And So the 4th Quarter Begins

The stock market fear gage, the VIX, is flashing extreme pessimism. If you follow the news flow, it is easy to see why. It’s a constant barrage of negativity. It’s important to note that crises and the stock market have coexisted for decades. Crises come and go, while the stock market has always been volatile, yet sustains a positive trend.

Near-term indications suggest that the market is challenged by the Fed interest rate policy but appears reasonably valued all things considered.

My favorite bottom-up indicator, the Morningstar Market Valuation chart, puts the US market at 91% of fair value on 9/30/23, suggesting slight undervaluation. On a deeper level, growth is slowing, but it is very debatable how much it will slow. For now, it appears that the answer is “not too much.”

Part of the reason the market pulled back from its recent high at the beginning of August is that the Fed signaled that it is likely to keep rates higher for longer. Higher yields translate into lower stock price multiples. Ultimately this will reverse when the Fed sees the threat of persistent inflation above target diminishing.

In the absence of an upside catalyst, I expect the market to remain rangebound (S&P 500 between 4,220–4,560) until either the positive scenario occurs with the economy’s slowing stops, the Fed becomes dovish, and disinflation proves successful. On the downside, if either of these factors deteriorates, the market could break to the downside.

This morning’s job report (Tuesday, October 3, 2023) sent interest rates higher. Accordingly, stocks dropped. The knee jerk reaction to a data point illustrates the market’s myopia in seeing the trees instead of peering through the forest. Every data point is extrapolated far into the future when we’re pretty sure that won’t be the case. That suggests the long-term outlook just went up by the amount of today’s decline.

A Chat GPT forest

I’ll also comment about Congressional dysfunction after this past weekend’s drama. A Government that can’t govern is not helpful given the fiscal state of this country. It can only create uncertainty in the Treasury market. Stocks will not go up with interest rates increasing from this level. Let’s hope Congress gets its act together sooner than later.

Last quarter I noted that the market “appears to be approaching fair value” after being up 15.91% in the first half of the year. The 3rd quarter pullback was not surprising.

The bottom line is that the S&P 500 went up 13.03% YTD through the 3rd quarter according to Morningstar. The 4th quarter should be interesting.

Investing involves risk, including loss of principal. Past performance is not indicative of future returns.