Seasonal: Bearish. October is the worst month in election years ranking last for the DOW, S&P 500, and NASDAQ. It is the second worst month for Russell 2000.
Fundamental: Softish Landing. The third estimate of Q2 GDP was in line with expectations at 3% and the Atlanta Fed’s GDPNow model is forecasting 2.9% in Q3 as of its September 18, update. Inflation metrics continue to trend lower but are still above the Fed’s stated 2% objective. The Fed has cut interest rates and employment data, though softer, is holding up. Q3 corporate earnings were broadly better than expected however, Q4 estimates have been retreating. Provided data does not weaken significantly, it appears the economy is headed for a soft landing.
Technical: Divergent. The DOW and S&P 500 have broken out to new all-time highs, NASDAQ has not. Small-cap stocks, measured by Russell 2000, are also struggling. Weekly breadth data suggests a rising tide, but it has not lifted all yet. Rate cuts were widely expected to aid small caps, yet there has been little sustained progress by Russell 2000. With NASDAQ approaching resistance at its previous all-time highs, it could take a period of consolidation before it can finally breakout.
Monetary: 4.75 – 5.00%. The Fed finally cut, and they went bigger than I had expected by trimming 0.50% off of its target rate. Interest rates are now in a new easing cycle. Historically this has been bullish for markets, but there are limits. Large reductions (more than 2% in a year) have generally been accompanied by rapidly deteriorating economic and financial conditions that resulted in considerable market losses.
Sentiment: Mixed. According to Investor’s Intelligence Advisors Sentiment survey Bullish advisors stand at 52.5%. Correction advisors were at 24.6% while Bearish advisors numbered 22.9% as of their September 25 release. While the number of bulls has increased so has the number of bears. This has narrowed the spread between the two to a point that has historically been associated with less risk. This does not square with recent market volatility. Until sentiment readings approach or reach an extreme, other indicators may provide better insight.
All the recent market action is bullish. Economic readings and corporate results continue to point to a soft landing. There are still weak spots and areas of concern, but for the most part the Fed’s 50 basis point cut, which was more than I expected, is likely a tailwind for stocks. It’s hard to fathom that lowering rates in the face of solid economic growth and a raging bull market is a negative for stocks. However, should the Fed continue to cut aggressively at the next two meetings that would be a concern. Years in which the Fed cuts rates by more than 2% have on average been a disaster. There is also plenty of uncertainty surrounding this election. Investors may be reluctant to commit capital until after Election Day. To the market it matters less who wins, it just wants to get past the election with a clear decision. I am also hearing talk of what happens when one party controls both chambers of Congress and the presidency. Historically a Republican Congress and Democratic President has been best for the market.
The evidence continues to mount that this bull market has legs. So, while October is notorious for declines and crashes and is historically weaker in election years, it doesn’t appear that the economy or the market are in any imminent danger now. I do not expect any sizable pullback between now and yearend. There will likely be some of the usual October volatility that results in a pullback. Perhaps somewhere between 3-7%. Unless something changes on the world stage and things escalate dramatically in the Mideast, Ukraine, Pacific rim or some new hotspot bubbles up or there is some unexpected systemic failure, the most likely scenario is for a mild pause in October, before the bull market takes off again to new highs after the election.
*Source: The Stock Trader’s Almanac