In the last Quarterly Market Overview we discussed the narrow market range and said, “We believe the market will soon break above current resistance. We should see new highs in time and, the momentum established as we finally break above this significant resistance area could propel the market for a while.” By mid-July the S&P500 did break out and make a new high and later established the current all-time high at about S&P500 2194 on August 15th. It is interesting that the market entered another narrow range and we saw one of the least volatile Augusts on record.
September and October are historically two of the worst market months. True to history, September started off weak and we had a big sell off early in the month but, it recovered by month’s end. Over all, the third quarter ended with the S&P500 up north of 3% and up about 6.1% YTD.
As we enter October and the beginning of the fourth quarter, uncertainties are back in focus. Recent weakness in oil, higher ten year Treasury bond yields, the rise of the U.S. dollar, the November election and, the likelihood of a Fed rate hike in December have all played a role in increased volatility. It would not be unusual, based on the level of uncertainty in front of us, to see some profit taking and a minor market correction short term.
We remain bullish intermediate and longer term and still believe any weakness creates opportunity rather than a reason for broader concern. Remember, since 1946 there have been 76 declines of 5-10%. The average time to fully recover was just one month. We again encourage patience if we falter short term. Avoiding short term emotional decisions is a major key to longer term investment success. Earnings are another factor. It has been typical over recent quarters to see some market weakness ahead of corporate quarterly earnings reports. Then, as the numbers start to flow, earnings generally come in above consensus estimates and the market fares better again. We expect the same dynamic over the next couple of months and then, November and December are two of the better market months over time.
Without being political, the market does not like uncertainty and one candidate would likely be deemed more status quo. However, longer term, many markets pundits believe the other candidate would likely be better for business growth and therefore, the longer term health of the overall economy. You can fill in the names. So, more uncertainty and potential volatility than most election cycles but, we do not expect the election to change the general direction of the market based on the underlying fundamentals.
The Fed’s decision on short term interest rates will also be a major factor in the fourth quarter. Higher interests rates and for that matter inflation, are not necessarily negatives for the market until they rise to a point that impacts economic growth. It is obvious that the Fed has been waiting until they believe the economy is improving enough to sustain a rate hike and that is actually positive for earnings growth going forward. Keep in mind also that the market moves based on a variance from expectations. Currently the interest rate market is pricing in about a 70% chance of a hike in December.
In conclusion, we would anticipate more volatility in the fourth quarter. However, we expect the year to end on a positive note. In terms of valuation, we are not seeing the excesses that would lend one to think we are near the end of this bull market. Interest rates remain low; earnings are growing and are fairly valued. There is also plenty of liquidity that can come to the market based on the amount of skepticism that still abounds. We believe we are still a long way from the euphoric stage of a bull market that could set a new path for stocks. Stay tuned…..