Beyond the Headlines: 5 Possible Tailwinds for Stocks in Q4 and Next Year

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Chris Perras:

So topic is not what can go right tomorrow or next week. We’re thinking about what can go right in the fourth quarter, what can go right at the beginning of next year. And this is historically actually the weakest time of the year for markets is usually September. There’s tax law selling from large institutions when Charles and I used to run money at AIM. Was there a September or August?

Charles Scavone:

Yeah, so people wonder, you know, sort of why did why did stocks, you know, crash in October, way back in September and October? And that’s because back in the day when we were managing very large mutual funds, those funds, fiscal year, the year, the calendar, the fiscal year for those funds typically ended right around those those months. It didn’t necessarily follow a calendar. So our bonuses were determined based upon your performance to that date. And if there was any sign of trouble, you’d been having a pretty good year and there was any sign of trouble, we’re hitting the exits, right? Because that’s going to determine how you’re paid at the end of the year. And so that led to a considerable amount of volatility. I like to have all these academic studies suggesting why certain things happen at certain times. Sometimes the story behind the scenes is what’s really going on. So we can reminisce about some of those later.

We always focus on, you know, forward looking and saying that capital markets are forward looking. And so it’s sort of picked out upon feedback on what Chris was saying. What then are these forward looking things? What are what are the situation? What are the current conditions and things that we’re looking at now that may give us some degree of confidence and optimism that stocks will continue to work going forward? And we kind of made we kind of made a list of those. We want to. Talk about them kind of individually or…

Chris Perras:

Yeah, we can talk about it individually. We made a list, but the common theme, regardless of which bullet point we come back to, I think the common theme is earnings, right here. And our earnings and all these other factors that we talk about today, are they going to help earnings in the fourth quarter of this year and next year or for earnings? And since we’re thinking about things that could go right, almost all of these things that we discuss should be helpful for the earnings outlook, whether they’re things like the big, beautiful bill helping with accelerated depreciation or the Fed cutting rates, actually maybe helping with the housing market. Those types of things that there’s a lag effect, but they tend to produce positive earnings momentum in quarters out one, two, three, four quarters out. So the common theme, whether we’re talking any of the five points, I think there’s some five points. It’s going come back to, do they help earnings? And do they help accelerate earnings through less friction in the markets, whether it’s deregulation or something else.

Charles Scavone:

Yeah, and think about what we always talk about, right? We’re growth investors. And so what, when it has a growth investor in the stock market, what are you buying? You’re buying an expected future stream of cash flow and earnings. And that’s why it’s so important what Chris has highlighted, why that’s important to us. So, you know, if you just start off with, despite everything that’s happened, economic growth remains pretty steady. And if it’s, you know, even if it’s just one and a half percent, I guess two to two and a half percent would be optimal GDP growth. Then you’ve got a nice foundational framework for companies to operate and deliver good earnings growth. And everything that we’ve seen so far as various factors have come into play, that those earnings growth numbers are actually ticking up. And so

The other thing, and so in that light, if there’s positive economic growth, then that creates a favorable, I like to refer to it as a tailwind. We’ll talk about a couple of things. One is a secular growth tailwind, but this is more of a cyclical, right? This part of the economic cycle is providing the ability for companies to be operating in an environment where the overall growth trajectory is positive. So think about that for a second, right? If you’re running any sort of business, and the economy is shrinking, right? You’re trying to capture a bigger piece of a shrinking pie. That’s not the case currently. So that would probably be big picture what’s going on in Sparrow.

And there’s a number of factors there. Like, you you can even talk about, you touched upon the tax bill, big, beautiful tax bill. That removed a big overhang because it maintains the corporate tax rate. If that tax rate would have ratcheted back up to 30, 35 or 36%, that would have taken a considerable chunk out of S &P 500 earnings and markets certainly wouldn’t be trading at this level. So something not happening like that was favorable. But to what Chris said earlier, some of the tax laws changes that provide for accelerated depreciation on your CapEx and credits for research and development. What does that do to a company? Well, it frees up, it improves their cash flow. What do they do with that cash flow? Well, as a corporate executive, you’ve got a couple of decisions you can make, right? We refer to that as your capital allocation decision. You can reinvest some of those proceeds into your highest returning projects that you’re working on in your company, or you can repurchase your company’s stock.

Or you can pay a dividend, increase your dividend. So by repurchasing your stock, it’s financial engineering at the end of the day, but if you want to increase your earnings per share, well, there’s two ways to do that. Increase your earnings or decrease your number of shares. And so that’s sort of the trick there. We prefer to see, we would call organic growth, growth from a company that’s coming as result of making good business decisions, investing in new projects as such that generate high return on that invested capital. So those are two things.

Chris Perras:

You know, we mentioned the last time we I think Charles and I were up here was that we were talking about tariffs, right? The tariff bomb had just kind of hit. And that had created a lot of uncertainty for earnings and for spending. And a lot of that has subsided at the financial markets level. Right. And we’re talking about the financial markets. We’re not talking about individual individual situation, right? Individual small companies. We’re talking about the big markets, S &P 500.

and earnings and offshore markets and things like that. So very different markets and how they’re affected. But you think about it, the S &P 500 now is very concentrated, large cap tech, large cap consumer discretionary names like Amazon there, and then telco service, which isn’t generally your Verizon’s and AT &T anymore. It’s your Netflix and Google’s and Facebook’s.

And all those companies which have kind of been driving this bull market in the spending have now a tax windfall, I guess, behind them to go out and actually spend even more money on AI infrastructure over the next six months, 15 months, because from a tax perspective, they’re not going to get penalized, right? We all know as a shareholder, we’re not really certain if those hundreds of billions of dollars that are getting spent are going to have high margin return investing capital. But right now, the financial markets are saying their earnings are good, their cash flow is good, let them take the chances because that tailwind is behind them.

The outcomes later in 2026 when they’re trying to turn it into revenue, we don’t know. But for now, in the fourth quarter, in the first half of next year, it’s a tailwind for earnings just because they can go spend the money, right? And some of these dollar figures seem absurd upfront. But, you know, they have the money to spend. And from a shareholder, right now they’re being rewarded because, you know, the secular trends behind AI, people are hoping that it’s essentially the early internet and the products and services will be delivered over the next five and 10 years. So they’re kind of getting a free pass to spend the money now.

It’s probably more deterministic the second half of next year, whether the market actually rewards them if the revenue starts coming in versus just the expenses going out right now.

Charles Scavone:

A couple of other things that we haven’t touched upon, big picture stuff, what might go right. Inflation keeps sort of rearing its ugly head in ways that capture a lot of notoriety, but we generally said from the onset that inflation was declining. And it has been. It doesn’t always do it in a straight line, and it does make for notable headlines when it pops back up. And so,

The focus now becomes on tariffs and the impact of tariffs on inflation. And it’s difficult sometimes to conceptualize, but think about a couple of things, right? Inflation is something that happens primarily with goods, with products. And you think about the composition of the US economy, it’s mostly a service-based economy now. Do services prices go up? You bet, right? But the majority of the focus of pricing increases as a result of tariffs is on products. So that’s a fairly small part of the economy or a relatively smaller part of the economy.

Chris Perras:

And this actually gets back to the Fed is finally going to cut rates, right? They’re going to cut in September. It’s going be 25 or 50. I tell people I don’t know and I really don’t care because they paused for six or seven months historically after they cut and they pause and they’re not cutting rates because it’s a crisis. It’s beneficial. know, I think they’ve done it like five times in the last 100 years each time over the next year, the stock market was up on an average 16 % because they weren’t cutting a crisis. That’s the good news.

The bad news is the first one to three months after they cut, the market was kind of choppy because the stock market is the anticipatory, right? People are like, hey, the market’s at 6,500 and the Fed hasn’t done anything lately because the market is anticipating that I’m already doing it the structure of the interstate market. Housing stocks have been on fire the last two months. Small cap stocks have been, they were the best performing asset class in August. I think they’re up 7%. While the S &P 500 was up maybe 1.5%. So the financial market’s forward looking earnings and revenue growth. you know, when they cut more than likely in September, regardless of what they say, you know, I can’t imagine it’s the good times, you know, straight up from there but it has historically been beneficial for stocks over the next 12 months.

Other topics that I guess positive, lower regulation, historically, we talk about friction. Under the last administration, there was a lot of friction for the financial markets, increased regulatory friction, which from a shareholder’s perspective causes more expenses in most companies and more expenses means generally lower margins, less cash flow for shareholders, right? And we’re assuming management teams make the right decisions with that cash, but you’d rather allow them to make those decisions than have it stripped away before they even get a chance to. So less regulations in banking right now. Yep. And energy.

Charles Scavone:

Well, across the board, yeah, simple enough. So we’ve hit regulation, economic growth, consumer spending remains positive.

Chris Perras:

I mean, what could go wrong? The thing that comes out to me is more than anything else is all this consumption that we’ve been hearing on conference calls, know, demand has been pretty strong in certain areas. All this consumption is being pulled forward, right? It’s, it’s the domain was going to be there for the fourth quarter, but maybe it’s happening in the third quarter and second quarter because consumers for 25, 30, 45 years old are going out there and buying stuff for their households that they finally are forming after delaying things for years, they went out and they bought the book bags and everything else in front of tariffs.

So, you know, is Christmas going to be, you know, higher than lower than people expect? And we are a consumer led economy, right? So, you know, is all that spending just being pulled forward and there’s going to be a whole come, you know, the fourth quarter and you can theorize it all you want, but no one knows, right? I mean, no one knows how Christmas spending is going to be until generally January. We do have better tools than we used to in watching spending day by day, week by week, given the technology that’s out there. Probably better than the government uses for sure collecting data on jobs. But at the end of the day, we don’t know if it’s demand pull forward and if things are going to drop off a cliff in the fourth quarter. It doesn’t feel that way particularly given the Fed is likely going to start cutting rates. And if you believe the administration, they’re going to start talking less about tariffs.

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