The midterm election is over and it ended with a split Congress as most polls suggested would be the case. The Democrats will have control of the House and the Republicans will have control of the Senate come January 2019.
That changeover will come soon enough, yet there is a lot of open road still for the stock market to travel between now and year end.
Call it the final exam and how the stock market grades out from here is naturally on everyone's mind.
Making a Case
There are a number of reasons why the punditry is making a case for the stock market to finish this year with a bang:
- The uncertainty surrounding the midterm election is over and investors can feel good that a split Congress means there won't be a legislative unwinding of market-friendly policies.
- November marks the start of the best six-month return period for the stock market, so this is typically a seasonally strong time.
- There is going to be performance chasing by fund managers who have underperformed their benchmark.
- Corporate share buyback activity will pick up in earnest now that the third-quarter reporting period is mostly behind the market.
- Valuation is more attractive in the wake of the October correction. The S&P 500 trades at 16.1x forward twelve-month estimates -- a slight discount to the five-year historical average and versus 18.3x at the start of the year.
- They expect President Trump and President Xi to convey some trade tension detente after meeting at the G20 Leaders' Summit Nov. 30-Dec. 1.
- The Federal Reserve could signal that it might not raise interest rates as much as it currently projects.
Generally speaking, we hear two variables cited often that would ignite a year-end rally.
The first variable is the U.S. striking a trade agreement with China. That hopeful outlook, however, doesn't necessarily rest on an actual agreement.
It has been suggested that China and the U.S. simply dialing down their trade disagreement would be enough to get the market popping.
The second variable is the notion that the Federal Reserve refrains from raising the target range for the fed funds rate in December or leaves the impression coming out of that meeting that the rate-hike path in 2019 might be less steep than the market currently fears.
With the November policy directive from the Federal Reserve in hand, there is ample reason to think the Federal Reserve will agree to raise the target range for the fed funds rate at its December meeting.
Accordingly, it would take quite the negative economic development, or financial shock, for the Federal Reserve to hold off on a rate hike in December. If it did, then there are going to be bigger things for the stock market to worry about that would negate today's thinking that holding off on a December rate hike would be a rally catalyst.
Like any preparation for a final exam, there is a lot to study and to think about. In turn, there is typically a lot of guess work that goes into what one thinks will be part of the final exam.
It is primarily guess work when it comes to the stock market's behavior from one day to the next, too, let alone over the span of a seven-week stretch, which is what remains in 2018.
There are technical and fundamental elements that provide a basis to make an educated guess, but that's all it is because no one knows for certain what the future holds.
Also, it is asking a lot of anyone to accurately predict crowd psychology. This past week was a perfect case in point.
On Wednesday the stock market rallied strongly in the wake of the midterm election results. The Nasdaq Composite, for example, surged 195 points, or 2.6%, on Wednesday.
Lots of people were feeling really good about the reaction and the notion that it was the start of a big, year-end rally. By early afternoon Friday, the entirety of that gain -- and then some -- had been wiped out.
It's still possible to see a big, year-end rally unfold, yet it's a reach to consider it preordained at this juncture when trade tension with China is still thick, when cracks in the global economy and U.S. housing market are evident, and when, most importantly, the Federal Reserve is still very much inclined to raise interest rates at a time when a growing number of stock market participants think it shouldn't be.
What It All Means
In light of today's presentation, you are probably wondering what our best educated guess is for the stock market's path into year end.
Our belief is that it is apt to look much like it has of late -- great one day and not-so-great the next.
That's because real interest rates are still low, yet the Federal Reserve is still on course to take them higher. Moreover, there isn't any good sense yet in the market as to where the endpoint will be with the tightening of monetary policy (which also includes efforts to cut the size of the Federal Reserve's balance sheet).
That uncertainty will be an ongoing source of trading volatility and an excuse to sell into strength.
The stock market has passed the midterms, yet the final exam is still in progress. A passing or failing grade is going to depend a lot on interest rate expectations.