Today’s market presented a mixed bag as Wall Street banks kicked off the third-quarter earnings season with better-than-expected profits, while geopolitical tensions in the Middle East kept traders on their toes. The Dow Jones Industrial Average edged up around 0.2%, but the S&P 500 and the tech-heavy Nasdaq Composite weren’t as fortunate, sliding nearly 0.3% and about 1%, respectively.
Wells Fargo and JPMorgan set the tone with strong earnings, drawing attention to how well the banking sector is navigating the Fed’s “higher-for-longer” interest rates and whether the two-year slump in dealmaking is on the wane. “It gets better from here,” said BofA strategists Ohsung Kwon and Savita Subramanian, signaling optimism that the second quarter’s 6% earnings decline was the low point.
While the Street’s consensus isn’t projecting stellar earnings growth for Q3, both Bank of America and Evercore believe the estimates are too conservative. Julian Emanuel of Evercore ISI sees more upside to earnings, driven by stronger-than-expected economic data. “Muted” third-quarter expectations set a low bar for earnings beats, providing “opportunities from potential surprises given the still strong economic backdrop,” Emanuel noted.
Recent economic data shows manufacturing activity catching up to services, a trend Bank of America’s team identifies as a “historical tailwind” for earnings outpacing GDP growth. This shift could be significant, as quarterly earnings growth has typically exceeded GDP growth by 1.5 percentage points since 1950, a trend interrupted in the past five quarters by the post-pandemic shift to a service-oriented economy.
Emanuel also emphasized that earnings are the main driver of stock prices. With the Fed’s “higher for longer” stance and rising bond yields rattling markets, a strong earnings season could be a welcome sign. “3Q23 earnings season will likely be a catalyst for Winners to start Winning again, leading the broad market to at least 4,450 by year-end,” he stated.
Artificial Intelligence (AI) will continue to be a trend to watch this quarter. During the first quarter, the prospect of technological innovations drove stocks higher. With many of those key stocks off their 2023 highs following a two-month market sell-off, investors may be ready to buy into the AI hype again at current valuations. “Winners are poised to win again,” Emanuel said, singling out Apple and Microsoft as stocks that could outperform.
Bank of America expects more clarity on AI projects this quarter and believes the technology will be a meaningful contributor to future earnings growth. The team projects that AI could boost S&P 500 operating margins by 250 basis points over the next five years.
In the backdrop, geopolitical tensions are affecting market dynamics. The 10-year Treasury yield fell nearly 8 basis points to 4.63% amid signs that Israel is preparing for a ground assault in Gaza. This comes after bond yields rose and stocks ended a four-day winning streak yesterday, following data that showed persistent U.S. headline inflation.
In commodities, oil prices surged amid Middle East concerns and after the U.S. tightened sanctions on crude sales to Russia. Crude oil futures climbed more than 4%, while Brent crude futures added 4%. On the corporate front, Microsoft closed its $69 billion takeover of “Call of Duty” maker Activision Blizzard, following clearance from the UK antitrust regulator.
