Wall Street's Rally Tested by Volatility & Inflation Data

Good morning investors,

Wall Street enters one of the most important weeks of the quarter with volatility firmly back on the radar. Last week's turbulence, driven by regional banking concerns and trade tensions, reminded everyone that risk never stays quiet for long. Now the focus shifts squarely to earnings and inflation data that will test whether the rally's narrow foundation can hold. The market's ability to brush off concerns depends entirely on corporate America delivering strong results across sectors, not just at the top.

Futures point modestly higher with Dow futures ($DIA ( ▲ 0.12% )) up 90 points, S&P 500 ($SPY ( ▲ 0.07% )) futures gaining 0.3%, and Nasdaq ($QQQ ( ▲ 0.21% )) futures advancing 0.3%. The Wall Street Journal reports President Trump has exempted dozens of products from reciprocal tariffs with hundreds more under consideration, acknowledging the reality that many goods simply aren't produced domestically. Treasury Secretary Scott Bessent suggested things have "de-escalated" with China ahead of potential meetings this week, calming fears that November 1st's threatened 100% tariff escalation might actually materialize.

The VIX retreated to 20 after spiking above 28 Friday, demonstrating how quickly sentiment shifts on trade headlines. Despite last week's daily volatility, major indices managed to close higher, with resilient earnings providing fundamental support even as credit concerns and geopolitical tensions created surface turbulence.

This week brings the broadest earnings test yet, spanning every corner of the economy. Netflix reports Tuesday, followed by Tesla Wednesday, joined by Coca-Cola, Procter & Gamble, IBM, Intel, and Honeywell throughout the week. Each report carries weight beyond individual companies, serving as bellwethers for consumer strength, manufacturing resilience, technology spending, and infrastructure investment.

Friday's long-delayed CPI report takes on outsized importance given the data blackout from the government shutdown. If inflation remains sticky above 3%, the Fed's ability to deliver expected rate cuts comes into question, something markets remain reluctant to price. The combination of earnings reality checks and inflation data creates potential for significant volatility as assumptions meet facts.

China's economy grew 4.8% in the third quarter, the slowest pace in a year, with fixed-asset investment unexpectedly contracting 0.5% through September. Property investment extended declines, sliding 13.9% year-to-date. Pinpoint Asset Management's chief economist called the fixed-asset contraction "rare and alarming," warning fourth-quarter GDP faces downward pressure. The last time China recorded such contraction was during 2020's pandemic lockdowns, highlighting the severity of current economic challenges.

This weakness paradoxically strengthens the case for trade de-escalation, as both economies need cooperation more than confrontation. The administration's growing willingness to exempt products from tariffs suggests pragmatism might prevail over rhetoric.

Amazon Web Services ($AMZN ( ▼ 0.41% )) experienced a major operational issue overnight, temporarily taking down over 70 services and affecting companies from Disney to United Airlines, Robinhood to government websites. While AWS restored full functionality within hours, the incident serves as another reminder of concentrated infrastructure risk in cloud computing. Unlike July's CrowdStrike debacle that revealed software update vulnerabilities, this appears to be a technical fault rather than cyber attack, yet the cascading impact remains equally concerning. For investors, this reinforces the importance of companies maintaining multi-cloud strategies and redundancy systems, while highlighting the extraordinary pricing power AWS, Microsoft Azure, and Google Cloud possess given how dependent global commerce has become on their infrastructure.

Small-cap stocks continue outperforming, officially breaking above a four-year downtrend that began in 2021. The Russell 2000 ($IWM ( ▲ 1.32% )) hit new highs before a slight pull back on regional bank weakness, demonstrating broadening market participation beyond mega-cap technology. This rotation represents an intermediate-term bullish signal, particularly as active fund managers trail benchmarks badly with only 22% outperforming through Q3. Underperforming managers facing year-end pressure may deploy sidelined cash, supporting continued small-cap strength.

The AAII sentiment survey flipping back to net bearish provides contrarian support, indicating investors aren't excessively optimistic despite recent gains. Historical VIX patterns suggest rising volatility often marks near-term market bottoms rather than tops, particularly when driven by resolvable concerns like trade negotiations.

I'll be watching for pullbacks in major banks that just reported exceptional earnings as regional banking concerns create indiscriminate selling. If stocks like JPMorgan, Bank of America, and Morgan Stanley get dragged down despite their 40%+ investment banking growth, that represents compelling entry opportunities. Big banks possess structural advantages that will only widen as AI transforms operations, enabling them to operate with far fewer employees while increasing revenue per worker. This shift moves them closer to technology company economics with higher margins and returns on equity, making current valuations increasingly attractive for patient investors.

This week determines whether October volatility represents healthy consolidation or something more concerning. Netflix and Tesla earnings will reveal consumer and innovation spending reality, while Friday's CPI data tests the rate cut narrative markets desperately want to maintain. The rally rests on narrow foundations - strong profits at the economy's top end, expected rate relief, AI investment cycles, and deregulation tailwinds. If any of these supports falter, we'll quickly discover how steady investor confidence really is.

Regional banking stress created buying opportunities last week for those maintaining perspective. Big bank earnings remain exceptionally strong, small caps are breaking out of multi-year ranges, and sentiment indicators suggest healthy skepticism rather than euphoria. I continue expecting volatility through October, but earnings growth, another rate cut this month supporting small businesses, and pragmatic trade policy adjustments should drive markets higher into year-end once current uncertainties resolve.

Volatility has returned, but that's not necessarily bad news. It means markets are finally pricing reality again rather than momentum, creating opportunities for active management to outperform passive indexing.

As always, feel free to reach out with questions about positioning for these evolving market dynamics.

Best regards,

Dan Sheehan

[email protected]

This newsletter is for informational purposes only and should not be considered as investment advice. Please consult with your financial advisor about your specific situation.