As we enter the fourth quarter, equity markets have experienced some mild choppiness (as expected). That’s seemingly given some pundits and financial “leaders” the confidence to reignite concerns that the market is overheated.
Today, as we prepare for third-quarter earnings season to kick off this week, let’s explore whether the underlying and expected fundamental market data is supportive of this narrative. We’ll do it in three parts: economic data, earnings expectations, and market fundamentals.
Economic Data
Simplistically and most importantly, from an economic standpoint it’s important to analyze what we think the Federal Reserve reactions will be in the absence of traditional governmental economic data reports due to the shutdown. In Cornerstone’s opinion, we think the Fed will continue cutting rates, even without government data.
The Fed should easily be able to glean weakening job market data and inflation data from other reliable sources. Even before the shutdown, the labor market trend was clearly leaning soft. That’s been further supported by proprietary private payroll data Carlyle released last week:
This is important because Carlyle has never released this data publicly before. It’s doing so out of a sense of public service during the governmental shutdown.
A second example of “reliable data swapping” even if the government shutdown prevents official data from coming out is the Federal Reserve Bank of New York’s inflation expectations. They continue to lean on balance and dovish as the long-term expectation has remained at 3%, indicating that consumers still clearly view any near-term tariff-driven inflation as transitory (Fed Chair Jerome Powell’s favorite word from 2022):
Current prediction market expectations show a probability of the government shutdown lasting past Oct. 15 at 98.7%. That means the Fed will almost certainly rely on private proprietary data to drive decisions.
If that is the case, this economic data is firmly supportive of another quarter-point rate cut at the end of October. As we've discussed exhaustively, continuing rate cuts will further support equity market gains going into the end of the year.
Earnings Expectations
When you cut through all the noise, earnings are what truly drives market action. So as we springboard into this earnings season, have analysts lowered earnings estimates more than normal for S&P 500* companies?
The short answer is no. Analysts actually increased EPS estimates slightly for the quarter:
This is important because analysts usually reduce earnings estimates in advance of quarterly earnings calls. Look at the chart above – lots of negative projections.
During the past five years, the average decline in bottom-up EPS estimates in advance of the quarter is -1.4%. Going back 10 years, the average decline in bottom-up EPS analyst estimates is -3.2%.
So, the current 0.1% projection matters. It’s the first time analysts have increased EPS estimates in aggregate during a quarter since 2021. More interestingly, analysts have not only increased their third-quarter estimates during the past three months, but also increased calendar year EPS estimates by 1.3%:
More importantly, during the past three months analysts have also increased estimates for the calendar year 2026 by 1.2%. Boosting quarterly and annual expectations is not a typical analyst move, so this is worth mentioning as an extremely bullish trend.
The analyst estimate revisions are a nice kind of expected strength. But what are the companies themselves telling us?
Overall, 112 S&P 500 companies have issued EPS guidance. Of them, 56 issued negative guidance and 56 issued positive guidance:
While that might not seem bullish on the surface, the fact is the number of companies issuing negative EPS guidance is below the 10-year average of 60 and the lowest since Q4 2021 (51 then).
This shows more corporate confidence than normal.
Conversely, the number of companies issuing positive EPS guidance is significantly above the 10-year average of 39. As a result, the percentage of companies issuing positive EPS guidance of 50% is above the five-year average of 43% and 10-year average of 39%:
Drilling down to the sector level, it's critical to point out that the information technology sector is driving the higher number of positive guidance instances (36 of the 56 companies guiding higher come from tech).
In fact, this is the highest number of companies in the tech sector issuing positive EPS guidance for a quarter since FactSet began tracking in 2006:
This level of earning strength from tech companies is a clear rebuke of the current popular AI bubble narrative. As we enter earnings season, the rarest of rare setups for both companies and analysts are aligned via more optimistic earnings outlooks.
Market Fundamentals
The early part of October has brought some day-to-day market choppiness. If you merely stop at that headline, you may begin to agree with the current media narrative. But as always, we examine the data to determine if there’s underlying weakness or if the market is resetting after an uncharacteristically strong September.
As always, we look first to MoneyFlows’ trusty Big Money Index, which is a 25-day moving average of all “big money” investor activity netted. The BMI is our initial flow gauge, and it’s been slightly easing recently:
Let’s look under the hood to understand why. It is clear that this recent slowing is because buying merely slowed (took a breath), not because sellers have come back into play. This makes sense given how uncharacteristically strong August and September were.
Moderation resets are typical after big runs. The equity flows chart below clearly shows that this early-quarter moderating pause is not due to an increase in outflows by sellers:
The early-quarter reset is also clearly in line with historical precedent. As we know, the fourth quarter is historically the strongest time of the year. But October isn’t nearly as strong as November and December:
That’s true because one half of October is often choppy, just like this one. We’re right on cue. There’s a slight slowdown in inflows, which is an indication of market digestion, not distress.
This is typical when we have such an uncharacteristically strong September. While some may think that would linger throughout the entire fourth quarter, history paints a different picture.
Going back to 1990, in the eight rare instances where September had a gain of 3% or more, the following Q4 average gain has been 7.63%:
Is the market setup in place to support historical precedent strength? Well, technology and industrials remain at the top of sector leadership, right alongside the newfound “growth sector” of utilities (thanks to AI energy needs):
This trio is exactly the kind of foundational support we want to see in a bull market. Tech underpins everything we build or buy and ties directly into industrials as they reflect the real-world capacity and infrastructure market economics.
This is further supported in our sector inflow data since Oct. 1, where typical growth sectors like technology, industrials, and financials are capturing the majority of inflows, even during the market choppiness:
Those are squarely in the strike zone for what we want to see for growth and expansion.
Lastly, even in the face of choppy waters, we can see 80% of equity inflows went into small- and mid-cap stocks this month:
This tells us institutional managers are continuing to position their portfolios for expansion, not caution.
Clearly, the underlying data undercuts the popular narrative. But what would change my mind? We would need to see a clear and decisive rotation into defensive areas like staples while tech, industrials, and financials bleed outflows.
But that’s not what we see in the data.
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