A Stock Pickers Market

Macro Perspectives: Wed 13 Oct 21

As earnings kick into gear over the next few days, the expectations are for another big quarter of earnings growth, just shy of 30% year-over-year growth. That's a big number, nowhere near the 90%+ (yoy) earnings growth of Q2 and as time passes, the numbers are (and will be) measured against a higher functioning economy of a year prior.

The key spot to watch in this earnings season will be margins. The record level margins of Q2 of S&P 500 companies (which was 13%),  are expected to come in slightly lower (at 12%). That's the vulnerable spot, for companies that are NOT having success in passing along higher costs to customers.

So there will be winners and losers in this earnings season, underpinning the regime change underway...from a passive investing market, to an active investing market - where there are winners and losers, sector to sector and within sectors. It's (finally) a stock picker's market.

With that, we enter Q3 earnings as the broad market has continued to stair-step lower over the past month. Let's revisit the chart...

The broad market still looks like a deeper decline is possible. We've been watching this 200 day moving average, which now comes in about 4% lower (about 8% peak to trough decline). If history is a guide, we should expect a 10% decline in the S&P 500 about once a year, on average - the decline thus far, by comparison, has been shallow.

This all aligns with a broad market that is overly top-heavy with big tech stocks. The valuation models on Wall Street aren't nearly as friendly to the high growth-tech giants, when a higher interest rate (discount rate) is plugged in. Thus, those stocks become vulnerable to a significant valuation adjustment in a higher interest rate outlook.