As we move into the second half of August, we have had a pretty full slate of earnings come from a majority of the S&P 500 companies. As of this week just under 90% of all index companies have released their earnings and guided for the periods forward out to a year. Here is what we have seen thus far in detail. Of note, earnings were reported up 22.1%, a huge number for only a year’s difference. When considering Tariffs, Wars, and huge political dislocation domestically I find this particularly impressive. Also of note is that 86% of the companies have beat expectations and beat them by almost 30%! So not only are they over 20% higher, but they also beat what analysts had expected by almost 30%. Here is the breakdown:
It would stand to reason then that the digestive phase that we just went through since around Mid-May really was not more than an uncomfortable period of back and forth since the indexes are now at new highs. I have been showing pictures of the price of the S&P and noting that this sideways action, better known as a “triangle formation,” went back and forth (in a triangle) and then on the day of the first Fed meeting of our new Fed chair, Warsh, broke down and almost certainly looked like a doomsday scenario where the market would do the flushing action to test the uptrend that has been in place since October of 2022. Well, this proved to be a bit of a “shakeout / fakeout” as the next day the market reversed right back up and left all the neigh sayers in the dust. Here is what it did exactly. Please really take a moment and study this picture as it shows what happened. Also, it was recently enough that all important facts could be considered and then decided as to what was most important. These facts, as I see them were; interest rates (breaking higher), oil (breaking higher), new Fed Chair (not giving the markets anything to go on with his new style), and earnings and forecasts basically blowing the doors off:
The point that made this action most frustrating and most difficult to predict was that the index under the surface really had a major tug-o-war going on. The S&P 500 currently offers attractive diversification between AI- and non-AI-related companies. According to Bloomberg data, 48 of the 500 companies in the index have positive AI exposure and collectively represent roughly 50% of the index's total market capitalization. During June and July, the S&P consolidated within a range (the triangle that is denoted above with the thin green lines converging) as these two groups moved in opposite directions. AI-related segments weighed on the index, while non-AI benchmarks) largely bucked this weakness. Last week, several AI-exposed benchmarks showed signs of stabilizing, and this improvement enabled the S&P 500 to break above its summer range and move to new highs.
The breakout measures to 8,000, and the breakout point (7,620) should now serve as support, according to Thomas Lee of FundStrat. Most encouraging is the continued expansion in market breadth. Approximately 69% of Russell 3000 constituents remain in uptrends, suggesting that AI weakness has not materially damaged broader participation metrics. While we’re open to additional backing and filling in the AI-focused indices over the coming weeks, we think the stage is set for a Q4 rally and the resumption of longer-term leadership. This is what would be normal as we are now in the worst two-month period in the worst year of the four-year presidential cycle.
I am not in the prediction business, but I am compelled to repeat what has been said throughout the year by the FundStrat team. According to Thomas Lee and his chief technician Mark Newton, this year was expected to be quite choppy. Well, this has certainly been the case. Also, they expected the markets to move into mid-August with new highs, then have a correction into the beginning of October, and then end 2026 with a strong finish.
To touch on how the market has been under the surface just a bit more, I want you to look at how the broad index has acted, and then see how the normally boring and stodgy value portion has acted and how the go-go momentum companies have acted in this most recent period:
Please note how the momentum, generally known as technology and other “growthier” sectors took a major breather and the rest of the market grabbed the baton and ran with it. You will also see that the last price bar on the Momentum index shows a spike up through the downtrend line.
The last point that I want to bring up about the internal action of the indexes is the breadth within the index that supports the strength of this move to new all-time highs in the price of the indexes. While a lack of renewed broadening is indicated, the narrow leadership is evident reflecting the lack of new highs in all indexes (S&P 500 at highs yet NASDAQ composite and NASDAQ 100 not at new highs).
Based on the lesser of new highs and new lows divided by issues traded, high readings reflect worsening breadth. And they can warn that the market is experiencing a blow-off, a narrow bull market finale. To be clear this is not insinuating a major and longer-term correction, but instead a needed recharging of the market’s batteries before the earnings forecasts kick in once again to allow the markets to advance once again.
Considering their positive correlations with the world indexes, it would be encouraging to see breadth indicators confirm the benchmarks at new highs, together with breadth signals, a bullish High-Low Index, and rising percentages of new highs across markets, sectors and stocks. At present this is what the breadth of world markets looks like. Since the US represents over half of the world market capitalization, this is really quite a telling picture. It speaks to a market that is strong in that it is at new highs, but the strength of all markets to be at new highs is lacking. It could be a pause to refresh, or it could mean (as Thomas Lee has stated) that the markets may need to do their final August/ September washout before the strong year-end performance. Here is the picture of what I am referring to:
The current move has been quite impressive I believe as they so far have defied what has tended to be the worst two-month period of the year within the worst year of the four-year cycle.
In closing, I don’t know if we are completely out of the woods or not on the markets’ volatility. What I do know is that if interest rates break up towards 5% and or oil goes back up to the high 80’s more negativity could rise its ugly head. If the earnings season ends with continued strong numbers and these other two points don’t materialize, then we could be in for maybe more sideways action than a decline before a year-end rally. I want to emphasize an important point that I have brought up for the last couple of years. Volatility is just part of a market. Here is the probability going back to 1928 of different levels of market drawdowns. Please note that drawdowns of 5+% tend to happen 3-4 times per year, 10% variety about once a year, and bigger one far less often.
-Ken South, Tower 68 Financial Advisors, Newport Beach
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