@theMarket: Markets Down, Economy Up, What Gives?

Sometimes good news on Main Street is bad news for Wall Street. Let's start with the good news. The U.S. economy grew at its fastest pace in nearly two years during the past three months. Third-quarter Gross Domestic Product grew at an annualized pace of 4.9 percent blowing away economists' expectations of a 4.5 percent growth rate.

 

The resilient U.S. consumer continued to spend, which has boosted growth, defying those who have been expecting the economy to slow down under the weight of 18 months of interest rate hikes. The bad news is the stronger economy will make the Fed's fight against inflation that much more difficult and therein lies the rub for the stock market.

 

The nation's second-quarter GDP came in at 2.1 percent, so the economy is accelerating not slowing. Despite past predictions of a slowdown that has not occurred, many economists are now predicting that this quarter will turn out to be the peak in economic growth. They point to a restart in student loan payments, the impact of lagging monetary policy, and a weakening worldwide economic backdrop as the negatives that will provide a huge impediment to further economic growth.

 

I remain doubtful, at least until U.S. employment begins to roll over. As long as the job market remains strong, Americans will continue to spend. The Fed knows that as well, which is why Chair Jerome Powell is adamant that he will continue his higher for longer interest rate policy. On numerous occasions, he has insisted that before he can relax this stance, he needs the economy to slow. It is doing just the opposite. That is bad news for the stock market.

 

However, the inflation fight, which has long occupied Wall Street's attention, is now in second place behind the fears that government spending is out of control. It is one of the reasons why we are seeing yields on longer-dated bonds continuing to rise. Sure, we have seen some minor pullbacks in yields, but not enough to make a difference.

 

For some reason, investors like round numbers. We hit a 5 percent yield on the benchmark U.S. 10-year Treasury bond early this week and traders bought bonds in a knee-jerk reaction. But is that the yield that will pay bondholders enough to satisfy their fears of higher deficits? I'm thinking we could go higher, possibly to 5.3 percent-5.5 percent or more.

 

Investor sentiment is really in the doldrums. The election of a new House speaker should have been good news, but it wasn't. Whether Mike Johnson, a far-right representative from Louisiana, can compromise with Democrats is anyone's guess. He is the least-experienced speaker in 140 years and his political stance on a whole host of social and economic issues may make cutting a deal with Democrats difficult at best. Miracles do happen, however, even in the Capital.

 

The AAII sentiment readings are extremely bearish, as is the CNN Fear index, which is almost at panic levels. "Stockmarketcrash" was one of the top ten searches on Twitter this week. Good earnings results from some of the market heavyweights like Amazon and Microsoft have not been able to support the averages. All of the above tells me from a contrarian point of view that we are nearing the end of this bottoming process.

 

Since the Israeli/Gaza conflict and the dysfunction in Washington, I have been extending the period of this equity pullback. Originally, I thought all this mess would have been concluded by the end of the second week in October. At the same time, I increased my downside target for the S&P 500 Index level.

 

As of last week, I was targeting the 4,100 level or possibly a little lower. We were only 37 points above that level before we bounced on Friday. Close but no cigar. I could see a worst-case scenario where the S&P broke below 4,100 by 30-50 points. Either way, I expect a rebound to begin in November if not sooner. Future events in the Middle East, however, will remain a wild card for the markets.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.