It’s the end of a period of historical seasonal strength as we begin to enter the heart of earning’s season this week. Under this backdrop, today we at Cornerstone want to turn our attention to how earnings are playing out so far and what we may be able to expect during the summer seasonal market doldrums.
At this early stage, the second quarter of earnings season for the S&P 500* is off to a strong start compared to expectations. Both the percentage of companies reporting earnings surprises and the magnitude of surprises are above their 10-year averages.
As of this writing, 172 companies from the S&P 500 have reported actual results. Of them, 80% have reported per-share earnings above estimates, which beats the 10-year average of 75%:
In aggregate, those companies are reporting earnings that “beat” estimates by a median of 4%:
This constitutes an earnings growth rate of about 6.2% (although still without much of the major growth drivers like technology having yet reported).
In terms of revenue, 80% of the companies that reported earnings beat their estimates, which is above the 10-year average of 64%:
Combined, those same companies are reporting revenues 2.3% above estimates, which is greater than the 10-year average of 1.4%. This amounts to 5.2% year-over-year revenue growth, on average:
These initial revenue numbers are extraordinarily strong, especially when considering we’ve only just started earnings announcements for the companies and sectors that are expected to drive growth most (i.e., technology, communication services).
As the earnings data picture gets clearer, it reflects continued fundamental strength underpinning the market. This also helps provide an additional level of comfort for the extraordinarily strong summer market performance we've experienced thus far. That’s good since historical seasonality data indicates an upcoming potential short-term cooldown starting at the end of July.
Seemingly every year August and September hurt bullish investors as most senior traders take off for their summer vacations, often leading to lower volume, increased volatility and weaker seasonal returns:
It seems to drag on like the dog days of summer, until volume begins to ramp back up in late September. That causes stocks to often whip around violently before entering the seasonally strongest time of the year beginning in October.
To provide visual confirmation, since 1990 it’s clear July is typically strong:
It’s also clear we shouldn’t expect much from August and September.
A Point-In-Time Temperature of The Market
Every year when we begin to prepare for historical precedents, we turn our attention to reliable, objective data indicators to take a point-in-time temperature of the market. Just like everyone else, we don't have a crystal ball, but we do have comprehensive and unemotional data sets to help shed light on our RoadMap.
The first place we look is MoneyFlows’ trusty Big Money Index (BMI), a 25-day moving average of “big money” investor activity. The BMI has been overbought for a while – 31 days to be exact (as of this writing).
That is longer than the 22-day average of all overbought periods since 1990. But what’s most important is not when the BMI hits overbought, but when the BMI turns lower and drops below the all-important 80% overbought threshold.
In this chart, the green arrow shows when the BMI crept towards the red line as it dealt with more difficult past comparisons, only to pick back up as the average comps begin to level out:
It may not seem like much, but it's an extraordinarily positive indication showing there’s no need to run to the exits. If you go back to the beginning of this overbought period, we mentioned how there were some similarities to the overbought period after COVID.
Then the BMI remained overbought for a record 87 trading days, which is about four months:
We're not saying with any certainty that we’ll remain in this market for four months like last time (as that was an extreme outlier). But it’s noteworthy because if we had run to the exits after 31 days of the the COVID overbought instance, we would have missed out on an additional 22% rally in the S&P 500.
Lacking a crystal ball, we turn to some key data points to help us unlock when the BMI may fall and thus lead to some softness in the equity markets overall. That is, we look for intensifying outflows.
The next couple charts will show that’s not happening right now.
First, let’s look at equity action from “big money” investors:
While there’s been some inflow “stop and starts”, outflows have remained basically nonexistent (yellow circle).
Even more encouraging, ETF inflows have maintained strength while meaningful outflows are similarly nowhere to be found:
This tells us there are no red outflow indicators that would sound alarms as we sit here today. That means it’s unlikely the BMI will fall from overbought soon.
What’s even more encouraging is this lack of “big money” outflows is taking place with consistent, healthy volumes that are slightly above the historical average of 504:
In other words, the situation is “not too hot, not too cold.”
Taking all this data together, it tells us that while the BMI is overbought, inflows are healthy, outflows are nowhere to be seen, and it’s all happening on normal market volumes.
Going a step further to see where the money is going, the bullish narrative strengthens. Since the beginning of summer, 88% of institutional money has been overwhelmingly flying into small- and mid-cap stocks:
That indicates “smart money” is aggressively taking on risk. During times of fear, we would begin to see these types of investors clamor for safety in lower-volatility large-cap stocks. That’s simply not the case yet.
Looking at sector data, money is almost exclusively flowing into high-growth areas like industrials, financials, technology, and communications (interestingly, with renewed focus on energy distribution for AI, it can be argued that Utilities are becoming a sneaky growth sector play):
Now understanding that the data is still supportive of the bullish narrative, we wanted to look a little bit deeper into what we can expect from money flows as we enter the summer seasonal weakness typical of August and September. The following three charts may look like a foreign language or hieroglyphics from Egypt. But they show a main pattern of July seeing more inflows (green jumps) versus August and September.
Going back to the earlier in this post, this pattern should make complete sense knowing equity markets historically cool off in August and September. It’s a consequence of more “big money” outflows than inflows in those same months.
So, is the ride over? Should we sell?
Our forecast wouldn't necessarily go that far. But this data offers a window of opportunity for us at CFS to strategically lighten some overweight positions, take profits on stalling positions, and maybe even clear out some positions that haven't played out as expected. This would be after another likely few weeks of bullish inflows.
But that doesn’t mean (as of today) that we’d pivot to a conservative, defensive profile. We said last week rate cuts might be delayed, but they won’t be denied. We wouldn’t be surprised if the end of summer weakness in August and September fortuitously aligns with the next period of expected rate cuts, likely boosting highly capitalized growth companies.
It could align nicely with already seasonally strong fourth quarters. Looking back to 1991, whenever the Federal Reserve cuts rates and the economy isn't in a recession, equities explode:
This performance has endured over multiple troubling environments, some of which line up nicely with today. If Fed cuts play out and our economy holds up, the above chart shows how stocks will almost certainly benefit at outsized levels.
Any late summertime pullback is an opportunity for some trimming and tactical rebalancing. The data continues to tell a different story than the popular news narrative and we fully expect the fourth quarter to show the same or more historical strength as it has for over 34 years running.
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