The stock market could still see a fourth-quarter rally, but it’s likely to feel more pain at first. Strategists following charts say Tuesday’s big sell-off was negative and signals further selling. But the market could also make a bottom from which to veer away over the next few weeks, and the debate is whether that level will be below or above the June lows. Parts of the market were marginally higher on Wednesday after Tuesday’s sharp drop. The S&P 500 fell 4.3% on Tuesday, its worst daily performance since June 2020. The sell-off came after a report of higher-than-expected consumer inflation Tuesday morning. This prompted investors to reassess how aggressively the Federal Reserve might be in its fight against inflation. It also cast doubt on whether the market will continue to follow the roadmap that analysts expect at midpoint in a typical election year. For most intermediate-term years, the market is typically negative in the second and third quarters before bottoming out in the third quarter and bouncing back in the fourth quarter. Ed Clissold, US chief strategist at Ned Davis Research, said the Dow Industrials and S&P 500 don’t need to fall as low as the June lows to stage a rebound. The S&P hit 3,636 in mid-June, around the same time the 10-year Treasury yield peaked at just under 3.5%. Stocks were higher ahead of Tuesday’s CPI on expectations that the data would improve and the Fed would soon be able to pause its rate hikes. Giving Back What It Gained “For the most part, the market gave back what it had gained in previous sessions,” Clissold said. “We had thought that this is the best window for a retest going in late September, early October.” Clissold said although Tuesday was a negative day, there was no clear signal whether the retest will fail. “From a broader perspective, supporting and filling the market and trying to figure out whether or not it can start a year-end rally, that’s probably what the next few weeks will be about,” Clissold said. Mark Newton, Fundstrat’s global head of technical strategy, said he expects the S&P to break through last week’s lows and potentially drop into the 3,650-3,750 range. The June low was 3,636 and the S&P was around 3,950 as of Wednesday afternoon. “Tuesday’s sell-off looks technically important and negative, likely accelerating the decline into early October,” notes Newton. “Currently, cycles are looking negative for at least the next three weeks,” he added. Tuesday’s reversal in stocks coincided with a sell-off in the dollar, rising Treasury yields and a decline in cryptocurrencies. “All of these sudden reversals could likely continue into early October. That should ultimately pave the way for higher prices in the fourth quarter given how bearish sentiment has been over the past few weeks,” Newton added. Oppenheimer’s technical strategist Ari Wald also expects the market to move higher in the fourth quarter following the typical course of a mid-election year. He added that he’s examined the S&P 500 after falls of 4% or more in one day and found that the market is typically positive a month, three months and a year later. Based on data going back to 1928, he said the S&P was up an average of 1.1% a month after a major sell-off, compared to the average one-month gain of 0.6%. After 12 months, the S&P was posting an average gain of 15.3%, better than the 8% average gain over a year. Going for higher lows Wald said he expects the market could find a short-term bottom soon. “We are on the side of a higher low rather than a lower low. A less intense lower low is possible,” he said. Wald said he still expects a fourth-quarter rebound. The leaders of this movement could be big-cap technologies that are lagging behind. “It’s their weakness that has taken a toll on the market… It’s actually masking the improving conditions below the surface,” he said. For big-cap tech, “Once our turn comes, they’ll probably be a part of it, but they’ll probably be in the box soon,” he said. Investors are now betting that the Fed will raise interest rates more than they had anticipated prior to the August CPI release. This report showed CPI rising 0.1% while the market was expecting a 0.1% decline. In the futures market, the Fed’s closing or final interest rate was rated at 4.38% on Wednesday, a sharp rise from just under 4% ahead of the CPI report. This is the rate at which the Fed is expected to end rate hikes. The Fed meets next Tuesday and Wednesday and is widely expected to hike rates by 75 basis points, although at least one Wall Street firm expects a full percentage point hike. One basis point corresponds to 0.1 percentage point. In addition to rate hikes, the Fed will present new forecasts for interest rates, inflation and the economy on Wednesday afternoon. “This will be the next big piece of information that markets will digest, and the CPI report increases the likelihood that the Fed will stick to its stance of continuing to hike rates,” Clissold said. He also said the Fed will continue to sound hawkish to maintain credibility. “You don’t want to appear wishy-washy. They will maintain that stance until they are ready to spin,” he said.
The stock market could rebound strongly in the fourth quarter, but there will be more pain first