We don’t have a recession and this is not a matter of opinion. The US economic data has been clear on this point with real GDP growing 3% year-over-year, unemployment hanging in at a meager 4.1%, and consumer retail sales continuing to beat expectations. With wage growth also coming ahead of estimates at 4% year-over-year, the labour market also paints a picture of a strong consumer. Hence, it is difficult to envision a Q3 earning season that drastically disappoints.
Therefore, it is surprising to see industry analysts bring down their expectations for S&P 500 company earnings. In early July, the projection was for a +7.9% increase in year-over-year earnings for Q3. This has gradually been lowered to just +4.7% and would represent the weakest earnings growth in four quarters. The magnitude of this adjustment is also much greater than historical averages.
These reduced expectations likely reflects some of the current obstacles facing investors, including: the uncertainty surrounding the U.S. presidential election, the pace and depth of Fed rate cuts, and the deepening conflict in the Middle East. That said, in our view, these obstacles should more impact investor confidence and the level of market volatility (VIX), rather than having an immediate impact on corporate earnings. Hence, this lower bar of earnings projections could leave more room for companies to beat expectations. Such an outcome could help equities advance higher even in the face of macro and geo-political uncertainty.
We will find out the health of Q3 earnings over the next six weeks. And during that period, volatility could increase as the drama of the US election potentially enhances stock market moves. However, unless Q3 earnings significantly underwhelms, it is the Fed that will likely have an even bigger influence on the direction of markets between now and year-end. Afterall, since 1971, the S&P500 has delivered an average return of 15% during periods where the central bank is cutting interest rates (see exhibit below). Those gains are even stronger when policy easing is done in non-recessionary periods.
