The rally earlier this week was a positive sign for the market; it tells us that buyers are looking for good deals and that investors are not overly worried about another significant decline yet.
It is also a good sign that the bounce occurred at a critical support level on the S&P 500 near 3,590. Solid support shows there are enough buyers to keep prices from crashing.
As we have been saying for a few weeks, third-quarter earnings should be better than expected, and as long as consumers are still spending, the floor under stock prices should remain strong. So far, that is the way earnings season is playing out.
Although things look positive so far, we still have to moderate our expectations; it is rare for a sustained bullish rally to begin with big reversals like last Thursday.
This tells us that investors are uncertain, and uncertainty is usually discounted into market prices. The negatives weighing on the economy (inflation, rising interest rates, slowing global economy) are still severe enough to keep uncertainty high in the near term.
In our view, the positives and negatives are balanced enough at this point to keep the market stable but will also prevent any big bullish breakouts.
So, we’re hanging out in a bit of a gray area for now.
But with earnings season in full swing, we do have some things to look forward to…
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Earnings
It is too early in earnings season to draw conclusions, but the bank reports look fairly good. In fact, if the non-cash losses banks set aside to cover loan defaults next year (if unemployment starts to rise) are added back in, the banks did extremely well compared to expectations.
Bank of America Corp. (BAC)’s report is a good example of what we mean.
Net interest income is the highest it has been in 10 years. According to BAC management, consumer spending on credit cards increased 13%, which is good because much of that spending is on travel and leisure, not essentials, as many analysts had feared. Additionally, the bank reported its second-lowest loan delinquency rate of all time.
Inflation is an issue for consumer spending, but the BAC report backs up our view that it has not influenced consumers enough to represent a serious economic threat so far. The only negative from this news is that as long as consumer demand is high, the Fed will continue to raise interest rates by selling bonds and raising its overnight target rate.
Until we see further deterioration in consumer spending and corporate margins, we think the odds of a big break below support are low.
Upcoming Catalysts
There are two big factors over the next three weeks that will likely determine whether the market remains within its channel (which is what we expect) or breaks out to the downside…
- Tech Earnings
Earnings season is ramping up this week, with tech companies starting to trickle in.
These reports will do a lot to improve (or damage) investor sentiment before the Microsoft Corp. (MSFT), Apple Inc. (AAPL), Alphabet Inc. (GOOGL), and Amazon.com Inc. (AMZN) reports next week.
We expect tech firms to sandbag (lower guidance, so next quarter is easier to beat) during their earnings calls. We would expect companies to justly point at a strong dollar and ebbing international demand as the cause for slow growth rates this quarter, but whether they think those trends will continue will make the most difference to investor sentiment.
- The Fed
The Federal Reserve Open Market Committee (FOMC) will almost certainly raise rates again on Nov. 2.
The bond market is currently pricing in the probability for a 0.75% hike at 95%, so we have to assume traders have already accounted for that change in the current market level.
However, we don’t know what the Fed chairman and other governors will say about the hike – and the pace of future hikes at that time.
FOMC members have been recently saying that there will be some debate about whether to continue hiking rates in 2023 at the same pace as in 2022. However, that was before the most recent CPI report, which exceeded expectations.
Therefore, many traders and analysts are worried that the Fed members may start taking on a more hawkish tone with less “debate,” which is bad for stocks. Right now, we think the Fed will remain consistent, but this is likely the most significant wild card.
Bottom Line
In our view, the negatives and positives in the market are roughly balanced.
Traders usually like clear black-and-white answers, so this can be uncomfortable. If the wild swings in the market are making you feel a little frustrated, you are normal.
We plan to continue using strategies that do well in a channeling market. That means selling calls at resistance levels and buying them back or writing short puts on the lows. As more data rolls in from earnings, the Fed (Nov. 2), and unemployment (Nov. 4) we will let you know if it changes our outlook or strategy in any material way.
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Sincerely,
John and Wade