October Gains Thrilled Investors, Now The Fed Has Its Say

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After two months of painful losses, stocks put together a nice, solid October rebound.

The Dow Jones Industrial Average had a sensational month, jumping 13.94%, its biggest monthly gain since January 1976.

The S&P 500 rose 8%, and the Nasdaq Composite added a solid 3.9%. The gains, however, come with two caveats.

  1. 2022 has been a rotten year and is likely to end as the worst year since 2008
  2. The party could end on Wednesday

Wednesday is when the Federal Reserve Board is expected to announce it was pushing the rate on its key Federal Funds by 0.75%. The announcement will come after a two-day meeting and will push the federal funds rate to 3.75%-4%, a level last seen in January 2008.

More rate hikes are expected in December and in 2023, along with a parallel move to pull money out of the economy as the central bank continues to wage war on U.S. inflation .

The real question facing the Fed's Federal Open Market Committee (FOMC), the Fed's rate-making body, is the size of the rate increases to come. Chairman Jerome Powell may not offer an explicit answer at the news conference he'll hold after the announcement. But he will probably offer some signals.

Here's what to listen for. If Powell says there's been too little progress on taming inflation and the Fed must continue to be ultra-hawkish with big increases in December and in 2023, the October rally may stall quickly.

But if Powell says something like, "We will raise rates at a less aggressive rate starting in December and maybe even stop to see if our policy is working," stocks could rally harder than they did in October.

The Fed decision is one of a bevy of economic reports that climax Friday with the October jobs report, expected to show an unemployment rate under 4% and nonfarm payrolls rising by around 200,000, down from 263,000 in October. (The number is likely to be revised both on Friday and in another month.)

But what the Fed really wants to see to prove its strategy is working is job growth slowing significantly. (It was 311,000 in August) accompanied by an uptick in unemployment.

In addition to economic reports, the third-quarter earnings season is in full swing with some 2,800 U.S. companies reporting earnings this week.

Winners And Losers

The stock market's October rally was not about tech, especially big tech, or at least about big tech in a good way.

Energy, industrials, and financials were the Dow's biggest drivers. Caterpillar (NYSE: CAT ), Chevron (NYSE: CVX ), and Honeywell (NASDAQ: HON ) were the Dow leaders; up 31.9%, 25.9%, and 22.2%, respectively. ExxonMobil (NYSE: XOM ) and Chevron (NYSE: CVX ) both hit 52-week highs on Monday.

There were just two decliners among the 30 Dow stocks: Microsoft (NASDAQ: MSFT ), off 0.3%, and Verizon (NYSE: VZ ), down 1.6%.

The Nasdaq and Nasdaq 100 saw smaller gains because of tech's woes.

Energy has been the best-performing sector of the market all year and is up 60.8% as crude oil shot up to as high as $122.11 a barrel in mid-June and gas prices topped $5.00 a gallon in mid-June, up 52.7% for the year and up 195% from 2016, according to the American Automobile Association, which tracks prices. Prices have fallen well below $4 a gallon but are still 10.6% higher than a year ago and 76.1% higher than on Oct. 31, 2020.

The sector was knocked down Monday, however, by reports that President Biden was considering proposing a windfall profits tax on energy producers as he tries to get oil companies to lower energy prices to consumers.

Techs were another story. Microsoft's small decline was an improvement over September's 10.9% decline. But the shares are down about 31% for the year. Meta Platforms (NASDAQ: META ) has discovered building the metaverse (a combination of video and software) is expensive and hard to define. And many investors gave up after the company reported third-quarter earnings and said it planned to continue to invest in the metaverse. Shares fell 31% in October and are now down 72% for the year.

Apple (NASDAQ: AAPL ) was up 10.9% for October, a significant improvement over its 12.1% loss in September. It's still down 13.6% for 2022, however. The iPhone giant more or less cheered Wall Street with its fiscal fourth-quarter results . The shares are up nearly 13% for the month but down Monday as reports from China suggested iPhone production may be disrupted by a big jump of COVID-19 cases at its key Foxconn (TW: 2354 ) plant.

But Wall Street was underwhelmed last from quarterly results from Microsoft , Amazon (NASDAQ: AMZN ), Alphabet (NASDAQ: GOOGL ), and Meta. By the end of the week, analysts were cutting price targets on Amazon, Alphabet, and Meta by upwards of 20%.

Why October's rally happened

At least four forces combined to produce October's rally.

The persistent hope/dream the Fed will start to ease off on rate increases. And Fed critics have been warning the central bank may go too far with its inflation hike. Some economic sectors are already getting hit by rate increases, like housing and real estate. Mortgage rates topped 7% last week for the first time since 2001. On a $200,000, 30-year fixed-rate mortgage, the principal and interest payment would rise from about $955 a month with a 4% mortgage to about $1331 on a 7% mortgage. U.S. construction activity is down across the country

Hopes the Ukraine-Russia War might end. The impetus was Ukrainian battlefield successes. This fall, however, the war has become more brutal, and both sides seem uninterested.

The September selloff planted the seeds for a relief rally. Relative strength indexes for the Dow, S&P 500, Nasdaq, and the Nasdaq 100 all dropped under 30 at the end of September. A reading under 30 is usually a buy signal. (Above 70 is a warning a market is overbought; above 80 is a guarantee a break is at hand.) Moreover, in mid-September, Moving Average Convergence/Divergence oscillator (or MACD) readings suggested in mid-September stocks were starting to turn higher. MACD is a widely watched technical indicator. (Here's a description of how it works.)

A possible GOP win in the mid-terms. Many investors are pouring money into Republican campaign coffers, anticipating a GOP takeover of at least the House of Representatives in next week's mid-term election and possibly the Senate.

Risks Ahead

Even if the rally moves ahead because the Fed really does signal a pause, there are a host of risks facing investors.

The Fed may slow down the rate increases, but interest rates will still rise. In addition, higher rates can take months before their effects are truly visible. The problems emerging in real estate are an early signal. And they are loud. Shares of the iShares U.S. Home Construction exchange-traded fund (NYSE: ITB ) climbed 8.4% in October, but are but down 31% for the year. The ETF's largest holdings include three of the biggest home builders: D.R. Horton (NYSE: DHI ), Lennar (NYSE: LEN ), and PulteGroup (NYSE: PHM ), is off 66% this year.

Many stocks are still overvalued. Chipmaker NVIDIA's (NASDAQ: NVDA ) shares were up 11.9% in October but down 54% for all of 2022. But the shares are still sporting a forward price-earnings ratio of 31. DexCom (NASDAQ: DXCM ), the top performing S&P 500 stock, sports a 109 forward P/E. The shares were up 50% in October but are down 10% on the year. DexCom makes glucose monitoring meters for use by diabetics.

Inflationary pressures will be hard to cap. The Fed may think just raising rates will do the trick, but oil, gasoline, and food prices in the United States are generated in part from conditions outside the country. Russia and Ukraine are among the biggest exporters of wheat and other grains, and food prices are a big reason for current inflation. Members of the Organization of Petroleum Exporting Countries are being mostly disciplined in oil and gas production.

History may be on the investor's side. In November and December at least. These are two of the three strongest months of the year, according to the Stock Traders Almanac. (April is tops.) Moreover, the holidays are coming, and there is lots of retail spending, whether in the mall or online.

Disclaimer: The author does not own any of the securities mentioned in this article.

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