The Q3 earnings season has started strongly, with US banks surpassing profit and revenue forecasts, driven by robust investment banking income. According to FactSet, approximately 12% of S&P 500 companies have reported Q3 results, with 86% exceeding analyst estimates (5Y average of 78%). However, the magnitude of these beats, at 5.9%, falls below the five-year average of 8.4%, partly because analysts raised earnings estimates for the first time since Q4 2021. The blended YoY earnings growth has risen to 8.5% from 7.9% at the end of Q2, and this upward trend may continue, as expectations for the 'Mag 7' – projected at 14% earnings growth for Q3 – look conservative given their 27% Q2 growth.
Despite markets hitting all-time highs, a spike in downside hedges following last week's credit concerns among US lenders signals widespread unease over rising credit and liquidity risks. The complete depletion of Reverse Repo balances has prompted several banks to anticipate an earlier end to the Federal Reserve's quantitative tightening, mirrored by the US 10-year Treasury yield now trading below 4%. While the liquidity drain from lower US reserve balances and the build-up of Treasury cash balances may be overdone – potentially creating favourable liquidity conditions for risk assets – the ongoing US government shutdown continues to suppress overall trading activity, reflected in the top-of-book order liquidity for ES1 dropping to its lowest levels since late August, warranting further caution.
We continue to favour Europe over the US, and following our last note, Europe finally breaking out?, momentum in the SX5E appears intact. We expect a broader catch-up in underperforming sectors, one of which, Autos, is currently trading near its 5Y range lows. An undemanding call skew favours the use of flat premium call ratios, and we propose Long 2x Mar26 540 calls financed by 1x Mar26 500 calls (Spot: 494.4, Fut 498.7).