• Stocks remain supported despite recovery in US dollar and yields
• Earnings are expected to grow in Q3, but at a slower pace than in Q2
• Investors remain cautious ahead of US election
• But VIX suggests increasing volatility around the event

Good news is actually good news

Although investors have significantly scaled back their Fed rate cut bets lately, Wall Street’s benchmark indices did not suffer. The US dollar staged a robust recovery last week, with Treasury yields rebounding strongly as well, but both the S&P 500 and the Dow Jones continued to consolidate near their all-time highs, while the Nasdaq stayed not far from its own record.

This may have been the result of a “good news is actually good news” strategy, as equity investors have been cheering every data pointing to a strong performing US economy, even if it translated into lower-than-expected rate cuts by the Fed in the months to come.

More specifically, with Powell and his colleagues placing extra emphasis on labor data, market participants have ruled out the possibility of a consecutive 50bps rate reduction in November just after Friday’s better-than-expected jobs report for September. They are now in full agreement with the Fed that quarter-point cuts may be needed at each of the November and December decisions. So, it seems that stock traders are content with the idea that borrowing costs will continue to decrease, although at a slower pace.

Earnings season to take center stage

For now, the spotlight is likely to turn to the third-quarter earnings season, which starts on Friday with results from JPMorgan, Wells Fargo, and First Republic Bank.

Analysts’ consensus points to a 4% y/y earnings growth for the S&P 500, marking a sharp slowdown from 11% in the second quarter. That said, history has shown that, usually, when the bar is set low, results tend to beat expectations.

Thus, companies that have managed to successfully deal with challenges like elevated borrowing and energy costs, as well as global supply chain disruptions, could see their share prices drift higher. Gains could be more prominent in stocks of firms that are usually valued by discounting expected free cash flows, like tech firms, as this could keep present values elevated.

Are investors cautious due to US elections?

Having said that though, the overall volatility in this earnings season may be more subdued than usual as it comes less than a month ahead of the US presidential election. Indeed, the notion that investors are cautious is supported not only by the latest price consolidation, but by the Put/Call ratio of the S&P 500, which currently stands at 1.97. Namely, the open interest of put options is double the open interest of call options, which likely translates into increased hedging activity of long positions ahead of the elections.

However, the VIX index, which measures the stock market’s 30-day implied volatility based on S&P 500 index options, entered into recovery mode on September 26 and hit a one-month high on October 6, which means that actual volatility may increase closer to the election date and just after.

S&P 500 could aim for new records soon

From a technical standpoint, the S&P 500 hit a record high of $5,767 on September 26 and then entered a consolidation phase, staying near that record. The broader trend remains to the upside, and even if a pullback occurs soon, investors may view it as an opportunity to enter the market at more attractive levels.

A rebound and a break above the record high of $5,767 would take the index into uncharted territory and may target psychological levels, like the $5,900 zone and the round number of $6,000. For a bearish trend reversal to start being examined, a decisive dip below $5,400 may be needed.