Stock market outlook for October 2023

The U.S. stock market is coming off its worst month of the year and a selloff that intensified in September. The market’s losses in the past two months wiped out a significant portion of the gains achieved in the prior seven months as investors have become more concerned the Federal Reserve will keep interest rates high even amid some signs of economic weakness.

The major benchmarks for the U.S. stock market have all tumbled since late July, reversing anywhere from 20% to more than 75% of the gains up to that time. September’s losses added to this selloff, as the Nasdaq Composite Index slumped 5.8%, the S&P 500 fell 4.9%, and the Dow Jones Industrial Average was down 3.5%.

As market participants had widely anticipated, Federal Reserve policymakers left a benchmark interest rate unchanged at their September meeting. But even as the central bank is close to its final rate hike to combat inflation, policymakers have warned a “higher for longer” strategy is likely necessary to keep inflation in-check so long as the economy remains strong. Investors are slowly coming around to this idea.

“What we’re experiencing right now is a re-test of investor convictions about the economy, the stock market, and earnings — and it’s happening during the more seasonally challenging period of the year,” notes Sam Stovall, chief investment strategist at CFRA Research. October has a bad reputation in markets, mostly because of a market crash in 1987, but it winds up being “a pretty good month,” with average gains that beat the average for all other months, he adds. “You’ve got to take the bad with the good.”

Some good news: Hours before the deadline, Congress passed a bill to avoid a shutdown with a deal that will keep the federal government funded through November 17. That deal eliminated a potentially significant cause of uncertainty, though investors should still brace for turbulence. October historically is 35% more volatile than the average of the other 11 months, according to Stovall’s calculations.Here’s what to watch in the month ahead, and how to invest in October and beyond.

Market participants are trying to reconcile the higher-for-longer messaging from Fed policymakers with economic reports that point to more weakness in the U.S. economy. And worries about a recession linger, even if economists have pushed back their projections for when such a downturn might arrive. “Right now, we’re at maximum uncertainty,” says Brad McMillan, the chief investment officer at Commonwealth. 

Sentiment among consumers is a top concern for McMillan heading into October. That’s because a monthly gauge from The Conference Board that tracks consumers’ assessment of the outlook for income, business, and labor-market conditions in the next six months fell in September below a level that historically signals a recession within the next year. 

While Americans reported feeling more optimistic about the present situation in the economy, their concerns about the short-term outlook warrant attention. That’s because consumer spending accounts for more than two-thirds of gross domestic product (GDP). “The consumer has been what’s driving the economy so far, and if that changes so does the path of the economy,” McMillan notes. The next report from The Conference Board is scheduled for release on Oct. 31.

Another reason why stocks have fallen out of favor is that fixed-income assets have become more attractive. The yield on the benchmark 10-year Treasury notched a 15-year high in September, as it approaches an important “psychological level” of 5%, McMillan notes. Jamie Dimon, CEO of JPMorgan, has warned that yields could reach as high as 7%.

The higher yield for Treasury bonds, considered to be among the safest investments, could lure some investors away from the stock market. What’s more, the current backdrop of high interest rates has already impacted stock valuations — and that could weigh further on the stock market if Treasury yields continue to rise, McMillan notes.

At the September meeting of the central bank’s Federal Open Market Committee (FOMC), policymakers signaled in their economic projections that they’ll raise the benchmark federal funds rate one more time this year. There are only two meetings left; the first is Oct. 31-Nov. 1 and the second is Dec. 12-13.

Despite these projections, market participants aren’t yet convinced the Fed will follow through. Traders currently expect, with at least 55% probability, that central bankers will hold steady at these two meetings and won’t raise rates from the current range of 5.25% to 5.5%. 

Expect the market to continue to readjust expectations for the Fed’s rate policy leading up to those meetings. While McMillan is in the camp that sees another pause on rates at the upcoming meeting, Stovall is expecting a rate hike — and cautions that stronger-than-expected economic reports and messaging from the Fed could cause investors to worry about the potential for another rate hike in December. 

That said, the most-recent reading of the personal consumption expenditures (PCE) price index, the Fed’s preferred measure of inflation, signaled that price increases are moderating. The next PCE report for September is due Oct. 27.

Even amid signs the Fed’s aggressive policy is taming inflation, the Fed’s warning of a higher rate environment is worth heeding. Going back to 1990, the Fed historically waited nine months after the final rate hike to begin cutting rates — and “maybe it will be a little longer this time,” Stovall notes.

While the pullback in the market during the past two months has been driven by rising fears among investors and there’s still a lot of uncertainty hanging over the market, things aren’t as doom-and-gloom as they might appear. Companies in the S&P 500 have reported a 0.1% decline in third-quarter earnings from a year ago, though earnings season will continue into October—and the quarter could end up being positive, Stovall notes.

The market could still have “some running room” through the end of the year, McMillan adds. And market volatility could provide a good opportunity to take advantage of dollar-cost averaging—or buying assets with modest amounts of money at regular intervals. This is a strategy McMillan has been recommending recently for investors. 

Historical trends could also provide some momentum for a turnaround in the market. That’s because October marks the start of what’s traditionally a “favorable” fourth quarter for stocks, and particularly in years leading up to presidential elections when a first-term president is in office, Stovall notes, citing data he’s analyzed dating back to World War II. 

While this type of seasonal trend isn’t guaranteed to repeat, it’s “an encouraging sign,” Stovall says. “October may offer investors a nice buying-in opportunity.” 

Specifically, stocks in the communication services, consumer discretionary, technology, and industrial sectors may be worth a look. “Those areas that have been beaten up the most could recover quickest.”

Finally, it’s important to keep a long-term outlook during periods of short-term uncertainty. Even with the areas of economic weakness that McMillan is monitoring, neither the stock market nor the economy are in disaster territory. That’s why, he says, some of the tried-and-true investing advice still applies. “It’s pretty much: keep calm and carry on.”

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This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at [email protected].