Bank of America (BofA) suggests that the third quarter could be an excellent environment for stock pickers, with S&P 500 component companies' performance expected to significantly contribute to the index's returns. The bank's equity and quantitative strategists noted that options market pricing reflects the highest implied volatility for single stocks post-earnings announcements since 2021.
As of September, corporate earnings have accounted for 45% of the S&P 500's 12-month return. In contrast, earnings multiples have lagged behind return rates in the "macro-driven market" of 2022 to 2023. BofA's equity strategist, Ohsung Kwon, highlighted in a recent report that the current earnings season might be ideal for stock selection. Last month's substantial Federal Reserve rate cut by 50 basis points to a range of 4.75%-5% signals an easing cycle, which is anticipated to increase the proportion of company earnings in future returns.
This week marks the beginning of the third-quarter earnings season for S&P 500 companies. Key players like Domino's Pizza (DPZ, Financial), JPMorgan Chase (JPM), Wells Fargo (WFC), and BlackRock (BLK) are expected to release their results. BofA noted that third-quarter profit option prices might be more expensive than recently observed levels, with an upward trend indicated by rising single-stock average prices.
The realized earnings volatility has recently been higher than the implied volatility, with an average so far of 1.2. Kwon pointed out that the underestimation of risk in the previous quarter might explain the rise in this quarter's implied volatility. If actual earnings performance again leads to greater-than-expected market volatility, purchased straddle options could end up in-the-money by expiration.
