US Stock Market Turmoil: Key Factors to Watch in 2023

U.S.stocks experienced a rollercoaster ride in September,with the Federal Reserve reinitiating its rate-cutting cycle and China announcing a large-scale stimulus plan to boost market sentiment.As a result,the three major U.S.stock indices achieved their best performance in at least five years for the same period.The S&P 500 and the Nasdaq have recorded a rise for four consecutive quarters,marking the longest streak since 2021.

Now,the market has entered the most turbulent month of the U.S.stock market in an election year,and the sustainability of the recent U.S.stock rebound has attracted more attention.

Historical data is favorable

Looking at historical data,the good performance of the stock index in September is expected to continue into October and the entire fourth quarter.

Sam Stovall,Chief Investment Officer at CFRA Research,recently released a report stating that the probability of the stock market rising in October following a positive performance in September of an election year since 1945 is nearly 80%,compared to a historical average of 61%.

Since 1945,the probability of the S&P 500 rising in the third quarter has been less than 60%,lower than in the fourth quarter.Stovall wrote,"Factors that may continue to drive the market this year (fourth quarter) include China's recent stimulus plan,a slowdown in personal consumption expenditure (index) growth again in August,and the possibility of the Federal Reserve cutting rates twice more,totaling 50 to 75 basis points."

On the other hand,the further spread of the U.S.stock market rebound has also sent an encouraging signal to investors."Market participation remains active,as the rise of the S&P 500 in the third quarter was accompanied by the strengthening of stocks of various sizes,styles,and industries," Stovall analyzed.

In terms of sector performance,since 1992,nine out of the 11 industries in the S&P 500 have typically risen in the fourth quarter of an election year,"possibly due to the elimination of uncertainty after the election," Stovall said.

The pace of Fed rate cuts may slow down

As signs of the U.S.economy moving towards a soft landing have strengthened,medium and long-term U.S.Treasury yields recorded their largest increase in nearly two years last week.The much-anticipated September non-farm payrolls added 254,000 jobs,and the data for July and August were also significantly revised upwards.At the same time,despite pressures in the manufacturing sector,the Institute for Supply Management (ISM) services data significantly exceeded expectations,reaching its highest level since February 2023,indicating the 49th expansion in the industry over 52 months.The Atlanta Fed's GDP Now model forecasts that the U.S.economy will grow at a rate of 2.5% in the third quarter,still above the long-term trend of 1.8%.

Federal funds rate futures indicate that investors have rapidly adjusted their expectations for the Federal Reserve's November meeting,with the probability of a 25 basis point rate cut rising to over 90%,reaching a level of full pricing,and the possibility of another aggressive rate cut has essentially been ruled out.

Some market views suggest that if Federal Reserve officials knew the September jobs report would be so strong,they would not have cut rates by 50 basis points last month.Alliance Bernstein Chief Economist Carson wrote that the Federal Reserve's decision to cut rates "prematurely" may be seen as a (big) mistake.He stated that policymakers rely too much on academic frameworks to set the appropriate interest rate levels without fully considering the actual performance of the economy.

Brian Mulberry,a client portfolio manager at investment management firm Zacks,believes that the entire narrative around easing inflation may need to change."You can see the acceleration of economic activity over the past four weeks.The biggest challenge for Federal Reserve officials throughout the cycle is to achieve lower prices without overly restricting interest rates.It's a delicate balance,and they may now be easing too much and too quickly,which could lead to more inflation in the future,so interest rates may not fall as quickly as the market expects," he said.

Mike Reynolds,Vice President of Investment Strategy at family office Glenmede Trust,said,"If the Consumer Price Index (CPI) data starts to move in the wrong direction,that would really cause trouble for the stock market and the economy,but we haven't seen signs of that yet.In extreme cases,maybe the Federal Reserve will start raising interest rates again...These are certainly not the base case scenarios,but they are tail risks in stocks worth paying attention to."

The September CPI,which will be released this Thursday,will therefore attract more attention.Economists expect the overall CPI to fall from 2.5% in August to 2.3%,while the core data is expected to remain stable in September,with a year-over-year increase of 3.2%.

Some institutions are concerned that if the September CPI report is hotter than expected,inflation may rise again in the coming months,further limiting the pace at which the Federal Reserve can lower policy interest rates.More importantly,this would become a significant headwind for the stock market rebound.

Nancy Tengler,CEO and Chief Investment Officer of investment and wealth advisory firm Laffer Tengler Investments,said: "The risk facing the market is that the Federal Reserve is too aggressive in cutting interest rates because inflation has not yet been defeated.We see a moderate upward trend in the core CPI monthly rate,which is not a positive phenomenon." She believes that housing costs are one of the most persistent drivers of inflation this year and remain sticky,and escalating tensions in the Middle East and last week's dockworkers' strike (although brief) could become economic and price disturbances again later this year.