Wall Street’s Big Q4 Test: Can Stocks Keep Climbing?

As Q4 gets underway with the S&P 500 and NASDAQ at record highs, investors are weighing the outlook for interest rates, AI spending, corporate earnings, and the broader market. Joining us now to break it all down is Melissa Otto, head of Visible Alpha Research at S&P Global. Thank you so much for being here, Melissa. Hi Justine, great to be here. Yeah, there is so much going on here. Just to jump right in, the S&P 500 and NASDAQ are starting Q4 at all-time highs. What do you think has been the biggest driver of this rally that we're really seeing right now? Well, first of all, thanks for having me on. You know, I think coming into last week, over the past month or so, the market was beginning to really price in more rate cuts, or excuse me, more rate hikes. I'm so used to saying cuts, now I'm saying hikes. Yeah, exactly. And when we got that somewhat disappointing jobs number, it was a catalyst to the market that said, oh, hey, you know, this, you know, it may not be quite as much as we think. And it created a bit of a relief rally for the market. Yeah, thinking about those kind of weaker jobs numbers than expected, and then also, again, expectations about interest rates, and what we've heard might be happening as we continue into the rest of the year. What kind of effect do you think that's going to have, not only right now at the beginning of the quarter, but as we move forward? Based on visible alpha consensus, we can see that expectations for the tech sector, as well as healthcare and some of the industrials are continuing to look quite robust. I mean, we are putting out our Dow Jones Industrial Average outlook shortly. And based on that, it looks like about an 18.7% implied return is expected for the market in the medium term. Yeah, and thinking about some of this policy that we've talked about, right, with rate hikes, and then again, we don't know what's going to happen as we move forward, but there's kind of some rumblings. How much of the Fed's broader monetary policy path is really going to affect what we're seeing here? Yeah, it's going to be critical, especially in these time periods between earnings. I think once we get earnings underway in the next couple of weeks, the market is really going to orient and anchor around earnings growth. And coming into this earnings season, it does look like earnings are probably going to be pretty robust. We're continuing to see upward revisions for many companies in the space, particularly in tech. But I think once earnings slows down, and we kind of grind into December, we could see a return to the market's focus on macro events, and those tend to create a lot of volatility. Yeah, they really do. I mean, you were talking about earnings right now as we kind of head into earnings season with all these big questions about massive AI capital spending, commitments from the mag seven, really talking about spending so much more on AI, even more than they already have been. How confident are investors that these investments will actually deliver the return that they're expecting and hoping for? Yeah, that's the million dollar question. And I can tell you in our data, we see very clearly that CapEx growth is significantly outpacing sales growth for the hyperscaler. So the market is wondering, when does that reverse? I think we did get a little bit of light at the end of the tunnel from Microsoft last quarter when they guided this quarter and said, you know, we're going to see an acceleration in that business, which was positive. But I think, you know, for the overall space itself, it continues to be an overhang. It does. Yeah. And of course, we'll have to see what happens with that as we move forward. But just thinking about this tech space a little bit more, do you think that AI related stocks now pricing in too much success? Or do you think that the earnings and cash flow potential really still justify those higher valuation? It's unclear. On one hand, these companies really need to invest their capital. They've been extremely successful over the past 10, 12 years. And so there's a lot of cash that they've had sitting on the sidelines. So investing it in the next generation of innovation is something that they're incentivized to do. However, the magnitude of it is so significant that shareholders are wondering, you know, what do I get out of the deal? Yeah, that's exactly what happens when it's just so big, so much spending there that people start to wonder, all right, when am I going to see the return on this investment? Looking outside of technology a little bit, consumer discretionary and other areas of the market have been underperforming. So does that signal weakening fundamentals? Or do you think that some of these areas really represent a buying opportunity? That's something we've been paying attention to, especially in our new Dow outlook. Consumer has been really under the gun. Companies like Nike, Home Depot, McDonald's, these are household names that really have significantly underperformed. Now, Nike, you could say there's some very fundamental questions about their business model. Home Depot affected by housing due to higher rates. McDonald's, you know, inflation. So I think when we sum all that together, at a certain point, we're going to get lower inflation and ultimately lower valuations. And does the combination start to become a catalyst for these? We get a bit of a mean reversion trade in there. Yeah, that's what we definitely have to keep our eye on as we move forward. And, you know, talking about heading into earnings seasons, as we have been, what do you think could really derail the market rally right now? What are you going to be watching most closely to see when it comes to what is happening next with this market rally? Absolutely. I mean, there are a lot of risks out there as there normally are. I think if turmoil in the Middle East potentially spikes up again, you know, I think, you know, it kind of is a bit contained at the moment. I think if we get earnings growth that comes in a bit below expectations, and if we get, you know, for example, a spike in oil prices, energy costs as a result of an increase in issues around the Middle East, that could potentially also cause some volatility. Yeah, it definitely could. Thinking about everything happening in the world, all the geopolitical pieces of the puzzle here moving as well. For investors, as we move forward here, thinking about portfolio positioning right at this moment, where do you see the most attractive value across the market right now that they should really be looking at? I mean, if we're talking about where we're seeing the most upward revisions, the most growth, the most excitement, tech continues to be the leader. I mean, this is the case on multiple fronts, not simply fundamentals, but I think just simply looking at the charts too, you know, from what we hear from companies, you know, these technology is very front and center in terms of driving a lot of current index performance and where we're continuing to see the fundamentals get upwardly revised and where we see the optimism and not such rich multiples that we've seen in the past. And so there could potentially be some opportunity there. Consumer discretionary as we discussed, you know, those have been beaten up a bit. So if we start to get a bit of a trickle down effect from all of this CapEx spend and energy costs, oil prices come down and consumers are feeling much more optimistic and upbeat. Potentially, we start to see them accelerate their spending and feeling better about things. Definitely. Well, you've given us so much to think about here as we move forward. We really appreciate your time. Melissa Otto, Head of Visible Alpha Research at S&P Global. Thank you so much for being here today. Thank you. Great to be here.