There’s still two months to go in the year, and this is already one of the strangest markets we have seen in a long time. In years when there are presidential elections, and particularly close elections, the market is usually more volatile earlier in the year, and returns are typically slightly lower than in non-election years. Not this year. While volatility has picked up recently, returns on the S & P 500 are far above normal, and it likely has little to do with the economic policies of either candidate. .SPX YTD mountain S & P 500, YTD It’s because the economy and earnings remain resilient. Tech earnings in particular are strong and not decreasing. That is the main reason the S & P 500 is less than 2% from its historic high. The election is the big wildcard It’s not clear how soon the winner will be announced in the election, and the market is reflecting some of that uncertainty. The market tends to experience higher levels of volatility going into an election, but after the election volatility drops and the market typically rallies into the end of the year. Close elections tend to have even higher levels of volatility, and that is certainly the case with this election. The Cboe Volatility Index (VIX) , at 22, has remained elevated since the end of the summer, largely on concerns about the election. .VIX YTD mountain CBOE Volatility Index, YTD The VIX curve (the relationship between the shorter-term and long-term prices of VIX futures contracts) is in backwardation: that is, prices for the cash contract and the front-month (November) contract are higher than contracts further out, implying uncertainty not just over who will win, but how long it might take to announce a winner. “The VIX spot and VIX futures markets are telling us that equities are bracing for a somewhat extended period of volatility,” Fundstrat’s Tom Lee said in a recent note to clients. Long-term, it’s the economy that matters The economy has been strong, with GDP growth near 3% . That and earnings are the biggest factor in this year’s market returns. The overall market returns for this year are highly unusual: 1) the return YTD of 20% on the S & P 500 is well above the average yearly return of roughly 9% (not including dividends) and 2) return in election years, particularly when the race is close, tend to be lower because election uncertainty weighs on the market. Nasdaq Chief Economist Phil Mackintosh noted in a recent blog post that while returns for the S & P 500 typically average 9% in non-election years, the returns are typically 3% in election years, much of that done after the election is held. Obviously, the returns are far above what would historically be expected. How to account for this? “Perhaps what this shows is that, regardless of what happens in an election year, macroeconomics matters,” Mackintosh concluded. Mackintosh noted that one key issue in returns is whether there was a recession. He noted the average total return for four-year terms that overlapped with a recession was 30% for the S & P 500, compared to 62% for those that didn’t. This was true, regardless of whether there was a Democrat or Republican in the White House. “So, much more than who’s in the White House, it’s the economy that matters to markets,” Mackintosh concluded. Earnings have been strong Two-thirds of the way through earnings season, and the aggregate numbers are strong. The third quarter is exhibiting a typical pattern: overall earnings come down a couple percentage points going into the quarter (this happens because analysts are always overly bullish and adjust expectations downward as they have better visibility), than estimates rise as companies begin to report and beat estimates. Third quarter earnings for the S & P 500 are up 8.4%, well above the 6.0% estimated at the start of October. 77.1% of the companies have beat analyst expectations (above the long-term historic average of 67%) and most importantly, companies are beating estimates by a wider margin than usual: 7.8% above expectations versus a long-term (since 1994) average of 4.2% above estimates. Much of this is being driven by technology. The sector is expected to grow 19.1% in the third quarter and estimates have been rising. It’s fourth quarter earnings that matter Remember, the most important thing to watch is the trend and whether it is accelerating or decelerating. Are earnings growing or are they shrinking; if they are growing, is the pace of growth accelerating or decelerating? For the fourth quarter, analysts are not cutting estimates any more than the historic average. John Butters, an earnings analyst at FactSet, noted that overall earnings for the fourth quarter dropped 1.8% in the month of October, which is exactly in-line with the 10-year historic trend of a drop of 1.8%. In the case of the technology sector, estimates for the fourth quarter have declined a modest 0.9% since the fourth quarter started October 1, not statistically significant. Most importantly, technology earnings have been growing in the mid-single digits for over a year for every quarter, and are estimated to keep up that pace well into next year. This is what is powering the S & P 500 and the Nasdaq higher. S & P 500 Technology earnings: double digit gains every quarter (rounded) Q1 up 27% Q2 up 21% Q3 up 19% (est.) Q4 up 15% (est.) Q1 ’25 up 18% (est.) Q2 up 21% (est.) Q3 up 19% (est.) Source: LSEG There has been some disappointment with a small handful of tech stocks, but much of it has been tied to CEOs offering conservative guidance. However, Scott Chronert at Citigroup noted this was not unusual: “There has been some conservatism in guides, which, to us, should be expected given an upcoming election and stocks near/at all-time highs,” he told clients in a recent report. Not surprisingly, there are some pockets of weakness. With oil prices dropping analysts have been lowering estimates for energy companies rather aggressively: earnings have been cut 8.5% since October 1st. The biggest problem for stocks The economic data may be reasonably strong, and inflation may be trending down, but rising bond yields indicate to many that high debt levels are going to be an issue no matter who wins. “You don’t want the bond vigilantes to control the market,” Alec Young at MapSignals.com told me. “Much of the rally is based on reasonably low rates, if that gets out of control, it’s going to be a problem.” The other major issue: The market is expensive on an historic basis, trading at 22 times forward earnings estimates, well above historic norms of roughly 17-18 times. The combination of higher rates and high valuations has made it tough for the market to continue to advance. “There has been a change in tone,” Young told me. “We’re not going up anymore. The market was at this level in mid-September. It’s a choppy, consolidating, sideways market, before it was making new highs on a weekly basis.” That is certainly understandable. This is a two-year old bull market. The S & P 500 is up 50% in those two years. That is quite a run, far above historic norms. The Street is certainly expecting a post-election rally no matter who wins, but maybe the safer course is just to be happy with the gains so far.