Stocks have taken a breather this week, following the S&P 500’s record intra-day high of 5,878. The index has risen 67% since it bottomed in October 2022 and is up 23% YTD.

Recent market gains have been driven by strong corporate earnings, solid economic growth, declining inflation, and expectations of further interest rate cuts by the Federal Reserve. According to Factset S&P 500 earnings are likely to grow by 3.4% in the third quarter, down from 11.3% in the second quarter, and lower than the 4.3% growth projected on the 30 ^th of September, as five sectors had faced downward revisions.

The U.S. economy grew at an annualized rate of 3% in the second quarter, with the Atlanta Federal Reserve’s forecast model predicting a 3.2% growth rate for the third quarter. Additionally, the September jobs report provided a boost for market optimism, revealing a rise in nonfarm payrolls by 254,000, up from 159,000 in August, and a slight drop in the unemployment rate to 4.1% from 4.2%.

Inflation Eases but Remains Above Target

Annual consumer prices rose by 2.4% in September, slightly surpassing expectations but were down from the August 2.6% rise. The Federal Reserve targets a 2% inflation rate, and its preferred measure, the Personal Consumption Expenditures (PCE) Price Index, was close to that goal in August at 2.2% year-over-year.

In response, the Fed cut interest rates by 50 basis points last month, with additional 25 basis points cuts likely at both the November and December meetings. According to the CME FedWatch tool, interest-rate futures reflect a 94% chance of a 25 basis points reduction at the Fed’s November meeting, with only a 6% chance of no change.

However, valuations appear elevated. As of 18 ^th of October, the S&P 500 was trading at 21.9 forward 12-month P/E ratio, well above its five-year average of 19.5 and its 10-year average of 18.1 according to Factset.

Labor Market Strength May Fade Despite Solid September Jobs Report

The U.S. economy added 254,000 jobs in September 2024, significantly exceeding expectations and marking the strongest job growth in six months. This figure is much higher than the upwardly revised 159,000 jobs added in August and well above the 140,000 forecasted.

September’s robust job gains also surpassed the prior 12-month average of 203,000 jobs per month, reflecting continued resilience in the labour market despite ongoing economic uncertainties.

The robust September jobs report could potentially influence future Federal Reserve policy decisions; however, labour market strength is unlikely to persist, and we favour a gradual softening.

Robust Retail Sales Highlight Consumer Strength

U.S. retail sales increased more than expected in September, showing the resilience of American consumers, which may influence the Federal Reserve’s approach to interest rate decisions in its remaining meetings of the year. Monthly retail sales in the U.S. grew by 0.4%, accelerating from August’s steady 0.1% increase, according to data from the Commerce Department. Economists had forecasted a 0.3% rise.

In August, retail sales, which largely consist of goods and are not adjusted for inflation, unexpectedly grew, with July’s figures also revised upwards. The strong retail sales data reinforced the overall strength of the U.S. economy. This consumer spending strength could support the Fed’s goal of achieving a “soft landing,” where inflation is curbed without triggering a significant economic slowdown.

Strong Start to Earnings Season

Positive earnings from major banks and technology companies over the past week led the S&P 500 to a fresh all-time high. As of Q3 2024, with 14% of S&P 500 companies reporting so far, corporate performance has been strong, with 79% of companies posting positive Earnings Per Share (EPS) surprise and 64% exceeding revenue expectations.

However, momentum appears to be cooling this week as investors brace for key events such as the upcoming Federal Reserve meeting and the highly anticipated U.S. presidential election on the 5 ^th of November. Concerns over stretched stock valuations are also contributing to the risk of potential near-term pull back in the market.

The Role of the “Magnificent 7” in Driving S&P 500 Earnings Growth

Several companies within the “Magnificent 7” group have been leading contributors to the S&P 500’s year-over-year earnings growth in recent quarters. For Q3 2024, four of these companies—NVIDIA, Alphabet, Amazon, and Meta Platforms – are projected to be among the top 10 drivers of earnings growth. Notably, NVIDIA and Alphabet are expected to rank within the top five, with NVIDIA projected to be the single largest contributor to earnings growth.

According to Factset, the “Magnificent 7” are forecasted to report 18.1% year-over-year earnings growth for Q3 2024. Excluding these seven companies, the remaining 493 companies in the S&P 500 are expected to see a modest earnings growth rate of 0.1%. Overall, the blended earnings growth rate for the entire S&P 500 is projected to be 3.4% for the third quarter of 2024.

Source: TradingView

Technical Analysis

With earnings season seeing mixed results so far, the S&P 500 is struggling to extend its five weeks rally. The benchmark index has been trading in a narrow range around its all-time high of 5,878 notched last Friday driven by lack of major economic data this week. Investors are wary of the rising bond yields, pointing to a likely slower pace of Fed easing. Concerns about the growing federal budget difficult and uncertainty over the outcome of the U.S. presidential election also weigh on market sentiment.

The lack of a correction and spike in volatility ahead of the election is quite unusual and could deter the expected strong post-election rally. The remarkable resilience of the stock market has been driven by optimism about interest rate cuts, despite hotter inflation data, rising bond yields, global geo-political risks, and concerns about a recession.

From Elliot wave analysis perspective, the current price action of the S&P 500 appears to be part of wave (v) out of the larger degree wave 3, which means that a deeper pull (wave 4) back is on the horizon. Once the correction is complete, wave 5 is likely to take the index to new record highs. Our first upside target is at 6,000 but higher levels are achievable in 2025.

Conclusion:

While strong earnings reports have lifted markets to new highs, concerns over stretched valuations and upcoming economic and political events are creating a cautious atmosphere. Investors will be closely monitoring economic data and Federal Reserve commentary in the coming weeks as they assess the sustainability of recent market gains. The role of leading tech companies, especially the “Magnificent 7,” will remain critical to the S&P 500’s performance, both in the near and long term.

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