Despite Bumpy Ride For Markets, Economy Chugs Along

As November begins, it’s a good time to take stock of what happened in the markets in October. Unfortunately, the news was not positive. We saw pullbacks across the board, with interest rates continuing to edge up. The U.S. indices declined for the third month in a row in October, by around 2 percent, with the Nasdaq performing the worst. International markets also dropped, by around 3 percent for both developed and emerging markets. Even fixed income was down for the second month in a row.

So, will this bumpy ride continue, and what does it mean for the economy? Let’s take a closer look.

Signs of Stress for Consumers

Although markets were down, the economy continued to chug along. Job growth remained healthy, consumer income and spending continued to grow, and retail sales were up strongly. That said, there were some signs of slowing in the employment data.

Consumer confidence dropped somewhat, influenced by higher gas prices and the continued weakness in the housing market. So, while the economy as a whole continues to grow, we are seeing increasing signs of stress for consumers.

Business Side Remains Solid

On the business side, the news was good overall. Manufacturing confidence is moving close to expansionary levels. And while service confidence ticked down, it remains healthy. Business investment was also solid last month, another good sign. We’re still in a pretty good place, economically speaking.

One area we do need to watch, though, is the inflation data. While the housing market will continue to pull inflation down, other components may be starting to strengthen. Again, the news remains good—but there are signs that improvement is slowing.

Market Risk Factors

With the economy solid, the major factors driving markets down in October were twofold: interest rates and war. Long-term interest rates rose further during the month, from 4.6 percent to more than 5 percent, before pulling back a bit at month-end. As rates rose further, markets have been adjusting their long-term expectations and, therefore, stock market valuations, which drove the pullback. Also weighing on markets was the Hamas terrorist invasion of Israel and the prospect of a wider Middle East war. It was a difficult month across the board.

Despite those very real concerns, there are also some bright spots. Earnings are coming in better than expected this quarter, which is a positive and offsets some of the damage from valuation contractions. Earnings are also expected to keep growing over the next several quarters, which should help. For rates, while they are up, there are also signs they may have stabilized and are likely close to their peaks. Finally, while September and October can be tough months, the remainder of the year is usually stronger. With a solid economy and with earnings growing, the market foundations are still in good shape.

Room for Recovery

None of this is guaranteed, of course. Risks remain, both here in the U.S. (inflation and the Fed) and abroad (Hamas war, China, Russia, and other problems). But with this many worries seemingly priced in over the past couple of bad months, there is room for a recovery, especially as the fundamentals remain solid. Despite everything, we are still in a pretty good place.