Markets Must Decide Which History to Believe

The S&P 500 Index rose for the fifth time in six days Tuesday, gaining 4.32 percent over the period and turning positive again for the year. The rebound comes as many point out that since World War II, there hasn’t been a down period for stocks in the 12 months following a midterm election. That seems like a compelling reason to be bullish, until you realize that with just one exception, every Federal Reserve interest-rate hiking cycle — like we’re in now — has ended in a recession.

Now, nobody is calling for a recession in coming months, but there are plenty of signs that last year’s global synchronized recovery has plateaued and is slowly turning into a global synchronized downturn. The International Monetary Fund last month cut its global outlook for the first time in two years, including its forecasts for the U.S. economy. And although one of the bright spots in the equities market has been corporate earnings, with profits again surging by greater than 20 percent in the third quarter, there are worrisome signals. Bianco Research notes that of 239 members of the S&P 500 that have posted their results, just 47 percent had revenue that exceeded forecasts, potentially making the third quarter the first since the end of 2016 not to show a beat rate above 50 percent. The reason this is an important metric is because if companies are having trouble expanding the top line, they will have even more trouble expanding the bottom line. This is all to say that no matter what happens in the midterm elections, the headwinds facing equities are getting stronger. That should result in much greater volatility, especially with Fed Chairman Jerome Powell saying last month that it may be necessary to push rates beyond “neutral” to a level that restricts economic growth. Note that the Fed has already boosted rates seven times since December 2015, and plans to do so again next month.