Investment Indicator Has Entered the 'Post Midnight' Zone

Jurrien Timmer, Director of Global Macro at Fidelity, stated that the Investment Clock has moved into the 'post-midnight' zone: mild tightening of financial conditions is beginning to restrain profit growth. The last two cycles with this pattern were in 2022 and 2018.

The indicator compares financial conditions with profit growth and currently shows only slight tightening. However, LSEG data indicates that analysts expect S&P 500 earnings growth in the third quarter to be at 30.6%.

"It seems the Investment Clock has indeed moved into the 'post-midnight' zone: mild tightening of financial conditions is now beginning to restrain the price momentum driven by profits," Timmer wrote on X, publishing data on October 11.

On the horizontal axis of the financial conditions graph, conditions are assessed relative to their 52-week history: positive values indicate tighter than usual conditions. The black line, tracking the market since October 2022, now ends slightly to the right of zero. The yield on 10-year Treasury notes reached 5.34% on October 1, the highest since early 2002. In September, the Fed raised rates for the first time since 2023, and CME FedWatch on October 8 estimated the probability of an October hike at about 18%. Goldman Sachs expects the next hike in December.

In 2022, profits continued to grow while valuations declined: forecasted profits increased by 6.2%, and the multiplier fell by 30%, according to Yardeni Research. The S&P 500 lost 25.4% from January 3 to October 12, with the decline driven by multiplier compression. In 2018, the index fell by 19.3% from its peak on September 20 to its low on December 24. Timmer noted that profit growth of around 30% might provide a more substantial buffer this time.

The test will come with the Fed's decision on October 28 and the earnings season. On October 6, the S&P 500 closed at a record above 7,800, Reuters reported.