Introduction

The highly anticipated third-quarter earnings season is set to commence as leading banks unveil their quarterly results this Friday. Analysts forecast a 4.7% growth in earnings, which would signal a fifth consecutive quarter of profit increases compared to the same timeframe last year. However, this growth rate marks the slowest year-over-year increase since the fourth quarter of 2023, leading to growing caution among investors.

Market Expectations and Caution

Binky Chadha, chief equity strategist at Deutsche Bank, explains that the robust rally in stock prices prior to earnings reports diminishes expectations for a typical 2% rise in the S&P 500 (^GSPC) during the initial weeks of the season. "Earnings seasons are generally bullish for equities, but given the elevated stock positions and surging market, we should prepare for a more subdued reaction," he noted.

Investor Concerns

Chadha, alongside other Wall Street analysts, expresses concern over various pressing issues likely to capture investors' attention in the upcoming month. Heightened tensions in the Middle East, which have driven commodity prices upward, and an impending presidential election that is sure to introduce market fluctuations present significant uncertainty. Additionally, discussions around Federal Reserve interest rate cuts, with differing opinions on their implications for the economy, add another layer of complexity to the equation.

Historical Context of Election Years

Julian Emanuel from Evercore ISI stresses that earnings seasons occurring in election years often yield less favorable stock reactions in the short term. Historical data from the last four election cycles, starting in 2008, shows that the S&P 500 typically encounters negative returns in October. He emphasizes, "In election years, earnings seasons exhibit a tendency for stocks to react less vigorously to their sales and earnings reports, reflecting the overshadowing concerns about the political landscape."

Positive Surprises and Market Outlook

Amid these wider risks, some market strategists remain optimistic that this earnings season could still offer significant insights. Citi equity strategist Scott Chronert highlights that the current earnings environment is on track for more positive surprises versus Wall Street's estimates, with fewer downward revisions anticipated. However, he cautions that investors are already "pricing in" expectations for stronger-than-average earnings trends, suggesting the market is on shaky ground. "The expectations are high," Chronert states, noting that index multiples are currently at historic levels. This scenario could lead to volatile market reactions regardless of reported earnings performance.

Looking for Signs of Improvement

Despite the concerns, there may be bright spots to watch. According to Bank of America Securities’ equity strategist Ohsung Kwon, 72% of companies are expected to report year-over-year earnings growth, the highest percentage since the culmination of 2021. He underscores the importance of what guidance corporations provide as a result of the Federal Reserve's easing monetary policy. "As interest rates begin to fall, we’ll be looking for early indicators of business improvement," Kwon remarks.

Conclusion

Overall, while the upcoming earnings season is poised against a backdrop of significant challenges and uncertainties, it is also rife with opportunities and indicators that could shape investor sentiment going forward.