Averting The Worst-Case, Calling The Top, And Prepping For Vol. Events

Earnings season isn’t turning out as dire as expected.

That statement is both true and absurd — akin to suggesting the US economy held up “better” than anticipated because the preliminary read on second quarter GDP “only” showed an annualized 32.9% collapse instead of the 34.5% contraction consensus was looking for. The truth is, lacking any kind of historical precedent, estimates of all sorts are pure guesswork, as opposed to the partial guesswork that always goes along with forecasting.

In any case, around 80% of reporting companies have bested estimates, setting the second quarter up to break the record for the share of S&P 500 names beating EPS expectations. The expected quarterly profit contraction is now seen at “just” 35%, an improvement from the 45% anticipated at the end of June.

There are big winners and big losers. Exxon and Chevron put up huge losses Friday, for example. Exxon reported no cash flow from operating activities. Mega-cap tech, meanwhile, blew the doors off on Thursday evening.

While management is still understandably loath to provide guidance given the exigent circumstances surrounding America’s public health crisis (not to mention rampant uncertainty in the months leading up to what promises to be a fraught presidential election), the word “optimistic”, or some derivation thereof, is making the most cameos on earnings calls in more than a decade and a half, on Bank of America’s figures.

While it’s probably true that management saw marked improvements in the operating environment in late May and early June (a time period that coincided with a pro-cyclical rotation in equities), there is no sense in which high frequency macro indicators are improving currently. At best, the US economy is leveling off. At worst, July payrolls could show a decline and retail sales for the month may end up reflecting consumer jitters about the future of extra federal assistance for the unemployed and looming evictions.

“To a large extent, investors are still pricing in ‘something’ out of Washington in the coming weeks, even if those expectations have been tempered”, BMO’s Ian Lyngen and Jon Hill wrote Friday. “As revealed in the June personal income data, the initial spike linked to transfer payments has run its course and what remains is downward pressure”, they went on to say, adding that “this hasn’t been compelling enough to curtail spending, of course [but] as the third quarter data is revealed the vulnerability of the pace of consumption will surely become topical”.

Read more: Domino Effect

As things currently stand, US equities are tracking for the most spectacular bear market rally in history — assuming it still makes sense to call this a “bear market rally”.

BofA’s Michael Hartnett said this week that history predicts an S&P 500 top of 3,300-3,600 between August and January. That’s based on a small sample of historical bear market bounces.

As noted above, the rally will have to contend with a stubborn biological threat, the possibility of a contested election, and geopolitical headwinds which now include an expected ban of the (hugely) popular video app TikTok, which will need to find a US buyer or face expulsion from the country.

You’re reminded that seasonality is not on bulls’ side in August. There’s a bit from Bloomberg’s Katherine Greifeld on that here. As noted repeatedly in these pages of late, this month is a breeding ground for vol. events, thanks in part to illiquidity.

Make of it all what you will. I suppose it’s worth reiterating that any kind of market stress which could be broadly construed as indicative of an unwarranted tightening in financial conditions would likely be terminated (with extreme prejudice) by Jerome Powell.

Of course, the Fed will exercise some modicum of restraint — pretension, at least, to decorum — when it comes to stock market weakness, especially now that many have suggested Japan-style equity ETF purchases are the next tool in the “kit” after yield-curve control.

But because falling stocks are generally accompanied by widening credit spreads, and because the emergency facilities were extended through year-end, any serious selloff would almost surely be met with ramped up corporate bond buying.

Oh, and for what it’s worth, the signal on BofA’s “Bull & Bear” indicator is now in “neutral” territory.