Market Tailwinds Turning Into Headwinds

We don’t expect any surprises from the mid-term elections. The early line from the prediction betting polls expect the Republicans to gain seats and control both houses of Congress. That could put a check mark on the side of the market bears and put a crimp on markets, as the gridlock in DC means no more stimulus until 2025. The tailwinds for markets (deflation, stimulus, QE, globalization) that we have seen for over a decade continue to recede. They are all turning into headwinds. We will need to invest in very different places than we have for the last decade.

The average bear market lasts 11 months. We are in month 11. Maybe this one won’t be so average. The Fed keeps raising rates, and as we told you months ago, the higher the stock market goes, the more room it gives the Fed to raise rates or jawbone markets lower. The Fed’s desire is to tighten financial conditions, and a higher stock market does not help. At this point, we would expect that the terminal rate interest rate that the Fed wishes to arrive at should see the S&P 500 at 3300. As we have said, markets could melt up for the end of the year and then run into a wall in Q1 2023 or skip that and sell off into year-end. Investors are positioning for Option #1 and the year-end Santa Claus rally. In most years, the market does rally into the year end. We don’t tend to see those rallies in bear markets. Positioning is very light, and traders are buying Hail Mary options for the bull case. When everyone expects something to happen, something else will.

An esoteric funding measure is the USD FRA-OIS. Without going into the weeds, it shows us funding pressure and if banks are getting cautious in lending to one another. I would expect things to get tight around year-end funding, but the FRA- OIS is already at 50. At levels above 50, things get a little dicey. Banks are not anxious to lend to one another. Could it be the Swiss central bank that is having issues?

The Fed meets this week and we get another CPI report. The G-20 conference is November 16^th. That should begin the turnaround in bonds and the US dollar. That would help stocks. The end of the year brings illiquidity and funding challenges. Things could move sharply in either direction. The more difficult journey has us headed higher for the next couple of months into the beginning of 2023. 4150 is the target resistance on the S&P 500 for now, and we would take off risk again.

Original Post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.