Red October?
My wife absolutely loves autumn, but especially October. And for the most part, I agree with her sentiment. It is a beautiful time of year.
The days are shorter, the weather cooler, it marks the cusp of the holiday season, and autumn leaves grace the trees.
It has always been a nostalgic and transitional time of year. And we look forward to it. (Ugh... I will miss the summer though).
But to the financial markets, October has not always been a month to look forward to.
The bank panic of 1907, The Market Crash of 1929, Black Monday of 1987, and the worst decline in 2008 (-17%). All taking place in October bred life to the ominous term "October effect".
Whether the term is merited or not is of much debate, because just as many bear markets have ended in October, as escalated.
But given what 2022 has produced, it begs the question:
Are we due for a reprieve or a Red October?
Well... back-to-back 2.5%+ rallies to start the month are encouraging and as rates potentially fall over the next few weeks we may be due for some relief. However, the macro landscape is not great.
A Tough Macro Landscape
As I am sure you are aware, rising interest rates, the extremely quick rise of the US dollar (see chart), and inflation are all trending headline topics currently.
All three are connected and even worse, they are playing a big role in pushing the WORLD into recession.
I'll give you a quick rundown:
To fight inflation, the Fed raises the overnight rate (which influences other interest rates) and in turn, the higher yields attract foreign investment into US debt. Because our debt needs to be purchased in US dollars, demand for the greenback rises... and the law of supply and demand takes over.
Yes, there are positives to a strong dollar. But the longer it persists consequences develop at home and abroad.
For example, US companies that are export-heavy feel the pinch as fewer goods are purchased (profits fall) and foreign countries with dollar-denominated debt face default as it becomes difficult to service said debt.
In fact, the current central bank policy has the very real potential to set us on a difficult course. So much so, that on Monday the UN Conference on Trade and Development pleaded with central banks to slow down rate hikes, citing a high potential for a catastrophic global recession. This comes on the heels of the Bank of England and Bank of Australia starting to pivot. Will the United States heed the warning?
Conclusion
I know, I know...the topic of recession is of much debate. Are we in one or not? Wall Street says yes, but the NBER says no. I have my opinions but I will save those for another time.
What we do know is that the Fed has said they are "data-driven". And a few of these data points have changed. More specifically, the ISM manufacturing index and labor market are showing some signs of cooling.
This does give us the potential for a Fed policy pivot. But much of the rhetoric is still very hawkish against fighting inflation and with their continued "higher rates for longer" position, I am not sure it is enough just yet.
Despite that, the technical picture of interest rates and the US dollar have been in "over-bought" territory for several weeks now and it looks as if a correction is due. The size and scope are unknown, but If the correction in rates that started this week continues, then the stock market in October may actually see more green than red.
Nonetheless, no matter the size and length of a relief rally, the macro landscape is muddy. Until the facts change any hope for a longer-term sustained rally should be kept on ice.
“When the facts change, I change my mind. What do you do, sir?” - Paul Samuelson
Thank you for reading,
James Anadon
