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Market Commentary: Another October Low Forming?

A late week sell-off saw stocks barely break their early October lows, with the S&P 500 now down 7.9% from the late-July peak. Although the weakness the past few months hasn’t been fun for investors, it is important to note that stocks are still up more than 10% for the year and a fourth-quarter rally is still expected.

  • October volatility continued, but a major late-October low could be forming.
  • The economy has strong momentum, with growth accelerating since the first half of the year.
  • Retail and food service sales have increased at an 8.6% annualized pace over the last three months.
  • Economic indicators across consumption, income, industry and the labor market don’t point to a recession.

As the chart below shows, the 4,200 level is quite significant and is expected to hold as support. With prices slightly lower than they were in early October, it is worth noting that more stocks are above their 50-day moving averages, a sign of potential strength under the surface. In fact, we saw a similar set-up last October, as prices made new lows but not as many stocks broke down.

October is known for extreme volatility, but it is also known for ending bear markets and corrections. Interestingly, many bear markets end later in the month, which could happen again. In the last 10 pre-election years since the early 1980s, stocks bottomed on Oct. 19 on average. With various signs of extreme negative sentiment and oversold market levels, we’d place the odds quite high for another late-October low.

Let’s Call It Like It Is: The Economy Is Strong, and There’s No Recession on the Horizon

A year ago, a Bloomberg Economics model projected a recession within the next 12 months with 100% probability. That’s right, a recession was all but certain. Fast forward 12 months and not only did we not have a recession, but economic growth has accelerated over the past quarter and is showing strong momentum as we head into 2024.

Through June 2023, the economy grew 2.4% after adjusting for inflation, matching the average annual pace between 2010 and 2019. Since then, the economy has accelerated. The Atlanta Fed GDP Nowcast is projecting 5.4% real growth in the third quarter. Amazingly, the “blue chip consensus” in June showed that economists on average expected zero growth in the third quarter, which means several expected the economy to contract.

At Carson, we have consistently believed the economy is resilient and will avoid a recession. But at this point, it’s time to call a spade a spade: the economy is not just resilient, it’s running hot. Now it’s unlikely to get close to 5% going forward, but even half that pace is pretty good considering the massive headwind of unprecedented rate hikes by the Federal Reserve.

The September retail and food services sales data underlined the economy’s momentum. Overall retail sales and food services rose at an annualized pace of 8.6% in the third quarter. Here are two data points that neatly capture the strength across both goods and services:

  • Online spending rose at a 12.3% annualized pace.
  • Restaurant and bar sales rose at a 9.6% annualized pace.

It wasn’t just about inflation either. Excluding shelter, the consumer price index for all other items increased at an annual pace of 2.7% in the third quarter. After adjusting for inflation, retail and food service sales were up 5.7%. Compare that to the 2018-2019 pace of 1.7% per year.

The consumption numbers quoted above came amidst surging student loan payments. I’ve written in the past about how we thought the restart of student loan payments was unlikely to cause a serious dent in the economy. Payments officially restarted in October, but borrowers clearly looked to get ahead of them. Payments jumped from an average of $1.2 billion per month over the first six months of the year to $2.1 billion in July, $6.4 billion in August, and $7 billion in September, according to the U.S. Department of Education. The last two months have exceeded the monthly average of $6 billion from 2019. In fact, the New York Fed analyzed a survey that included student loan borrowers and found that payment resumption would have only a small 0.1%-point impact on consumption relative to August. Many borrowers expected to enroll in new, more generous, income-driven repayment plans. Several borrowers also began adjusting their savings and consumption decisions after learning that payments would resume. It doesn’t look like any of this has adversely impacted consumption in a significant way.

The 6 Economic Horsemen Don’t Point to Recession

The official arbiter of recessions in America, the Business Cycle Dating Committee from the National Bureau of Economic Research (NBER), uses six economic indicators to decide whether the economy is (or was) in a recession. To make that call, the committee looks for broad-based declines across incomes, consumption, industry, sales, and the labor market. These include:

  • Employment: both using the nonfarm payroll version (monthly jobs number) and the household survey version (unemployment rate)
  • Real personal consumption expenditures, which is spending adjusted for prices
  • Real personal income excluding transfers, which is income adjusted for prices
  • Industrial production, which is a measure of the real amount of production in the economy, especially manufacturing
  • Real wholesale and retail sales, which are sales of goods adjusted for prices

As the chart below shows, not only have all these measures grown over the last three months, most are also running ahead of the pre-pandemic growth rate. Even the manufacturing sector, within industrial production, is trending upward. Real incomes have been hit by the pickup in gas prices (through August), but prices have fallen since then, which will be another tailwind for households.

The data shows we’re clearly not in a recession, and economic momentum suggests that’s unlikely to change over the next three to six months. Twelve months from now is a long time, but even then, the odds of a recession seem low given the current conditions, namely strong household and business balance sheets, will still be in play. Throw in higher fiscal spending on manufacturing and we shouldn’t be surprised the economy is strong.

Yes, interest rates are rising, but we believe the market is pricing in a stronger economy in the future. That means the Fed will have to keep rates higher for longer. The market is currently treating that as bad news, but a stronger economy ultimately translates to greater profits. In fact, 12-month forward earnings estimates for the S&P 500 continue to hit new highs. That’s a good thing as far as we’re concerned.