Stocks continued to struggle in Q3 for all the same reasons the first half was rough. If anything, Federal Reserve Chair Powell and his colleagues doubled down on their hawkish messaging last quarter. We said throughout the first six months that the market pullback was rather orderly given that higher interest rates is the problem for stocks – the most expensive and unprofitable companies saw their stocks get hit the hardest. Many profitable companies have seen their valuations decline also, appropriately reflecting the higher discount rate at which future profits and cashflows are now being discounted back to present value.

Stocks rallied significantly in August only to give back those gains and then some in September. After dropping 8% in September alone, stocks appeared to not only be pricing in lower multiples but also the likelihood of a recession severe enough to hurt profits. We still don’t know if the economy will enter a recession or how deep it might be, but after three quarters of brutal stock market action, no one would be caught off guard if it happened. Thus, a lot of bad news is “priced in the market” at current levels.

Chairman Powell does not want to tighten so much that the economy enters a recession that requires the Fed to then cut rates in 2023. But he knows that if he even hints that he’s pleased with the massive drops in across the board in commodities (including lumber, copper, oil, gasoline, wheat, and corn) or acknowledges the defined slowdown in housing, markets will loosen again before inflation is sufficiently wrung from the system. We still don’t think the Fed will actually “drive the economy over the cliff” particularly since Powell has been very “data dependent” throughout his term. However, for any of the Fed’s actions to hold traction and slow the real economy, he must continue threatening to do so.


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