Leading research firm reveals stock market forecast for Q4

The stock market was full of cross currents after the S&P 500 fell 4% from its record peak on July 16.

A slowdown in the economy, especially job growth, has convinced many experts that the Federal Reserve will begin cutting interest rates at its September 17-18 meeting. Fed officials almost said the same.

But how much the economy is weakening is open to question. Nonfarm payrolls rose 142,000 in August, well below the average monthly gain of 202,000 from a year earlier. But the increase topped the 89,000 gain for July.

Inventories have declined since mid-July; will they come back in the fourth quarter?

Experts are divided on whether the Fed will cut interest rates by 0.25 or 0.5 percentage points at next week’s meeting. According to CME FedWatch, interest rate futures indicate a 71% chance of a quarter-point move and a 29% chance of a half-point move.

Equally important is the question of whether a rate cut is good or bad for stocks.

If the Fed’s move is seen as a boost to the economy, that should be good for stocks. But if a rate cut is seen as a move toward a rapidly weakening economy, that could be bad for stocks. That view could prevail, especially if the central bank cuts rates by half a point.

Corporate Earnings and Stock Valuation Trends

Corporate earnings are also a double-edged sword for stocks right now. Earnings per share for the S&P 500 rose 11.3% in Q2 from a year earlier, the most since the fourth quarter of 2021, according to FactSet.

Analysts are forecasting a 4.9% rise in earnings for the third quarter, which isn’t bad considering the strong second quarter. But some experts say the slowing economy will prevent such a strong showing.

Related: Wealthy investors make unexpected move on stocks, bonds

And in any case many experts say the market is overvalued. As of Sept. 6, the S&P 500 traded at 20.6 times analysts’ earnings estimates for the next 12 months, according to FactSet. That’s above the five-year average of 19.4 and the 10-year average of 18.

Then there is the September effect on stocks. It’s usually not a happy month for investors. The S&P 500 has lost an average of 1.2 percent in September since 1928, according to Dow Jones Market Data.

This is the worst monthly performance on the calendar. The index has fallen 56% since September.

Ned Davis Research issues stock forecast

But the outlook could soon change, according to Tim Hayes, chief global investment strategist for Ned Davis Research, a respected investment research firm.

The market has become very defensive, as indicated by metrics such as market risk appetite, he wrote in a comment.

“Looking at how defensive the market has become, you’d think either a recession is brewing or inflation is back with a vengeance, sending rates into an upward spiral,” he wrote.

Related: Morgan Stanley, JPMorgan present stock market views

But that’s not the scenario, Hayes said. “The likelihood of a recession remains low, inflation is well under control and interest rates are trending lower,” he said.

“The earnings outlook remains favorable, which would not be the case if macro conditions were to deteriorate.”

So what explains the defensiveness? “It could be the post-summer blues with the arrival of September, historically the worst month of the year,” Hayes said.

Stock market rebound may be coming

“If so, and the macro environment remains constructive despite the recent jobs data, then the market will be poised to recover once the worsening sentiment produces excessive pessimism and September has run its course.”

While September is often a bad month for stocks, the fourth quarter is the best three months of the year, he said. “Of course, we wouldn’t consider a recovery intact without a decisive trend and improvement in magnitude.”

In September, utilities and consumer staples were the only S&P 500 sectors to gain.

Expert Stock Picks:

• Single Best Trade: A Veteran Fund Manager Picks Chinese Stocks
• Top value fund manager says Google parent Alphabet is deep value stock
• Fund manager picks 3 best stocks (including Chevron)

Another market professional expecting a rebound is Mark Hackett, head of investment research for Nationwide Mutual Insurance.

“We expect continued volatility through November as investors await greater clarity on Fed policy, macroeconomic trends and, of course, the upcoming election,” he said.

“However, our outlook for the end of the year remains positive. We expect a strong fourth quarter driven by seasonal tailwinds, reduced election uncertainty and the Fed (rate cuts).

Related: Veteran fund manager sees world of pain coming for stocks