This week saw a re-test of the October lows. That is to be expected in most stock market corrections. What is important to the future well-being of equities globally is that the averages do not decline much further from here.

 

That does not mean that if the S&P 500 Index, for example, falls by another percent or so the ball game is over. Remember, folks, calling the levels of the stock market is an art, not a science. Sure, we could overshoot (most times we do), thrash around a bit more, and then recover. What I don't want to see is a solid and definitive drop lower over a week or more.

 

On the S&P 500, if we were to break 2,685, the next level of technical support would be 2,603. That would, in my opinion, trigger a panicky rush for the exits. If the 2,603 support breaks, then who knows.

 

From a fundamental point of view, there isn't much different that has transpired since last week or, for that matter, the last few months. The elections are over, but the new Congress doesn't get a chance to bat until after the New Year. In the meantime, we are already hearing the

noise levels rise.

 

One Democrat, California's Rep. Maxine Walters, a ranking member of the House Financial Services Committee, has promised to roll back some of the bank deregulation of the past two years. Another Democrat warned that signing on to the new North American Trade Agreement will require "adjustments" in the deal.

 

At the same time, the FANG stocks, led by Apple, continue to batter the technology sector, dragging the NASDAQ index lower. Many individual stocks have already dropped 10 percent, which would technically qualify as a "correction."

 

In a race to the bottom, oil prices have also come under pressure, declining over 20 percent in the last month or so. In hindsight, the oil price was over-extended. Oil is in the throes of a sharp, short sell-off, which is exactly why most investors should steer clear of commodities. It takes a strong stomach to weather the ups and downs of a commodity cycle.

 

Both equities and energy, however, are due for a bounce, which should happen soon. The Iranian embargo, as I predicted, is not working out as well as the president had hoped this second time around. Since many nations did not and do not agree with Trump's unilateral decision to re-instate an embargo on Iranian oil, its effectiveness has been dramatically reduced. Cheating is rampant. Nations may be grudgingly forced to pay lip-service to the U.S. embargo but are looking the other way, allowing their companies to find ways around the Iranian oil embargo.

 

Of course, if you follow the financial news, the bulls of September have now all turned bearish. The TV Talking Heads are showcasing one "Permabear" after another, who are confidently predicting (for the 100th time in the last two years) that this time they are going to be

right. Calls that "The end is nigh," or "Run for the hills," should be ignored.

 

In this atmosphere of panic, pain and fear, try to remember the positives. Seasonality is in the bull's favor. The S&P 500 was up every year after a mid-term election since WW II. And if this were truly the end of the upside for this cycle, where was the blow-off top that has always marked the end of a bull market? No, it is too early to get defensive and it is way too late to sell. 

 

Hunker down and wait. You will likely be rewarded.

 

Stocks are in the process of consolidating after the big gains over the last week or so. So far, the October sell-off has led to a recovery of about half of what was lost. In the two months ahead, we should see even further gains.

 

No matter how much we would like it to, the stock market rarely goes straight up. It is one reason why I constantly advise clients not to check their portfolios on a daily, weekly, or even monthly basis. And never check them in down markets. Why put yourself through that emotional turmoil — especially when you have no intention of using the money anytime soon.

 

As we now know, the Democrats regained the House this week. As I, and everyone else on Wall Street predicted, the Republicans maintained their hold on the Senate. Some races, such as Florida, are still too close to call. But the results were predictable enough for the markets to rally over 2 percent the day after the results.

 

Since then, traders have been selling. That's natural. Once they bank some profits, and some of the overbought technical conditions as well as investment sentiment is reduced, stocks will find their footing and advance once again. In the meantime, get ready for the political noise that will most assuredly begin emanating from Washington.

 

President Trump, at long last, has fired his attorney general, Jeff Sessions. It won't matter who he appoints in his stead, in my opinion, because nothing will stop the Mueller investigation and its findings from being disseminated. The Democrats will see to that.

 

The question that the markets will ask is:

 

"Who, if anyone, did anything wrong?"

 

Chances are it won't be Donald Trump, if history is any guide. Rarely does the captain go down with the ship in politics.  His first mate, bosun, and any number of sailors might drown, but unless he has been stupid and failed in some way to cover his trail, the president will come out blameless. In which case, the markets will celebrate that victory.

 

My column yesterday pointed out that little, if anything, can be expected in the way of legislation over the next two years. That removes an unknown variable from the financial markets. What's left?

 

Trump's trade war and rising interest rates. Both will receive undue attention from investors. Trade will likely take a back-seat until Trump meets his Chinese counterpart this month, which leaves interest rates.

 

Throughout their careers, few of Wall Street's professionals have ever experienced a rising interest rate environment. Most are too young to remember. Many were not even born during the era of the oil embargo, double-digit interest rates and inflation. To them, this is all theoretical and not anchored in experience.

 

Therefore, they won't know when and how rising interest rates may trigger a recession. What's worse, they also won't know when too much inflation, versus too little inflation, is good (or bad) for the stock markets. As such, most of the investment community will live in a state of perpetual jumpiness. Jumpiness is a state of nervousness marked by sudden jerky movements. We just had such a day on Friday.

 

The Fed met this week and simply repeated what the markets already knew: that a rate hike was in the offing next month and further hikes should be expected next year. The only "new" comment was a sentence indicating that business investment seemed to be moderating slightly. Nonetheless, global markets fell on Thursday night and into Friday because many felt disappointment that the Fed was still on course.

 

 My belief is that kind of overreaction may continue to occur. When few in the markets understands the natural process of a growing economy, rising interest rates, and over (versus under) heating, any hike in interest rates is automatically considered negative for stocks.

 

It is not, but one must live through the experience of rising interest rates in order to understand them and to take the process in stride. Unfortunately, our "professionals" are all on a learning curve. What is theory and what is true will only be realized in hindsight. This is the world we live in, so expect more jumpiness in the foreseeable future.  

 

 

It happened like clockwork. Earlier in the week, all three main U.S. averages re-tested their lows and then proceeded to bounce back, only to give it all back. That's what happens during corrections, but it is not over yet.  After all, it is October.

 

Readers will recall that last week I wrote that nine out of 10 times markets will re-test their recent lows. Naturally, this is more of an art than a science, so prices can bottom somewhat above or below those lows. In this case, the Dow hit its lowest level in four months. The S&P 500 Index slipped below its recent lows while NASDAQ got hit the worst, wracking up a total 10percent decline from its highs.

 

This is how it should be since all year long the markets have been led by the advances in the tech-heavy NASDAQ. And by the way, there was no new news on Tuesday. There was no event that anyone can point to for the decline. That also makes total sense when you understand that this entire pullback has been technically-driven. 

 

And it isn't over yet. We still have five days left in October and another six until the mid-term elections. The way the market has been acting this week, we could continue to see 1-2 percentage point-sized swings daily.

 

The fuel for these pyrotechnics is earnings results. Remember my warnings that earnings this quarter, although good, would not be "as good" as the past few quarterly results? As an example, Thursday evening, two of the big FANG stocks, Amazon and Google, reported after the close. Their top line revenue growth was less than expected, which came as a bit of a surprise to investors. No never mind that profits beat expectations since these days profits can be manipulated easily by simply buying back additional shares.

 

Index futures Thursday night dropped like a rock as a result, and Friday morning the Dow dropped 300 points on the opening. Earlier in the week, companies like Caterpillar and Boeing reported. Their announcements were enough to move the markets (up in the case of Boeing, and down on Caterpillar's results). Why, you might ask, do individual company results suddenly have the power to move markets like this?

 

It's all about expectations. Investors have been fretting about Trump's trade war all year. So far, the fallout has only impacted a few areas. Farming, for one, and maybe some companies in the steel business. The fear is that over time more and more companies will pull back investments, lose sales, or be damaged by these tariffs. And what may happen to one, may happen to all.

 

If you believed, as I do, that this is an inaccurate and rather simplistic view of the world than the fact that one company might see some fallout if tariffs are imposed does not warrant taking an entire sector, or in this case, an entire market down with it. However, markets are not rational at times. This is one of those times.

 

Friday, it was announced that the country's economy grew by 3.5 percent in the third quarter, which was faster than expected. Fearful investors barely paid attention to the news. That should come as no surprise. You can search to doomsday for a solid fundamental reason why we are experiencing this sell-off. You won't find one. Bottom line: the markets were overbought and in need of a healthy pullback. Don't over think this one and stay invested.

 

After this week's trade deal between the U.S., Mexico, and Canada, investors are waiting to see if China will now come to the table. What would it take for that to happen?

 

Mid-term elections could be the trigger. It wouldn't surprise me to see a deal before November — since the polls appear to favor the Democrats. Trump's tariff offensives, while supported by most of his base, are deeply disturbing to those who are feeling the brunt of foreign-trade retaliation.

 

Farmers, for example, and blue-collar workers in certain steel-related industries, are suffering. Many of them are also part of the 39 percent minority of Americans who support Donald Trump and his presidency. These predominantly white, uneducated voters might be swayed to vote against the GOP because of these tariff issues. That could mean a drubbing for the "Grand Ole Party" come November.  

 

A deal with China, even one that does little but save face, might be preferable to the president and his party than a big loss in the election booths. If one examines the successful deals the president and his men have negotiated thus far, we see some minor changes in the trade terms, but certainly not the massive overhaul in trade terms we have been promised practically every day for well over two years.

 

Minor fiddling around with auto manufacturing content and $40 million worth of reductions in Canadian barriers to milk imports (think American farm voters) is not a major overhaul of NAFTA. We have essentially cosmetic changes similar to those announced last week as part of the South Korea/U.S. trade agreement. 

 

It appears to me that we are simply witnessing a continuation of Trump's U.S. foreign policy of "Speak loudly but carry a tiny stick." Why should we not expect the same treatment in our on-going negotiations with China, as well as the European Community? A similar deal with China would have little to no impact on our terms of trade but would allow Trump to claim he has "solved our trade problems." It might also improve Republican chances in November.

 

As for the market's reaction, we celebrated with all the indexes soaring at the open on Monday. The S&P 500 Index, at one point, was just five points away from making a new all-time high. The Dow Jones Industrial Average did make a new high on Tuesday and another one on Wednesday. The other indexes were more subdued as investors sorted through the potential winners and losers of Trump's new U.S.-Mexico-Canada Agreement (USMCA).

 

Taking a 30,000-foot view of the markets, what I see are positive returns for six straight months. If we look back to 1928, there have only been 26 prior six-month periods with that kind of winning streak. In the month that followed these events, the S&P averaged a gain of 0.95 percent with positive returns 69 percent of the time.

 

Over the following three months, the index averaged a 3.92 percent gain with positive returns 85 percent of the time. There have been only five prior streaks where the index was up in each month from April through September. In those instances, the average gains were even better.

 

Next week, we begin the quarterly beauty pageant of earnings results for this year's third quarter. Depending on the results, we could see a continuation of the rally and a slow grind higher or, if earnings are disappointing, a sharp, short, pullback, so strap in and get ready.

 

Today marks the end of the third quarter for stocks in 2018. But it is the fourth quarter that will determine what kind of year it will be. Let's place our bets.

 

First, we should look at what could go wrong over the next three months. Tariffs probably lead the list. More of them, (although the dollar amount is minimal in the scheme of global trade), would be bad for sentiment within the global stock markets. Mid-term elections are a toss-up, but simply not knowing the outcome I count as a negative. Quarterly earnings results might also hold some risk for investors. And finally, the latest investor sentiment readings (a contrary indicator) are as high as they were back in January before the stock market sell-off.

 

Since there is no way of knowing what our esteemed president will do on the trade front, let's simply acknowledge that risk and move on. Mid-term elections are also an unknown quantity, but my bet is that the Democrats will take the House, while the GOP will maybe hold the Senate if they're lucky. In all likelihood, after a bit of volatility, the markets will move on regardless of results.

 

As for earnings, they may be a bit different than the pleasant, upside surprises we have become used to over the last two years. Negative pre-announcements by various companies are ticking up. As of this week, 74 out of 98 S&P 500 companies, according to FactSet, have guided lower for the third quarter. So, what gives on the earnings front?

 

It is simply confirmation of what Federal Reserve Chairman Jerome Powell told us this week about Trump's trade war: "We've been hearing a rising chorus of concerns from businesses all over the country about disruption of supply chains and materials cost increases."

 

Bottom line: you don't actually need tariffs to be implemented to impact economic growth. Trump's constant threats and tweets about what he might or might not do on the trade front is creating an atmosphere of uncertainty. Corporations are becoming more cautious, guiding down expectations, and generally delaying expenditures until they see what happens.

 

Right now, investors expect third-quarter revenue growth to average 7 percent, while year-over-year earnings growth should come in at around 20 percent. Sounds good, doesn't it? But those numbers are down from second quarter results of 10 percent revenue gains and 25 percent earnings growth. The fourth quarter expectations are even lower with 6 percent revenue growth expected and 17 percent gains on the earnings front.

 

In the past, I have discussed the phenomena of "peak earnings" and how the wonderful results of the past few quarters have been artificially inflated by one-off events. The Republican tax cut giveaways to the nation's corporations were squandered on buy-backs of shares, increases in dividends, and mergers and acquisitions, but those effects are winding down.

 

Despite the effort in Congress this week to make those tax cuts permanent (in hopes of propping up the markets until after the mid-term elections), it is doubtful the Senate will go along with it. Adding another $750 billion or so to the $1.2 trillion it has already cost to cut taxes this year seems to be a "bridge too far" even for a party that has abandoned all semblance of fiscal integrity.

 

The U.S. Advisory Sentiment data now places the bulls at 60.6 percent, the most bulls counted since Jan. 18, 2018, and the seventh straight count above 55 percent.  Usually, readings above 55 percent indicate caution. Over 60 percent signals elevated risk and the need to take defensive measures. 

 

On the surface, all these arguments should set us up for a bear market in the last quarter. However, every one of these arguments has been around for at least the last three months and look what the markets have done. The Dow is up 9 percent, the S&P 500 Index up 7.5 percent, and NASDAQ gained 7.7 percent. Bottom line: the markets have shrugged off the negatives and moved higher. Why should the fourth quarter be any different?