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This Q4 Could Be Like 2018

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The stock market is setting up for a big buying opportunity in Q4. In fact, I’m making a big list of stocks that I can’t wait to buy.

But even though the S&P 500 has already corrected 25% in this bear market, we have to wait until a specific confluence of events occurs in the next few weeks that will make stocks even better bargains.

In this report, I’ll explain that path to a Q4 stock market bottom based on something very similar that happened in 2018.

The Collision of Slowing Growth and Strong Inflation

Four years ago in late September and early October, the Federal Reserve Open Market Committee (FOMC) detailed plans for vigilant tightening of monetary policy.

They had just raised the Fed funds rate by 25 basis points to 2.25% and their forecast was for consistent and steady rate hikes over the next several quarters.

Plus, $50 billion was being liquidated from the bond balance sheet on "autopilot," to quote Fed chief Powell's infamous words that tanked the market in December. QE had turned into automated QT (quantitative tightening).

The stock market reacted violently, dropping 10% through early December -- even though the FOMC did not hike rates at their November policy meeting.

Instead, they waited until the December 19 meeting to bump another 0.25 to 2.5%. The S&P 500 dropped 7% that week.

Continued . . .


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Why So Serious?

The dynamics of that reaction were based on two glaring trends.

First, the Fed was tightening into a period of moderating economic and earnings growth.

Second, corporate credit spreads went into seizure. Here's what I wrote to TAZR Trader members in late December 2018 as Goldman Sachs was slashing their GDP estimates for 2019 from 2.4% to 1.9%...

Credit Alarm Bells

Many economists insist that a recession doesn't happen unless a shock occurs in financial markets first, i.e., stocks, bonds, credit, lending, etc.

I don't know if that's always true. What about exogenous events like war, politics, trade wars, or other economic supply/demand/country/competitive disruptions?

In any case, we'll listen and focus on what financial markets could be trying to tell us about the future of the economic expansion.

And the one getting the most attention after the stock market should be the credit markets.

We've seen high-yield spreads "blow out" (at least relative to the extreme complacency and ease of the past 5 years or so).

And on Dec 19, after the Fed blitzkrieg, we heard Scott Minerd of Guggenheim ($225B+ AUM) worried about a trillion worth of Investment Grade credit slipping off the last rung of IG (BBB-) to BB, or junk status.

This is what can happen in tsunami fashion if companies that have relied for too long on easy money to finance operations and debt all of a sudden have to pay much higher borrowing costs.

The ratings agency models take note and downgrade the borrowers’ ability to service that debt -- and then their lifelines of credit get even more expensive.

That is the sort of vicious spiral that can tip an economy into recession, or at least very close.

(end of Dec 2018 commentary excerpt)

The Q4 2022 Bottom 

I've been writing about why the stock market would probably make a trip below S&P 3400 this quarter as higher rates ran into lower earnings.

I'm not saying we'll have a 19% correction like four years ago, but another 10% is easily in the cards.

And this week I'm not alone in the sentiment that a holiday rally doesn’t always “have to happen.”

Bank of America released details of their Institutional Investor survey and found many large players sitting on their hands, waiting for the tightening hurricane to hit the fragile coast of decelerating earnings.

Many opinions in the survey of big money managers described a Fed who now has tunnel-vision about inflation, with blinders on to GDP and credit market gyrations -- again.

The fund managers think that a trip to S&P 3300 will wake up the wonks, as credit and recession shocks to financial markets herald a peak in yields and the US dollar.

This is exactly what finally happened in late December of 2018.

Train Engineer Powell On Track

And Morgan Stanley Chief Investment Strategist Mike Wilson has been all over this forecast for months. Here was his update recently...

"A Fed pivot is likely at some point given the trajectory of global M2 [money supply]. However, the timing is uncertain and won’t change the trajectory of earnings estimates, our primary concern for stocks at this point.

“Bottom line, in the absence of a Fed pivot, stocks are likely headed lower. Conversely, a Fed pivot, or the anticipation of one, can still lead to sharp rallies. Just keep in mind that the light at the end of the tunnel you might see if that happens is actually the freight train of the oncoming earnings recession that the Fed cannot stop.”

In other words, it's nearly impossible for the Fed not to overdo its tightening cycle and basically wreck things.

Army Training, Sir! 

It was said throughout the 2010s that every time the market had a "taper tantrum" about Fed policy getting tight, Wall Street stock traders were training the Fed.

But I think it's actually the other way around. The Fed holds most of the cards and power here.

And when they reversed course in early 2019 and actually conceded to slowing growth and friction in financial markets, it was the policy wonks who trained the traders by consoling and rewarding their panicky behavior.

The reward is coming again. But not until the clenched-jaw Jerome has established himself as a respectable inflation hawk.

It may be his final chance to mold the last impression of his economic reputation.

Q4 Shopping List Is Loaded

And all this means that I can't wait to see what kind of bargains the next 6 to 8 weeks bring. My shopping list of equity stocking stuffers is already quite large.

My only problem will be having too many choices. But that's a very good problem to have if you are a fundamental and technical investor with ready cash.

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Good Investing,

Kevin Cook
Senior Stock Strategist

Kevin Cook, Senior Stock Strategist at Zacks, is a world-class expert in technical analysis and what makes markets move. He provides commentary and recommendations for the Zacks TAZR portfolio.

¹ The results listed above are not (or may not be) representative of the performance of all selections made by Zacks Investment Research's newsletter editors and may represent the partial close of a position.


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