The stock market has been full of cross-currents following a 4% slide by the S&P 500 index from its July 16 record peak.
A slowdown in the economy, particularly job growth, has convinced many experts that the Federal Reserve will begin cutting interest rates at its Sept. 17-18 meeting. Fed officials have almost said as much.
But how much the economy is weakening is open to question. Nonfarm payrolls grew 142,000 in August, well below the average monthly gain of 202,000 over the prior year. But the increase surpassed the 89,000 gain for July.
Experts are split on whether the Fed will cut interest rates by 0.25 or 0.5 percentage points at its meeting next week. According to CME FedWatch, interest-rate futures point to a 71% chance of a quarter-point move and a 29% chance of a half-point move.
Just as important is the question of whether a rate reduction is good or bad for stocks.
If the Fed move is seen as a stimulus for the economy, that should be good for stocks. But if a rate cut is seen as a move to right a rapidly weakening economy, that could be bad for stocks. That view could be prevalent, especially if the central bank slashes rates by half a point.
Corporate earnings and stock valuation trends
Corporate earnings also are a double-edged sword for stocks now. Earnings per share for the S&P 500 surged 11.3% in Q2 from a year earlier, the highest since fourth-quarter 2021, according to FactSet.
Analysts project earnings growth of 4.9% for the third quarter, which isn’t bad given the strong second quarter. But some experts say the decelerating economy will prevent that strong a showing.
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And in any case many experts say that the market is overvalued. As of Sept. 6 the S&P 500 traded at 20.6 times analysts’ earnings estimates for the next 12 months, according to FactSet. That tops the five-year average of 19.4 and the 10-year average of 18.
Then there’s the September effect on stocks. It’s usually not a happy month for investors. The S&P 500 has lost 1.2% on average in September since 1928, according to Dow Jones Market Data.
That’s the weakest monthly performance on the calendar. The index slid in 56% of past Septembers.
Ned Davis Research issues stocks' forecast
But the outlook could change soon, according to Tim Hayes, chief global investment strategist for Ned Davis Research, an esteemed investment research firm.
The market has turned very defensive, as indicated by metrics such as the market’s risk appetite, he wrote in a commentary.
“Looking at how defensive the market has gotten, you would think that either a recession was developing or that inflation had returned with a vengeance, sending rates into an upward spiral,” he wrote.
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But that’s not the scenario, Hayes said. “The recession probability remains low, inflation is well under control, and interest rates are trending lower,” he said.
“The earnings outlook remains favorable, which wouldn’t be the case if macro conditions were deteriorating.”
So, what accounts for the defensiveness? “It could be post-summer blues with the arrival of September, historically the worst month of the year,” Hayes said.
Stock market rebound may be coming
“If so, and with the macro environment remaining constructive despite the recent jobs data, then the market will be poised to recover once the worsening sentiment has produced excessive pessimism, and September has run its course.”
While September is more often than not a lousy month for stocks, the fourth quarter is the best three-month period of the year, he said. “Of course, we wouldn’t consider a recovery to be intact without decisive trend and breadth improvement.”
In September, utilities and consumer staples were the only sectors of the S&P 500 that appreciated.
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Another market pro expecting a rebound is Mark Hackett, chief of investment research for Nationwide Mutual Insurance.
“We anticipate continued volatility through November as investors await greater clarity on Fed policy, macroeconomic trends, and, of course, the upcoming election,” he said.
“However, our outlook for the end of the year remains positive. We expect a strong fourth quarter, driven by seasonal tailwinds, diminished election uncertainty, and Fed [rate cuts].”
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