs in August. A recent survey shows about 85% of retailers expect supply chain disruptions to affect customers, with more than half saying they will be understaffed at least once a week.
• Recent economic data provide a mixed picture on the health of the economy, with the NY Fed’s Weekly Economic Index showing high-frequency data points are consistent with growth of roughly 8%, while the Atlanta Fed’s GDPNow model predicting growth of just 1.2% for the third quarter after 6.6% in the second quarter. Retail sales remain robust, rising 14.9% from a year ago and beating estimates despite the issues around supply. Consumer sentiment ticked lower in October, remaining near 10-year lows. The NFIB Small Business Optimism Index fell to a six-month low, with labor costs and availability the primary constraint.
• China GDP slowed to 4.9% in the third quarter from 7.0% in the second quarter and below the 5.2% consensus estimate. September activity was weak, with softness in industrial production and fixed asset investment, although retail sales remain robust. The slowdown was lamed on tightening credit standards, the energy shortage and government initiatives to limit speculation. There is speculation that the slowdown will spark government officials to add stimulus to the system.

What to Watch

• Earnings will be an increasing story next week as the pace of releases increases. Economic data include industrial production on Monday, housing starts on Tuesday, the Fed’s Beige Book on Wednesday, existing home sales on Thursday, and PMI data on Friday.