What the US Credit Downgrade Means to the S&P 500 & Nasdaq

Digesting the Fitch downgrade, earnings results, and inflation concerns

• Fitch's rare downgrade of U.S. government securities to AA+ raises concerns about political fighting and growing debt.
• Earnings season surprises: Contrary to early pessimistic forecasts, many S&P 500 companies are beating expectations, indicating positive upside surprises.
• Meme stock resurgence: Tupperware and AMC are demonstrating the continued interest and engagement generated by meme stocks.

As the stock market continues its impressive performance, investors find themselves both captivated and cautious amid the volatility. The famous line from Russell Crowe's character, Maximus Meridius, in the movie Gladiator, "Are you not entertained?" seems oddly fitting as market participants experience a mix of excitement and apprehension.

This blog post explores the recent events and trends in the stock market, including the S&P 500 and Nasdaq Composite's outstanding gains, a rare downgrade in government securities, earnings season expectations, meme stock resurgence and other market indicators to watch.

S&P 500 and Nasdaq Composite's impressive performance

In July, the S&P 500 added 3%, marking its fifth consecutive month of gains, resulting in a substantial 19% increase year-to-date. However, the real star of the show has been the Nasdaq Composite, delivering an astonishing 36% return so far this year.

These exceptional gains have kept investors on the edge of their seats, seeking opportunities amid the market's upward momentum.

Rare downgrade in government securities

A significant event that caught investors' attention was the rare downgrade of U.S. government securities by a ratings agency. Fitch downgraded the U.S. to AA+ from its prestigious AAA rating; the first downgrade since 2011.

This downgrade was attributed to concern over political disputes related to budgeting, which could increase the risk of a potential default. Additionally, the escalating level of debt as a percentage of GDP poses a growing concern, especially with many experts predicting a recession later in the year. While bonds have remained relatively stable following the downgrade, investors are keeping a close watch on how this development may impact market sentiment in the coming days.

Earnings season expectations and surprises

The 2023 earnings season has been an unpredictable ride, with initial forecasts of a slow start and strong finish. Investors built expectations on the assumption that interest rates would decline in the second half of the year and that corporate profits would grow by 5% in the third quarter and 10% in the fourth.

However, stronger-than-expected economic data shifted the interest rate outlook, resulting in a significant plunge in corporate profit forecasts. Second-quarter earnings were projected to drop by approximately 8%, and previously optimistic late-year profit forecasts were revised down to nearly flat for the third quarter and 7.5% growth in the fourth quarter.

Despite the earlier pessimism, the year has seen positive upside surprises in earnings. To date, 58% of the S&P 500 companies have reported earnings, with an impressive 83% beating expectations. This turnaround has led to revised third-quarter year-over-year losses of just over 7%, according to FactSet, a financial data and software company. The earnings season's resiliency has instilled confidence in investors, demonstrating that the market has the potential to outperform even the gloomiest forecasts.

Meme stock resurgence and stock market engagement

The phenomenon of meme stocks has returned, capturing the attention of market participants once again. Stocks like Tupperware and an original OG meme stock, AMC, are experiencing renewed interest and trading activity. Despite criticisms surrounding meme stock trading, it is essential to acknowledge its role in generating stock market interest and engagement. Many investors allocate a portion of their portfolio to speculative opportunities, and meme stocks provide them with a platform to explore new possibilities.

Market indicators to watch

As the market continues its action-packed performance, certain indicators deserve close monitoring. Oil prices have been gradually increasing, with premarket activity indicating a rise of over 0.5%. Given its potential to impact inflation, oil's trajectory may influence market sentiment and investment decisions. Additionally, the CBOE Volatility Index (VIX), after reaching a low of 12.74, surged nearly 8% in premarket trading, standing at just over 15. The increase in VIX could be a response to the Fitch downgrade and anticipation of earnings reports from tech giants Amazon and Apple. The market eagerly awaits their forward-looking statements, as they hold the potential to significantly sway overall earnings expectations for the third and fourth quarters.

Conclusion

The stock market's performance this year has been nothing short of thrilling, keeping investors entertained with its twists and turns. From the impressive gains in the S&P 500 and Nasdaq Composite to the rare government securities downgrade, earnings season surprises, meme stock resurgence, and fluctuating market indicators, there is no shortage of excitement. As investors continue navigating this roller coaster ride, staying informed and adhering to their long-term objectives will be key to successfully maneuvering through the market's ups and downs.

Tastytrade, Inc. commentary is for educational purposes only. This content is not, nor is intended to be, trading or investment advice or a recommendation that any investment product or strategy is suitable for any person.

JJ Kinahan is CEO of IG North America—which includes tastylive, tastytrade and IG's FX Business. Kinahan traded for 21 years at the Chicago Board Options Exchange. He serves on the CBOE Advisory Board and the SIFMA Options Committee. @thejjkinahan

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