With Q4 commencing, here are a few things we’re thinking...in no particular order. I say this with a high degree of trepidation given the unlimited pounding of the pavement by media prognosticators talking about the midterms, the war, oil, and the financial markets.
Seasonals turn very supportive around now. As I have been showing in my seasonal cycle studies, markets tend to trade sideways for much of the summer in midterm election years and begin to bottom and then rally into the start of November. According to Larry Williams, the exact day that statistics show as being a possible day to deploy capital is actually two trading days prior to the voting day of November 3rd. This is on the Friday just prior. I am not saying this as a recommendation in any way but just want to be on record as reflecting comments of a sage of the markets.
A key theme to contemplate in all of this: Interest rates are certainly a headwind. But profits are an even bigger tailwind.
Yes, the 10-year is tickling 5.40%. And this is the scariest since it affects corporate lending, US Government debt service costs, and mortgage financing.
- But analysts expect Q3 earnings to come in at +27% vs a year ago.
- Yes, a deceleration but still an absolute monster of a number.
- And as we’ve repeatedly stated, the US economy is less interest rate sensitive than we’ve historically accepted.
- Sure, there are still some segments of the economy that are rate sensitive:
- Small caps, homebuilders, utilities, REITS, etc.
- But tech and the AI trade will just keep humming along.
- When the attitude in the AI race is that second place is for losers, an incremental 50bps in borrowing costs isn’t likely to slow things down.
But let’s reflect on the inflation readings- the drivers of inflation in many cases:
Retail Sales for the month of September:
Flashy headline, modest details. Retail sales rose 0.8% in September, easily beating consensus expectations, while sales in previous months were revised higher. However, most of the surprise can be attributed to a 6.4% jump in gas stations sales, reflecting higher prices at the pump, not a boost to economic activity. Still, growth was broad-based with eight of thirteen major sales categories rising in September. sales at restaurant and bars – the only glimpse we get at services in this report – increased 1.1% in September following an upwardly revised +1.4% gain in August. Sales in this category have shown solid growth since February and stand 7.0% higher than a year ago, outpacing the 6.3% increase for overall sales.
Producer Price Index:
Producer prices surged in September, rising across the board. The Producer Price Index rose 1.3%, the largest monthly gain since 2022. While more than 40% of the headline increase was due to energy (which rose 10.8% for the month), final demand prices excluding energy also rose 0.7% in September, as the second-order effects of higher energy prices work their way through the economy. Gasoline prices jumped 20.3% in September and are up 64.3% in the past year. Further back in the supply chain, price increases for intermediate goods were broad-based, with elevated energy prices continuing to burden businesses at every stage of production.
If all of this is true, and it must be as these are unbiased numbers based on consistent statistical data, why would interest rates fall precipitously immediately following the PPI release last Thursday? I believe that is again a reflection of the importance of energy even in a new world of AI. Lower-income households spend a smaller absolute dollar amount on gas than higher-income households, but it consumes a significantly larger percentage of their total income or budget. This tends to be in the area of 3-6% of their monthly income on energy related products like gasoline and heating oil.
So, if the conflicts in the Middle East were to calm then oil prices and gasoline prices should pull back. I believe that the situation with interest rates is a bit more related to the overall level of debt in the global systems and if the debt levels are high then rates should reflect this. Here is what we are seeing:
Favoring global liquidity, the government’s debt level, maturing debts, interest payments, and total debt service payments stand at record levels today and trending higher over the next couple of years. The debt burdens are at their highest level since WWII and are expected to worsen. I am OK with the fact that the debt as a percentage of revenues is at a cyclical point, but what I am not happy with is that the overall level of debt keeps on rising. The root of the argument in this year’s Midterms is in regard to increasing spending on social programs yet no comments on how to rain in frivolous programs that continue to gain more funds. This is an argument for another time!
Global money market funds attracted +$166.4 billion in inflows in the week ending October 7th, their largest weekly inflow since April 2020 (the post COVID Government helicopter drop). US money market funds alone posted +$72.3 billion in inflows, lifting their total assets to a record $8 Trillion.
Since 2023, US money market fund assets have risen +$3 Trillion. Investors are piling into risk-free investments as rates surge.
Back to our normally scheduled programing- the US Equity markets:
The market is under clear pressure. Distribution has shown up in the Nasdaq and leading growth names, inflation data has rekindled rate-hike odds, and the AI complex is no longer getting an automatic free pass. South Korea’s KOSPI just delivered the clearest illustration: it crashed more than 7% in a single session, triggered a circuit breaker, and extended a multi-day rout that has wiped out a large chunk of its recent gains. Samsung Electronics and SK Hynix, the purest large-cap expressions of the HBM/DRAM boom, fell roughly 9-11%. Foreign selling has been relentless. When the memory leaders that have been the global supply bottleneck for AI accelerators are being liquidated this hard, it is not background noise. When this occurs, initially, investors see it as a simple correction / digestion. As it progresses and extends in time investors begin to question whether they are not seeing things clearly and fear begins to set in. This is where we are currently.
Historically, strong earnings from the true leaders can reverse a corrective phase—if the market is still in a general uptrend and the selling has been selective. Right now, the backdrop is more fragile. The KOSPI action is not an isolated emerging-market event; it is a high-beta read on the same HBM and advanced packaging demand that has underpinned the entire AI capital-spending story. When those stocks gap down on heavy volume and fail to find support, it raises the bar for what U.S. hyperscaler, and chip earnings must deliver. Guidance on capex, memory commitments, and forward order visibility will matter far more than the headline beats. Price and volume remain the final arbiters. The coming earnings reports will either reassert institutional demand in the leaders or confirm that the recent Korean and U.S. semiconductor selling suggests deeper re-pricing. Watch how leading stocks react, not the headline numbers. The market will tell you which is which.
The most recent factoid was the earnings report from ASM Lithography, the European company that has a virtual monopoly in making the machine that make the chips. They announced earnings last week. They beat the most recent expectation and said that they expect to grow approximately 30% in both 2027 & 2028. What was most interesting was their comment that they would could grow even much more than this IF they had the capability to make more! This tells us that the bottleneck is still alive and well and could well extend for many years to come.
Back to Midterms:
Gridlock after the midterms is not, by itself, bearish. A divided Congress is usually neutral to mildly constructive for stocks, because the big swings in tax policy, regulation, and spending get harder to pass. What the market actually discounts into November is unresolved uncertainty: who controls the committees, and what can still get through. Once the seats are known, that range narrows. Wall Street has lived with gridlock for decades for that reason. Hence the study mentioned above by the legendary Larry Williams.
The seasonal record is a real average, not a buy signal. Since 1950, midterm years have often been choppy into the fall (where we are today, things are right on schedule), then stronger in the fourth quarter. Here is the Four-Year Presidential Cycle Chart that I showed last week. As can be seen, we are right where I have circled on the chart:
FactSet data compiled puts the average Q4 gain in a midterm year at 6.6%, nearly double the next-strongest year in the presidential cycle. Silvia Insights has the following year, year three of the cycle, as the strongest of the four, with a 17.2% average annual return, more than double the post-election year. Over seven decades the S&P 500 has also averaged a 31.8% gain from its midterm-year low. The sample is about 18 midterms, and the average hides years that did not rally. Interesting fact: Since 1942, every November-to-June period following a midterm has been positive for the S&P 500. 21/21. Average: +16.6%. That’s a 100%-win rate. Here is the chart from the Gilmo Group. This shows the statistical numbers going back to 1950.
In closing, I truly recognize how volatility in the markets at the same time as the political arena is its most frictional is no fun! But, in looking at the different places assets can be deployed, the US Equity market still stands as the leader. At the same time, things could continue to be a bit saucy going into November 3rd voting day.
Just remember to have your sights set on history and the final chart of what has happened on the Four-year Presidential cycle going all the back to January of the year 1900:
-Ken South, Tower 68 Financial Advisors, Newport Beach
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