Stock market: 3,500 ‘a battleground’ for the S&P 500, strategist says

RBC Capital Markets Head of U.S. Equity Strategy Lori Calvasina joins Yahoo Finance Live to discuss stock futures, fourth-quarter earnings expectations, the probability of a recession, the expectations for midterm elections, and investor sentiment.

Video Transcript

- Welcome back, everyone. The S&P 500 has had its best back to back days since April 2020 and the best two-day start to the fourth quarter going back to the first full year of the five day trading week in 1953. For more on what this means, though, for the markets going forward, let's bring in RBC Capital Markets head of US equity strategy Lori Calvasina. Lori, great to speak with you this morning.

Of course, in the futures at least right now, we are discovering that it can indeed go the other way still. And so with that in mind, how are we really set up for the fourth quarter? Is this just-- the two days at least that we had seen to begin October and the fourth quarter, is that just a bear market bounce? Or is there something more that you're seeing in the tape?

LORI CALVASINA: Well, I think both of those things could be true. We actually went back and looked at how markets traded in 2002-2003 and 2010-2011 and how that compared with the environment we're in today. The reason we picked those periods is because we had come out of major crises, had an initial bounce, and then we basically settled into these kind of year, year and a half type trading ranges where bottoms were formed. It took quite some time to get that done. It was painful. It was bumpy. It lasted a long time.

And I feel like as I peer into the early part of 2023, that's really what we're set up for. So we've come down. We're seeing a big battle back at the June lows. We dipped a little bit below them. But I think markets, you know, I've heard a lot of people try to defend that 3,500 level. I wouldn't say people are crazy bullish out there. That's certainly not a stretch.

But I think there has been this talk of a potential pivot. Maybe earnings have been worked down in the minds of the buy side at least, even if numbers still need to come down. So I think people are trying to come up with reasons why the market could bounce here at the end of the year. And I do think if you look back at that '02-'03 and 2010-2011 history, you can find a justification for it.

- Lori, do you still think we will see a lengthy bottoming process? And how long do you think that will play out?

LORI CALVASINA: So it's interesting because that '02 example, the stock market has been trading with a 72% correlation this year with that 2002 period. And when I think about 4Q and 1Q, what happened back then really does seem like a reasonable template for going forward. And what I mean by that is you think about the earnings backdrop.

We're going into this reporting season where based on a lot of these preannouncements we're starting to see it does feel like the earnings mandate is going to be ripped off at least to some extent. But I think that that's not really possible to do entirely until we get into February and March of next year. And that's going to be year ahead outlook season. That's when the full year numbers for '22 are going to be reported. And companies are really going to be forced to talk about 2023.

And so I think you're not really going to be out of the woods from an earnings perspective until you get through that 4Q reporting season. And we'll sort of see what happens here in the next few weeks. I feel like kind of short-term predictions on earnings reporting season never quite pan out for anybody. But I do think that earnings Band-Aid, we're just really not going to have that visibility on 2023 for a few more months.

- Given the calls that we're seeing around and describing what another recession could look like from everyone from the economists to CEOs right now, and some of them saying that it should be short and not painful. At the same time, there is the question of how it would actually compare in the stock market reaction to previous recessions as well. What do you believe that might look like?

LORI CALVASINA: So I am in the short, shallow recession camp. And I know that feels awfully consensus. And there's always risk to consensus arguments. But I do think that both corporations and households are in a very strong position heading into this relative to past recessionary periods. So I the starting point matters. And the starting point is very good relative to where we've been in the past.

Now, when you think about stock market reactions, I think that's why 3,500 is such a battleground because if you look at the history of recessionary drawdowns in the stock market back to the 1930s, the median drop has been about 27% peak to trough. And that takes you to 3501 on the S&P. If you look at an average recession drawdown, it's a little bit worse. It's about 32%, which takes you down to 3,200 on the S&P. As I talked to some of my friends in the technical analysis community who just read the charts, they tell me 3,500 and 3,200 are also important levels to watch. So that history does seem to be rhyming or kind of syncing up with some of those technicals.

I have a very hard time believing this would be worse than what we saw in the pandemic when there was just enormous uncertainty, enormous fear. And that was a 34% drawdown. So it could be a little bit below that 3,200 mark. But I think it was interesting that when confronted with that great calamity that was building on the health side, markets basically priced in a typical recession. So it's very hard for me to think we're going to do much worse than that this time.

- Lori, do you think this is a market that would cheer a Republican just a take over in the midterm elections?

LORI CALVASINA: Markets historically-- if you look at the combination of a Democratic president and either a Republican-led or split leadership Congress, that has been one of the best environments for stocks over time. And again, we're looking at very long stretches of history on that. We also know that investors intuitively like gridlock. And a lot of investors have worried that the Democratic agenda-- and I'm not trying to cast any sort of view on this personally.

But what I hear from investors is that they worry that some of the Democratic initiatives that have been on the table in the past that haven't gone through would end up adding to the inflation problem. So I do think that markets would benefit from a sentiment perspective from the Republicans doing well this fall. And I think what's really interesting about that is back in June and July, even when sentiment was pretty dour in the equity markets, a lot of investors were telling me the Republicans are going to do well. That's a potentially positive catalyst for markets. Markets typically do well in the fourth quarter of a midterm year.

And then we started to see the polling data. And the betting market data start to shift against the Republicans and back in favor of the Democrats. And I think that took some of the wind out of the sails of the market, contributed to the down move we saw. But now if you look at the Real Clear Politics data, it's starting to suggest that Republicans are doing a little bit better in the generic ballot. And I have to wonder if markets are starting to sniff that out when you look at the price action of the last few days.

- Lori, I have to give you and your team a shot out. A lot of these charts that we showed throughout the segment came from your extensive research. Big fan, always, of your charts. So please do keep them coming. RBC Capital Markets head of US equity strategy Lori Calvasina. We'll talk to you soon.

LORI CALVASINA: Thanks.