This was quite a week as we kicked off the fourth quarter. There was a lot going on, so in today’s Market 360, let’s see if we can make some sense out of it…
First of all, the fourth quarter is by far the strongest of the year historically. What’s more, we are in a midterm election year, and the market has a strong pattern of performing much better in the six months after the election (November 8 this year) than in the six months leading up to it. That has held true in 17 of 19 midterms since 1946.
The market seemed to get the memo as it kicked off the week, month, and quarter with an absolute bang. Monday and Tuesday were the best back-to-back days for the Dow in two years. It was great to see buyers jump in – and our stocks were especially strong.
Still, I think some investors may have jumped the gun a little too early. Everybody right now is looking for the “Fed pivot,” as it is being called. Essentially, that’s when the Fed’s language will sound a little less hawkish and a little more dovish. Investors hope it will signal the end – or at least the approaching end – of interest rate hikes.
To start the week, investors began to consider and even hope that the Fed might raise rates just 50 basis points (or half a percentage point) at its early November meeting instead of the previously expected 75 basis points. The idea came from overseas, as Australia’s central bank raised rates less than everyone expected. And remember, the Bank of England began quantitative easing last week to lower rates.
In light of those events, a lot of folks concluded that the Fed might also raise less than expected. I’m sorry to disappoint, but I don’t think that’s a correct narrative. When the Fed telegraphs what it intends to do, they almost always do it. Only shocking economic news would give them a reason to change course.
And, so far, that hasn’t been the case. Take this morning’s employment report, for example.
Wall Street was looking for a lackluster report, which would show a slowing economy and give hope to those wanting the Fed to slow down rate increases. The Labor Department reported that 263,000 jobs were added in September, and the unemployment rate slipped to 3.5%. While this was the weakest payroll report since April 2021, expectations called for 250,000 jobs and the unemployment report to remain unchanged at 3.7%.
Given that the employment report came in better-than-expected, Wall Street realized the Fed isn’t likely to change its key interest rate policy. As a result, Treasury yields resumed their climb higher, with the 10-year Treasury back around 3.9% today, and all of the major indices slipped lower.
The fact is Treasury yields are the key right now. As we’ve discussed, the tail is wagging the dog, and rising yields remain the biggest potential threat to the market. They are stubbornly high right now, and we don’t want to see them spike again.
This Week’s Clear Winner
As we navigate these sometimes changing crosscurrents, one important constant is energy prices. Oil is up about 10% so far this week, driven in part by the somewhat surprising decision of the OPEC+ alliance to cut production by two million barrels a day. The cut will actually amount to more like 900,000, as there is often a lot of “quota cheating” among OPEC nations.
Still, oil is up nearly 17% since its recent low two Mondays ago, and this move comes when demand is seasonally low. If oil prices are increasing now, think about what they will do over the winter and into the spring. That’s why I expect at least $100 a barrel if not $120 in the coming months.
Oil’s surge also comes at a time the Biden administration has been trying to keep oil prices down by releasing a million barrels a day from the nation’s Strategic Petroleum Reserves. As they’ve done so, the reserves are now at 40-year lows, and they can’t keep drawing them down forever. The administration has filed to continue releasing oil through the end of November, and whether it is then or sooner, I expect the releases to end after the midterm election.
Energy stocks were on the move again this week. The SPDR Oil & Gas Exploration & Production ETF (NYSEARCA:XOP) has jumped nearly 25% since its recently low on September 26, which was 10 trading days ago.
Those two stocks are now above our buy limits in Growth Investor, but I continue to be very bullish on energy stocks. They are set up to report blowout earnings, and they continue to be undervalued with low PE ratios.
Bring on the Earnings!
Speaking of earnings, the next reporting season starts in earnest next week when several of the big financials will kick things off. According to FactSet, S&P 500 earnings are expected to grow 2.4%, which would be the smallest growth since the third quarter of 2020 when earnings contracted 5.7% during the pandemic. But to be honest, earnings estimates are all over the place – from positive to negative on the S&P 500.
I expect earnings to work for the fundamentally strongest companies – which is where I always recommend you invest – especially with valuations so low. In fact, they are crazy low. When I was digging into small and mid-caps recently, I got down to 3.6X next year’s median forecast earnings. That’s ridiculous! When I did my large cap research, I got down to 7.6X next year’s median forecast earnings.
With everything going on in the market and economy, it’s basically every stock for itself right now. That’s why stock selection is so important. Simply put, good earnings ultimately drive stocks higher.
We know the ups and downs will continue, but I do expect the strong sales and earnings growth to set companies apart and drive outperformance. It will be a busy few weeks coming up as earnings season cranks up, but I anticipate they will also be a profitable few weeks for those invested in fundamentally superior stocks.
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