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It’s been a rough year for markets and investors are looking for a little breather as we move into the fourth quarter – historically a good one for stocks, particularly in election years. Unfortunately, this year may buck the trend.
The outlook is what analysts at Goldman Sachs put it “bleak” and more volatility is expected. With so much uncertainty surrounding inflation, central bank policy and corporate earnings, investors could be in for a tumultuous end to a tumultuous year.
What’s happening: Investors waded through a very poor third quarter – grappling with persistent inflation and aggressive rate hikes by western central banks, repeated lockdowns in China and an energy crisis in Europe.
The S&P 500 fell 1.5% on Friday and is down almost 24% so far this year. All three major indices are in bear markets — or at least 20% below recent highs — and economists are warning the stage is set for a global recession.
Here’s what to look out for in Q4.
Central Bank Issues: Some investors are hoping that policymakers will become more dovish this quarter and steer clear of aggressive rate hikes. but Inflation continues.
The US Federal Reserve’s preferred benchmark for consumer inflation, the Personal Consumption Expenditure Index, rose month-on-month in August. This increases the pressure on the central bank to continue its aggressive course tightening of the policy.
Investors are still underestimating the central bank’s determination to hike rates, Lisa Shalett, Morgan Stanley’s chief investment officer of wealth management, wrote in a note. This means that when interest rates rise, markets are more prone to precipitous falls.
The higher interest rates go and the longer central banks keep them there, the less chance there is of avoiding a recession. That the pain is already beginning. Soaring mortgage rates of nearly 7% have helped depress existing home sales for seven straight months.
The Fed meets again in early November, and as of Friday it was investors’ turn The probability of another three-quarters-point hike is close to 60%, according to the CME FedWatch tool.
Income weakness: Third quarter corporate earnings are about to start and the outlook is bleak.
According to FactSet, companies are in the S&P 500 are likely to report the lowest annual earnings growth since 2020.
Analysts signal pessimism. They lowered their earnings growth forecast to 3.2% from 9.8% since June.
“Weakening earnings will challenge markets,” wrote analysts at BNY Mellon. The S&P 500 price-to-earnings ratio, the ratio of a company’s stock price to earnings per share, is still close to all-time highs. That means if earnings weaken, selloffs and market falls are likely.
The impact of central bank policy on the economy and corporate earnings usually comes with long lags, said Morgan Stanley’s Lisa Shalett. So even if corporate earnings beat estimates, there could be pain ahead.
“This means investors could get a false sense of security no matter what earnings potential they see in stocks today,” she said.
The light side: Barclays analysts say there will be some pain, but it won’t be unbearable. “Our analysts are still bearish on most risk assets, but feel much of the adjustment has already taken place,” they wrote. “We see more gloom than doom.”
History is ultimately on the investors’ side. Since 1928, the S&P 500 is up 73% in the fourth quarter, with an average gain of 7%, according to S&P Global Indices’ Howard Silverblatt.
The Federal Reserve announced last week that six of the largest U.S. banks — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo — will participate in a pilot program over the next year that will assess their ability to range of climatic conditions to withstand change-related scenarios.
Climate activists have said the project is long overdue (Fed Chair Jerome Powell has been asked about it several times over the past year) and that other central banks are way ahead of the Fed in assessing climate risks. The Bank of England conducted a similar exercise in 2021.
They also said the proposal lacked real teeth. In its announcement, the Federal Reserve emphasized that the exercise “is exploratory in nature and has no capital implications.” She also said that she would not publish the results of individual banks.
San Francisco Federal Reserve Chair Mary Daly told me Thursday that this is a learning and exploratory exercise for the Federal Reserve. It would be “incredibly premature to conclude that new policies or programs would emerge from this,” she said.
The other side: Still, critics argued that the Federal Reserve was overstepping its bounds and that it could soon start enforcing fines.
“The Fed’s new ‘pilot program’ is the first step in pressuring banks to limit lending to and investment in traditional energy companies and other disadvantaged carbon-emitting sectors,” wrote Republican Senator Pat Toomey, senior member of the Senate Banking Committee. “The real purpose of this program is to ultimately create new regulatory requirements.”
The Institute of Supply Management (ISM) releases its US Manufacturing Purchasing Managers Index (PMI) report for September at 10 a.m. ET.
Tomorrow: US Job Vacancy and Labor Turnover (JOLTS).