This week kicks off the US earnings season with analysts setting a high bar to beat for the market by anticipating c.9% YoY earnings growth for the S&P500. Reflecting the potentially overly optimistic expectations heading into 2Q earnings, they have only been revised down by 0.5% compared to the two-year average of 3.8%, as there are now signs ahead of both a weakening consumer and job market. The highest growth is expected in Communication services +18.4%, Health Care +16.8% and Info tech +16.4% while the weakest growth is expected in Industrials -3.4%, Materials -9.7% and Banks -10%. Major banks dominate the first week of earnings season and results are expected to remain broadly in line with the first quarter with earnings declining 10% YoY, on the back of benign loan growth and elevated yields for the second quarter pointing to additional OCI losses.
As mentioned in our previous weekly note Liquidity drain to offset strongJuly seasonals, the first half of July is seasonally the best two-week trading period for the S&P500, however, maintaining the strong market momentum posted in June might be challenging, as hedge funds are still reducing their risk exposure even though the ongoing retail investors' involvement could balance the selling pressure. Sectors such as Industrials, Financials, and Energy have been the most net bought globally, while Communication Services, Info Tech, and Utilities have seen the most net selling with the trend suggesting a shift towards defensive and value-oriented investments. Declining volumes in single stock options also suggest less optimism for short-term gains as historically, low volumes and elevated equity levels have been precursors to market pullbacks, as seen in August 2023 and April 2024, increasing the risk of market weakness, particularly for popular retail stocks.
Volatility continues to remain at depressed levels as dealer gamma has spiked to record high levels of USD15bn+ following the latest market rise, potentially cushioning the market in the short term and up until the next OPEX on 19 July ahead of a seasonally weak second half of July and August. The gap between bond and equity volatility is also at its widest in a long time, signalling potential market stress, all while the realised correlation among stocks is nearing five-year lows, and the SPX's 10-day realised volatility is at its lowest percentile in three years. As we approach a seasonal turning point, the VIX is expected to rise from now through October/November and into the election period. In terms of liquidity, we still see a significant drop in US balances with the FED with a bigger disconnect between the rising S&P500 and the decreasing liquidity impulse.
In terms of economic data, the main focus will be on the US CPI report and jobless claims on Thursday, while we get the US small business optimism survey today (09/07), and CPI & PPI data for China and Japan PPI on Wednesday. Even though markets continue their upward trajectory on the back of increased rate cut expectations, we maintain our Sep24 440 Puts on the QQQ due to stretched positioning and continued weakening in terms of market liquidity.