We're almost through Q3 earnings. As we discussed heading into earnings season, Wall Street was looking for another contraction (albeit slight) in S&P 500 earnings, and (confusingly) that was in a period during which the economy was hot, growing at about a 5% annualized quarterly growth rate.
So, the stage was set for positive surprises. And positive surprises tend to be good for stocks.
Indeed, we've had a better than average number of companies reporting positive earnings surprises, for a blended year-over-year earnings growth of better than 4%.
And over the past six weeks, since earnings season kicked off with the big banks, stocks are up 4% (S&P 500). And it's broad based. The equal-weighted S&P is up 4.5%.
Of course, the Fed has a considerable influence on this outcome for stocks. A few days into earnings season, Jerome Powell signaled the end of the tightening cycle in a discussion at the Economic Club of New York. That "signal" immediately materialized in the interest rate market, with this technical reversal pattern in the 2-year yield (an outside day).
Similar reversal patterns followed over subsequent days, in the 10-year yield, the largest corporate bond ETF (LQD), and the largest government bond ETF (TLT).
Now, we get October core PCE on Thursday, the Fed's favored inflation gauge. Will it derail the conditions we discussed above? Highly unlikely.
It's expected to come in at a 3.5% year-over-year rate of change. That will increase the "real interest rate" (the difference between the Fed Funds rate and inflation) to 200 basis points, which further tightens financial conditions.
And with that, as we've discussed over the past few weeks, as inflation continues to go the Fed's way (i.e. continues to trend lower), the Fed will have to cut rates aggressively next year.
