Although still trading broadly range bound, major US and EU indices posted a c.1.5% drop for the week, with the market weakness mainly focused on Thursday, which saw one of the largest one-day drops for the S&P 500 in two months. The downturn was driven by three key factors: tech giants like Microsoft and Meta reporting increased capital expenditure forecasts, a sign of potential pressure on forward earnings growth; rising bond yields on concerns about the rising US deficit; and a possible pre-election reduction in risk exposure with the Hedge fund cohort seeing the fastest degrossing since the March 2023 banking crisis. The US10Y yield briefly reached c.4.4% despite the US labour market showing further signs of softening, with just 12k jobs added in October, marking the smallest monthly gain since December 2020. However, the rise in US yields could have also been partly affected by 10Y Gilt yields moving up to 52-week highs due to lower BOE rate cut expectations.
Caution is also likely to be the prevailing sentiment this week together with elevated volatility, as the markets main focus will be on the U.S. elections on Tuesday. Market expectations of a Red sweep have fallen to 39% from the high of 49% last week, with odds of a Trump win on Polymarket retracing from 66% to 54% over the weekend before rebounding currently to 58%.The significant pullback in expectations was driven by the highly anticipated Selzer De Moines Register Iowa poll, as it is deemed to have one of the best track records and which saw Harris with a 3-point advantage in a state where Trump had a 9-point lead in the polling averages.
The Fed Policy meeting on Thursday is unlikely to move the needle, as the market is pricing in a 99% probability of a 0.25% cut, further supported from the ongoing weakness in the jobs market. In the UK, the BOE is also expected to cut rates by 0.25% on Thursday. The focus in international markets will turn to China and the National People’s Congress Standing Committee meeting scheduled this week, anticipating potential details about fiscal stimulus measures.
Despite the increase in caution, earnings season has delivered mostly positive news, particularly for major tech names, with expectations of a 4% earnings growth entering the quarter having risen to c.5% as of last Friday. Roughly 70% of the SP500 market cap has now reported, with c.52% of companies beating estimates by >1SD above the historical average of 49%, outperforming the S&P 500 by +160bp on earnings day, while 14% of stocks have missed estimates by >1SD broadly in line with the average, underperforming the Index by -127bps.
In terms of liquidity, although the draining of the Reverse Repo facility, the rise in US Reserves with the FED and corporate buybacks should all be supportive of equities in the short term, we see rising liquidity risks as SOFR rates have seen the biggest one-day shift since March 2020, signalling heightened funding pressure in the Repo market. In light of the ongoing uncertainty and elevated rates volatility, we maintain our SPY and SX5E puts.