Broker Check

History Is on Our Side in These Conditions

| October 30, 2023

We’re in the early stages of earnings season and there is a period every quarter where the flow of data slows to a trickle. We’re in one now. Results are being announced, but many more announcements await. Similarly, we’re also awaiting more data from economic reports.

In times like this, we look to bridge the gap until a clearer data-driven picture emerges. When an onslaught of data is released over the next few weeks, the near-term direction of the market will largely be determined.

In the meantime, September retail sales data showed a monthly increase of 0.7%, which was well above the 0.3% consensus, while there was also an upward revision of August data to 0.8% from 0.6%. Excluding retail sales, we were up 0.6% month-over-month compared to a forecasted 0.2%. And excluding volatile gas, retail sales were still higher by 0.7%:

All of this indicates the American consumer is probably still spending more than the Federal Reserve prefers. So, that now becomes a closely watched narrative, particularly as we get into the holiday shopping season.

We view this data as a double-edged sword. On one hand, the strong retail sales drove gross domestic product growth. Conversely, a “hot economy” could weigh on future Fed policy. That becomes even more plausible since industrial production for September also came in above forecasted levels. Data that includes the effects of auto strikes still showed increased production of 0.3% versus an expectation of 0.0%.

Initially, bond yields rose in reaction to this strong data. When combined with the fallout and uncertainty from the Israeli/Hamas war, the result was pressure on stocks. Still, the market is trying to shrug off the “yields up, stocks down” narrative (more on that in a bit).

To us, the key is the fundamentals.

In a strong earnings season, good economic news like this is good for stocks. It's obvious there's no easy short-term solution to what’s happening right now. That said, history has shown that even in “uncertain geopolitical times,” if these events remain outside the U.S., stock markets tend to trade higher. That’s especially true when we get into earnings season and strong fundamentals support the overall market and individual companies.

But as we sit here today, we're in a bit of a lull. We’re waiting for the anticipated good earnings news to replace some of the widespread geopolitical and bond market negativity.

For now, only 17% of S&P 500* companies have reported earnings as of this writing. Of them, 73% reported actual earnings per share (EPS) above estimates, which nearly aligns with the 10-year average of 74%. In aggregate, those same companies are reporting earnings 6.6% above estimates, which matches the 10-year average:

When it comes to the averages so far, it’s important to highlight two outlier health care companies. They announced significant downward revisions to forward EPS that threw off the larger averages. Rest assured, this is not a market contagion situation, but rather specific to just those two firms. Without these two massive outliers, earnings results would be well above the 10-year averages.

Sector-wise, eight of the 11 sectors are reporting or expected to report year-over-year earnings growth:

Even with the headwinds mentioned above, it did seem that last week we started to see equities attempting to stage some sort of stabilization near their early October lows. It’s as if Samson and his supernatural strength are propping up the market baseline:

The move in long-term interest rates still has a dominant impact on equity prices. However, the beginning data from earnings and the potential pause in interest rates’ relentless rise may help the market turn around.

Last week we saw another additional positive economic data point – the S&P Flash U.S. Purchasing Managers Index (PMI), an estimate of manufacturing activity, which came in at 50 – its best reading since October 2022. This PMI recovery coincides with elevated industrial production levels and suggests an underlying economic momentum that’s beginning to point towards expansion:

The upturn in PMI, continued better-than-expected economic data, and solid-so-far earnings suggest that most (or all) of the bad news is already priced into stocks. That’s led to the encouraging stabilization of equities over the last week.

For this to continue, strong fundamental support must follow. And by the time you’re reading this, we’ll have finished the first big week in the heart of earnings season. Last week 162 S&P 500 companies reported, which is 41% of the total index (see below). These two weeks could be the haul of good earnings (i.e., fundamental support) the market needs.  

Looking back to the first half of October, it’s clear the bulk of stock market pain centered on small-cap stocks:

But as our readers know, history is on our side in these conditions. When the market is oversold, it tends to rise afterwards. But that was then, and this is now. So, in the quest for fundamental equities support, let’s review some current market pressures to see what stocks are up against, in addition to intensifying geopolitical tensions:

  1. The U.S. government asking for billions in “emergency humanitarian aid.”
  2. Inflation fears.
  3. Rising interest rates.
  4. The “consumers are tapped out” narrative.

And there are probably more!

But the data we laid out over the past month or so still supports the belief that we are at (or close to) the point where undervalued stocks are bought up. Plus, history shows only one catalyst is needed to shut out the noise, and we think that will be earnings.

To better understand timing, using history as a guide, since 1990 there have been 24 instances of the market being this oversold. In those instances, oversold conditions lasted an average of 18 days.

That brings us to last Tuesday, Oct. 24, as day 18 of oversold conditions. From a historically average perspective, that means we're closer to the end of the oversold market than the beginning:

Yes, some of the oversold durations above are quite long. But optimists will note how the timing of the current oversold market coincides with earnings season, and more importantly, how the table’s long-term returns are overwhelmingly positive.

* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.