Seasonal Buy Signal TriggeredLast week, we discussed the triggering of the seasonal MACD buy signal. To wit:“On Friday, the market broke out to the upside of that wedge pattern, triggering a “seasonal MACD buy” signal. Notably, that buy signal also marks the beginning of the seasonally strong 6 months of the year. The series of high lows, now combined with higher highs, remains a significant bullish backdrop for investors. With earnings season starting in earnest this coming week, the bias remains to the upside, but risk management protocols should not be abandoned.”The chart below is the WEEKLY S&P 500 chart, with three different signals to confirm the start of the seasonal period. With Friday’s close in the green, keeping the week broadly positive, all three seasonal buy signals have been triggered. 
However, as noted last week, just because the seasonally strong period of the year has technically started, it doesn’t mean that the markets won’t have corrections along the way. Notably, we have already had 6-straight weeks of gains, which is a long stretch without a pullback. Secondly, while the market is on a weekly “buy signal,” the market is both deviated and overbought short-term. When the market breadth is very elevated, combined with overbought and deviated markets from the 50 and 200-DMA, corrections and consolidations tend to be more prevalent. 
We expect that the market will experience a short-term consolidation or correction. However, there are three reasons why such will likely provide a better entry point to add exposure.
The current bullish trend remains intact, and bullish sentiment is very strong. This has led to significant and continuing inflows into the market, which will support asset prices.
Corporate buybacks will resume at the end of the month and will amount to roughly $6 billion per day into year-end.
Many managers lag in the market and must play catch-up by year-end for reporting purposes.
These three reasons will likely push asset prices to our target of 6000 on the index by year-end. However, do not get too complacent, as 2025 will be a year of increased volatility.This week’s discussion will examine Q3 earnings, which will pick up lots of steam next week. Q3-Earnings Estimates Remain OptimisticAs the Q3 earnings season approaches, market participants are eyeing the outlook for S&P 500 companies amid economic uncertainty. After a challenging year for corporate profits in 2022, many investors look to Q3 earnings as a barometer of where the market might head next. However, current consensus estimates from analysts have seen notable downward adjustments, raising questions about whether the market has priced in all the potential risks. Current Consensus Estimates and AdjustmentsAccording to analysts’ consensus, Q3 earnings for S&P 500 companies are expected to grow moderately. However, compared to earlier in the year, these projections have been revised downwards domestically and globally. Interestingly, despite rather exuberant optimism about the stock market, there have been very few analysts’ earnings upgrades. 
Currently, the Q3 earnings season is starting with a fairly low bar.
Consensus Earnings Growth: Analysts estimate that S&P 500 earnings will increase by around 3-4% year-over-year in Q3. This represents a significant decline from earlier expectations of 7-8% growth.
Revenue Growth Projections: Revenue growth is expected to remain subdued, with consensus estimates forecasting a 2-3% increase, down from earlier projections of 5%.
Notably, there is a stunning lack of earnings growth outside the top 10 largest companies in the S&P 500 index. According to Bank of America, while overall Q3 earnings growth was expected to be a modest 3-4%, this would be entirely due to a 19% increase in the “Magnificent 7” earnings. However, even those earnings are down from 37% in Q2 and down from 55% a year ago. The rest of the S&P500, some 493 companies, are expected to post another quarter of flat earnings. 
If that isn’t quite apparent, here is the problem more succinctly. Since 2009, virtually all of the earnings growth in the S&P 500 index has come from just seven (7) stocks. 
Therefore, it should be relatively unsurprising that downward revisions to estimates come in response to several factors, including weakening consumer demand, tighter monetary policy, and rising geopolitical tensions, which impact those bottom 493 companies the most. As shown, Q3 earnings have seen the largest negative revisions since 2022. 
Given the prevailing economic headwinds, this has led to concerns that earnings estimates may still be too optimistic. Drivers Behind the Downward RevisionsDespite the Federal Reserve’s recent shift toward cutting interest rates, analysts have lowered Q3 2024 earnings estimates. Several factors are driving these downward revisions.First, although lower interest rates aim to stimulate growth, the economy still grapples with slowing consumer demand and job growth. Companies are struggling with softening sales and rising labor costs as unemployment increases. These pressures outweigh the potential boost from cheaper borrowing costs, potentially limiting near-term profit improvements. Furthermore, as noted by Albert Edwards this week:“When we say US profit margins are absurdly high, the chart below rams home the point. These are whole economy BEA data and so include unquoted companies, and the BEA ‘scrubs’ the data clean. Until Greedflation emerged in the aftermath of the pandemic, 15% of GDP was typically top of the pops. The even larger share of GDP comes at the expense of workers.” 
In other words, further profitability improvements will likely be much harder. Businesses also face lingering uncertainty about the strength of future economic recovery, prompting cautious guidance. The Fed’s recent pivot reflects concerns about maintaining labor market stability and addressing economic slowdown risks, not just inflation reduction. Additionally, while inflation has moderated, input costs remain elevated, potentially further squeezing corporate margins. 
The benefits of rate cuts could take several quarters to materialize, leaving Q3 results particularly vulnerable to macroeconomic headwinds this year. However, analysts are highly optimistic that results will improve markedly, double-digit growth, following the Q3 earnings season. 
Be wary of the exuberance. Historical Overestimation by AnalystsThe pattern of analysts overestimating corporate earnings is commonplace. Every year, going back to 1994, when “operating earnings” became a thing, analysts‘ forecasts were consistently too optimistic at the beginning of each quarter. Historically, that overestimation has been approximately 30% higher than the eventual reality. 
This tendency to overshoot earnings growth has been attributed to several factors:
Delayed Reaction to Macroeconomic Signals: Analysts have tended to underestimate the lag effect of monetary tightening on corporate profits. While initial forecasts are often based on historical growth patterns, they do not always reflect sudden economic or policy changes.
Corporate Optimism: Companies often guide higher during earnings calls, buoying analyst expectations. However, as the actual economic environment proves more difficult, earnings often fail to meet these expectations, resulting in post-reporting season disappointments.
Investment Banking Needs: Wall Street is in the business of selling products. Therefore, increased estimates lower forward valuations, improving investor appetites, particularly for high-growth companies. A previous study showed that the accuracy and timeliness of earnings forecasts are the LEAST important for analysts. (Read: The Truth About Wall Street Analysis)
Given these historical trends, it’s reasonable to question whether current and future earnings forecasts are too high. Should economic conditions worsen, the risk of further downward revisions could increase. Market Expectations and Return OutlookDespite the potential challenges for Q3 earnings, market expectations remain relatively stable. Analysts forecast a double-digit return for the S&P 500 through the end of the year, and investors are increasingly optimistic. In October, investors raised their equity allocation by the largest amount since June 2020. Currently, 31% of the investors surveyed by BofA are overweight equities, up from just 11% overweight last month. 
Notably, the composite allocation (professional and retail) “fear/greed” index, while not yet at extremes, is beginning to reach levels more associated with market peaks than bottoms. 
However, the relationship between earnings and market returns is complex. In recent quarters, the stock market has often rallied on the hope of easing monetary policy, even when earnings have disappointed. However, sustained market returns are heavily tied to earnings growth over the long term. If Q3 earnings fall short, it could cap gains and increase volatility in the year’s final months. 
Risks to the Q3 Earnings OutlookSeveral key risks could impact the Q3 earnings season and the broader market:
Inflation Rebounding: While inflation has moderated, there’s a risk that energy prices or wage growth could reignite inflationary pressures. This could cause the Federal Reserve to “pause” on rate cuts, disappointing investor sentiment.
Geopolitical Tensions: Ongoing conflicts, particularly in Eastern Europe and the Middle East, could exacerbate supply chain disruptions and drive up commodity prices, putting additional strain on corporate margins.
Consumer Weakness: Should consumer spending continue to decline, particularly in the critical holiday season, many companies may find themselves cutting profit forecasts for Q4, further dampening the outlook for 2024 and into 2025.
Stronger-than-Expected Economic Slowdown: A significant risk to analysts’ estimates is that economic growth could slow more sharply than currently anticipated, particularly if corporate investment and hiring pull back more aggressively in response to higher interest rates.
As Last week,Last week, we think #4 is probably the biggest risk to the market currently.“One of the more troubling components of the NFIB survey is the outlook for future sales. According to the data, many small business owners expect sales to decline over the next six months. This pessimism is particularly pronounced in the retail and service sectors, where rising costs and shrinking profit margins force many businesses to scale back their operations. 
A slowdown in economic growth typically results in weaker corporate earnings as businesses experience declining demand for goods and services.As Q3 earnings season kicks off, the S&P 500 faces a mixed outlook. Downward revisions to earnings estimates suggest that analysts are increasingly cautious about corporate profitability in the face of persistent economic headwinds. However, historical trends of overestimation, coupled with the possibility of unexpected economic shocks, could lead to further downward revisions.Investors should approach Q3 earnings with a balanced perspective, recognizing both the opportunities for selective gains and the risks of broader market volatility. Staying diversified, managing risks, and rebalancing allocations will likely be the best strategy for navigating the market into year-end. How We Are Trading ItLet me conclude with what we wrote last week.“We continue to manage our portfolios in a manner that allows us to participate in the market increase but still hedge against underlying risk. As such, we suggest rebalancing risk as necessary and adjusting portfolio holdings to provide some hedge against a sudden pickup in volatility. While the number of stocks making new 52-week highs is rising, indicating strong breadth and participation in the market also serves as a warning. As shown, previous high levels of participation also coincide with market peaks and corrections.
The trick to navigating markets is not trying to “time” the market to sell exactly at the top. That is impossible. Successful long-term management is understanding when “enough is enough” and being willing to take profits and protect your gains. For many stocks currently, that is the situation we are in.”
That advice remains relevant this week as we head into the heart of earnings season. A pickup in volatility, some surprises and disappointments will be the nature of the market next week as the mega-cap companies report their results. The trick will be to navigate the outcome without making emotionally driven decisions.Continue to follow the rules and stick to your discipline. (Read our article on “What Is RIsk” for a complete list of rules)Feel free to reach out if you want to navigate these uncertain waters with expert guidance. Our team specializes in helping clients make informed decisions in today’s volatile markets. 
More By This Author:Taiwan Semiconductor Nullifies ASML FearsBastiat And The “Broken Window”Cava: A Hot Trend Comes At A Dear Cost To Investors
