US equities have demonstrated remarkable resilience over the past five months, boasting one of their best performances since the 1950s, despite persistent concerns about economic strength and the impact of tariffs. As the third quarter nears its conclusion, the S&P 500 Index is poised for yet another increase, although signs of a potential shift in market mood were evident towards the end of last week. The equity benchmark experienced a three-day decline—its longest slump in a month—before recovering slightly on Friday. The index has risen less than 1% since the Federal Reserve’s rate cut on September 17, with a broad array of sectors, including Big Tech, consumer goods, materials, and healthcare, all experiencing setbacks.
Positioning data reveals that investors are increasingly betting on a year-end rally. Volatility remains below its long-term average, with derivatives markets indicating that traders are willing to pay more for protections against significant market gains than for downturns. However, some seasoned Wall Street analysts urge caution regarding exuberance for risk assets.
Recent comments from President Donald Trump serve as a reminder of potential market headwinds, with new tariffs imposed on various imports, including furniture and pharmaceuticals, just as the effects of prior tariffs are expected to surface in earnings reports. The corporate earnings season kicks off on October 14 with JPMorgan Chase & Co., and expectations for profit growth are notably high.
The impending flood of earnings data is crucial for the sustainability of the current bull market. Labor market indicators set to be released could provide insights following signs of weakness that prompted the Fed’s first rate cut in a year. The central bank’s next decision on policy is slated for October 29, as traders remain divided on the likelihood of further reductions, especially after unexpectedly strong data on consumer spending.
Despite the looming risk of a government shutdown on October 1 and the historically volatile nature of October for US equities, the market has largely overlooked these threats. Analysts, however, express concerns over stretched equity valuations following a significant rally; some predict potential pullbacks and increased volatility as the month unfolds.
Economic data has recently surprised to the upside, challenging assumptions for further rate cuts—easing measures that seem to be priced into a market exhibiting signs of froth. According to Citi Research, aggressive corporate earnings growth is already factored into stock prices, with the market anticipating an 8% earnings growth for the third quarter. Historical patterns reveal that similar high expectations preceded selloffs in 1999 and 2021.
Drew Pettit, a US equity strategist at Citi, articulated the crucial concern facing investors: the ability of firms to meet or exceed heightened expectations, as anything less could trigger profit-taking. October’s unique seasonal volatility may also present challenges, as mutual funds traditionally engage in “window dressing”—selling stocks by month’s end to manage losses against gains.
The bullish chase for stock gains has persisted since a market downturn in early April, leading to significant overall market growth. The S&P 500 has surged by 33%, adding approximately $15 trillion in market value and achieving 28 all-time highs. The index is on track for its strongest September since 2013, reflecting a 6.4% increase during the quarter, rising in seven of the last eight months.
Traders currently display a lack of hedging, focusing on potential upward momentum rather than safeguarding against risks. Andrew Thrasher, a portfolio manager, warns this trend could pose dangers to the rally, as unanticipated events could prompt a rush toward protective put contracts, causing volatility spikes.
Fifty years of data might provide hope for bulls, as similar previous patterns indicate that, despite an average loss of 0.6% in October, there may be a subsequent 3% gain in the fourth quarter. Ed Yardeni, a long-time bull and investment strategist, anticipates a year-end S&P 500 target of 6,800, bolstered by optimism for upcoming earnings and recent GDP revisions. Nonetheless, even he acknowledges that a temporary pullback could benefit the market, viewing selling pressure as a potentially healthy correction amid current valuation concerns.
