Equity investors face tests in 'coin toss' moments

by Jan-Patrick Barnert

Equity investors face a bewildering sequence of tough-to-predict outcomes and confusing market signals. Patience and a steady hand look like valuable attributes in navigating through the noise.

There’s the tight White House race, a European earnings season that’s taking a turn for the better after a patchy start, a troubling grind higher in rates and a market seemingly caught between hedging for declines and preparing for a bullish leg higher.

Momentum in equity benchmarks is cooling, without turning clearly negative. There is also no indication that the current consolidation is morphing into a deeper correction.

It’s hard to take a cue from thematic positioning. Big tech has wavered lately, depriving stocks of a strong driver for gains. Lower-quality parts of the market, like unprofitable tech and stocks with high short interest, are underperforming. Stocks that will benefit from inflation and stagflation, and to an extent pure growth, are leading gains.

Volatility has ticked higher of late. While most of this year’s S&P 500 Index record highs occurred during low VIX Index readings, those set in recent weeks have accompanied wider price swings. This isn’t necessarily something to worry about.

“Periods of rising volatility within bull markets are not necessarily cause for concern but rather an indication of a maturing rally,” said strategists at Tier 1 Alpha.

It’s a set-up that leaves the path clear for a potential rally — depending on the outcome of a few coin-toss events. And the biggest of these is the US election. History suggests that volatility should recede in the final days before polling on Nov. 5. But for now, the spectrum of outcomes looks wider then ever.

“Most importantly, it will not be clear until after the elections which policies will be implemented – beyond the election rhetoric – or whether Congress would agree to enact them,” writes Amundi SA Chief Strategist Monica Defend.

The earnings picture, meanwhile, is developing day by day. The European season’s first Super Thursday is done with roughly €1.4 trillion ($1.52 trillion) of stock market value reporting.

Strong results from Hermes International SCA and Unilever Plc suggested there is good news to be had after all in the spheres of luxury and consumer products. More broadly, analysis shows that while there are headwinds for revenue, companies are still generating profit beats.

Investors have been happy to reward companies for strong quarters, while there hasn’t been too much punishment meted out for misses. A low bar has created room for surprises and “several companies were able to utilize that already,” said Fuerst Fugger Privatbank AG portfolio manager Christoph Mertens.

Merck Finck’s co-head for equities, Marc Decker, noted that 74% of US companies have beaten expectations, while about half managed that in Europe. The critical pivot point for earnings — again, one hard to call with any certainty — are the big tech numbers. 

“Share prices and valuation multiples can undoubtedly be considered quite high. And so are the expectations of investors,” said Decker. And while some are looking for alternatives beyond big tech, this hasn’t yet developed into a full rotation away from the sector, he said.

Given all this, market direction remains event-driven, staying potentially erratic as traders digest one headline after another. Positions taken by hedge investors potentially limits the scope for losses, but the unknown implications of earnings, the US election result and the direction of rates could make things messy into year-end.

Under these conditions, Fuerst Fugger’s Mertens advised staying optimistic, but well diversified. Investors should keep cash handy for potential opportunities, as the coming days were destined to serve up some big moves, he said. 

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