Inside Markets — Seasonal Weakness and Proverbs

The three main factors that contribute to September-early October seasonal weakness are fund flows, earnings estimate revisions, and October fiscal year-end for active mutual funds.  Corporate buybacks enter blackout windows 4-6 weeks prior to earnings.  For corporates without 10b5-1 selling plans in place, the rolling blackout window has already started with CQ3 earnings season kicking off on 10/14.  Given weaker fund flows and stretched systematic positioning (last week in 99th percentile), next week’s Fed meeting could become a ‘sell-the-news’ event as investors take time to consider the macro environment amid signs of labor market weakness. If that happens, we’d expect any pullback to be contained in the 3-5% range.  Companies exit their buyback blackout window 2-3 days after earnings, which should improve fund flows starting the week of 10/20, becoming an incremental tailwind for bullish Q4 seasonality.  Estimate revisions are the single biggest driver of near-term price action with a tendency for September sell-side industry conferences to result in lower out-year estimates.  The past two weeks of conferences have already covered the most significant industries/companies and there is no discernible change yet to C’26 estimates.

Proverbs: Market concentration is at an all-time high with the top 10 positions accounting for ~38% of the SPX market cap, and 9 of those positions are secular growth mega-cap tech stocks.  This makes a cyclical economic acceleration/recovery a significant ‘unidentifiable’ risk for most investors who are grossly overweight mega cap tech.  As we all know, ‘the bus that hits you is the one you don’t see.’  A prolonged Fed easing cycle that delivers a cyclical acceleration would likely narrow the performance differential between secular growth and deep cyclical stocks.  Using the Russell 2000 (RTY) as a cyclical proxy, this performance differential is currently at its widest in history. When looking for risk, it’s important to have an unconstrained imagination, and a prolonged Fed easing cycle would be in addition to a supportive fiscal backdrop, accelerated depreciation, deregulation agenda, and ultra-easy financial conditions.  A one-and-done Fed rate is unlikely to generate the cyclical impulse that would make secular growth stocks a source of funds.  And how does one know if the Fed is about to embark on a prolonged easing cycle?  In our view, the best cross-market indicator in the current environment is the 2-year Treasury yield with a sustained break below 3.47% as our queue to add cyclical exposure.  Be careful what you wish for and always sleep with one eye open.