Stocks Could Get A Boost From Better Third Quarter Earnings

U.S. stocks could get a boost from a better third-quarter earnings season, as bond yields ease.

Treasury bond yields have been a significant headwind for equities in recent months. The benchmark 10-year Treasury bond yield reached 4.85% in the previous week, up from 3.50% at the beginning of the year. As a result, bonds and money market funds are posing severe competition for stocks, especially the scores of smaller profitless tech stocks.

But the 10-year Treasury bond yield eased last week, around 4.60%, following the breakout of the Middle East war, which raised the demand for safe-haven assets.

Then there's the ongoing dead-ceiling deadlock in Washington, which raises the prospects of the Fed skipping a rate hike in its November meeting.

Meanwhile, traders and investors keep an eye on the third-quarter earnings season. It has been on a good start thus far, with larger banks reporting better earnings thanks to trading income.

As of October 13, the S&P 500 has been reporting year-over-year earnings growth of 0.4% for the third quarter. It's the first quarter of annual earnings growth reported by the index since the third quarter of 2022.

That's according to FactSet, which monitors closely the earnings of the large U.S corporations.

John Butters, Vice President of FactSet, expects this trend to continue for the rest of the season.

"When companies in the S&P 500 report actual earnings above estimates during an earnings season, the overall earnings growth rate for the index increases because the higher actual EPS numbers replace the lower estimated EPS numbers in calculating the growth rate," he explained. "For example, if a company is projected to report EPS of $1.05 compared to a year ago EPS of $1.00, the company is projected to report earnings growth of 5%. If the company reports actual EPS of $1.10 (a $0.05 upside earnings surprise compared to the estimate), the actual earnings growth rate for the company for the quarter is now 10%, five percentage points above the estimated growth rate (10% - 5% = 5%)."

Young Pham, the Co-Founder of BizReport, finds the performance of the S&P 500 remarkable in the face of significant economic headwinds. "Record-breaking inflation, rising interest rates, and global economic uncertainty, including the ongoing challenges in China, have created a complex financial landscape," he told the International Business Times.

However, Pham thinks it is unlikely to see uniform earnings across all sectors of the S&P 500.

Instead, he sees a tale of two earnings reports. On the one side is the energy sector, which is expected to be a standout performer, benefitting from rising oil prices and growing demand.

"Earnings growth in this sector can be substantial due to a recovery from the lows experienced in the earlier phases of the pandemic," he added.

Then, there's the defense sector riding on robust growth due to domestic and international security concerns. "Ongoing contracts and government spending are expected to bolster earnings in this area," Pham said.

On the other side is the banking sector, which encounters setbacks. "Higher interest rates can compress net interest margins, and market volatility could impact trading revenues," he added. "This sector faces unique challenges despite its adaptability."

Todd R. Walsh is CEO and Chief Technical Analyst of Alpha Cubed Investments, sees a highly bifurcated market this year, across stocks rather than sectors. He observes that the magnificent 7/AI components of the S&P 500 carrying most of the water-generating returns. "The other companies, which I call the Forgotten 493, are muddling through waiting to see if the Fed is going to make the reverse policy error that they did in 2021 by leaving rates, higher for longer now, or continuing to raise and creating a more serious recession," he told IBT.

Still, investors should cast a wary eye on inflation, which remains elevated, according to recent CPI and PPI numbers. They complicate the Fed's job beyond the November meeting.

But Emin Hajiyev, senior economist at Insight Investment, is cautiously optimistic. He sees the overall inflation to continue easing into the next year.

Meanwhile, Walsh expects the bifurcation between the magnificent 7/AI and the rest of S&P to persist. "Not just because there is real money pouring into the AI ecosystem stocks, but because those companies have extremely strong balance sheets with extremely strong internal cash flows."