Stocks rose again last week and we see several key factors supporting stocks and other risk assets.

Earnings Continue to Exceed Expectations: At the beginning of third-quarter earnings season, earnings were expected to increase by 27%. Similar to other results since the second-quarter earnings collapse of last year, earnings are far exceeding analyst expectations—impressive despite the Delta surge, supply-chain problems, and inflationary pressures.

With about 26% of the S&P 500's market capitalization having reported, earnings are beating estimates by 13.7%, with 83% of companies topping projections. This has caused the original estimate of 27% for third-quarter growth to rise to 31%. This 31% estimate should rise even further with more companies reporting—earnings are on pace for 38% growth, assuming a blended beat rate of 10% for the remainder of the season. Upward earnings revisions provide powerful support for stocks, as we have seen since the hard lockdowns of last spring ended.

This week is one of the busiest weeks of third-quarter earnings season with results from 156 companies representing more than 43% of the S&P 500’s market cap, including the largest five stocks. The cyclicals (Energy, Materials, and Industrials) are expected to show the highest third-quarter earnings growth at100%. This reflects very weak earnings in last year’s third quarter and a strong snap-back in earnings this year. The non-cyclicals (Consumer Staples, Health Care, and Utilities) are expected to show relatively slower growth of 11%.

Further Economic Growth Should Support Stocks Going Forward: Economic growth is a critical factor for further stock market gains. Last week brought encouraging news from two important leading indicators, despite supply-chain disruptions and associated inflationary pressures.

The Conference Board Leading Economic Index (LEI) for the U.S. rose again in September, although at a slower rate, suggesting the economy remains on a more moderate growth trajectory compared to the first half of the year. While the Delta variant, rising inflation fears, and supply-chain disruptions are all creating headwinds for the economy, strength among the components remains widespread. Indeed, The Conference Board continues to forecast strong growth ahead: 5.7% year-over-year for 2021 and 3.8% for 2022. For perspective, economic growth averaged about 2% in the decade prior to the pandemic.

Friday’s release of the IHS Markit Flash U.S. Composite PMI confirmed the positive outlook from the Conference Board’s forecast. This preliminary business survey which combines readings from the manufacturing and service sectors signaled the fastest increase in activity for three months and one that was sharp overall. Stronger growth was driven by the service sector, which registered the quickest rate of expansion since July. However, the latest rise in factory production was the softest since July 2020 and only mild, as goods producers continued to be severely hampered by material shortages and supply-chain delays. Meanwhile, hiring has also picked up as firms have been encouraged to expand capacity to meet rising demand.

In aggregate, these readings suggest an encouragingly strong start to the fourth quarter for the economy, which provides support for profits and ultimately stocks.

Market Internals are Supporting a Positive Outlook: Stock and other asset prices send important signals themselves. Consequently, we continuously monitor market technicals (price movement) for confirmation of incoming economic data and business sentiment. We are encouraged by the recent market action.

Financials and importantly banks, which provide critical support for economic activity, are outperforming and making new highs. Copper, known as “Dr. Copper” by market participants because it’s the base metal with a Ph.D in economics, has made a major bullish inflection higher after its recent consolidation. 

The U.S. dollar, which spiked higher last March at the start of the pandemic, remains below important technical levels—an encouraging risk-on signal for global stocks. The defensive Consumer Staples and Utilities sectors continue to underperform which is also a bullish signal.

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