Traders Blow Off US Election Risks as Stocks Race Into October

(Bloomberg) - US stocks survived what's traditionally their toughest stretch of the year, and investors expect the rally to keep running in October despite a contentious presidential election campaign, shifting Federal Reserve policy and fears of a pending recession.

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The S&P 500 Index just posted its third straight winning week and is up 5.1% in the third quarter, putting it on track for its best start to a year since 1997, according to data compiled by Bloomberg. It also has pushed the benchmark's market capitalization above $50 trillion for the first time. And oddly enough, it all happened in September, which historically is the stock market's worst month.

The gains were accomplished for the most part without the help of the Big Tech companies that have provided so much growth for so long. Indeed, the technology-heavy Nasdaq 100 Index is up just 1.7% for the quarter, while the equal-weight version of the S&P 500 has jumped nearly 9%. Meaning, the recent rise has largely been broad based, fueled by hopes that the Fed will engineer a soft landing with interest-rate cuts that started earlier this month.

From here, the question is can the rally continue through next month and into year-end — and if so, what will it look like? Based on positioning data, few traders and investors seem worried enough to bother hedging after playing defense in the early part of the summer.

"I'm really bullish on stocks," said Mary Ann Bartels, chief investment strategist at Sanctuary Wealth, who sees the S&P 500 ending 2024 at 6,000, a roughly 4.6% bump from Friday's close. "The chip rally has paused, and people have taken notice. But Big Tech and semis will lead this market higher in the fourth quarter."

Her intuition is backed by hedge fund trading, which shows nearly three times as many bets that information technology stocks will rise than bets that they will fall, according to Goldman Sachs Group Inc.'s prime brokerage desk report.

Economic Risk

Of course, there are reasons to be concerned. The Fed is trying to engineer a soft landing after a period of rapid inflation and aggressive rate hikes, an effort that's rarely successful. In addition, the probability of a recession in the next 12 months remains elevated, according to the New York Fed.

"Friday's jobs report will be crucial because that will give us more indication on the economy and how much the Fed will cut rates at its next meeting," Bartels said.

That said, consensus expectations are for economic growth to remain steady. The Atlanta Fed's GDPNow model sees real gross domestic product climbing at a 3.1% annual rate in the third quarter, up from 3% in the second quarter.

Options positioning shows similar optimism. The five-day moving average for the equity put-to-call ratio, which rises as bearish bets increase, is near 0.51, its lowest level since July 2023.

This year's stock market rally has defied skeptics ever since growth jitters sent equities spiraling into their worst selloff of the year in the first week of September. It also came without much help from Nvidia Corp., the poster child of the artificial-intelligence boom that's powered the nearly two-year bull run in stocks but stalled out this summer.

The savior for investors has been the rally broadening beyond megacap tech. The S&P 500 Equal Weight Index is on pace to beat the regular market-cap weighted version of the benchmark in the third quarter by the most since the final three months of 2022, according to data compiled by Bloomberg.

Chip Bulls

That mini-slump is why Rich Ross, head of technical analysis at Evercore ISI, is bullish on semiconductor stocks in the fourth quarter, particularly after Micron Technology Inc., the largest US maker of computer memory chips, delivered a surprisingly strong sales forecast. He sees the $253 billion VanEck Semiconductor Exchange-Traded Fund, which includes chip bellwethers like Nvidia, Micron and Broadcom Inc., climbing another 20% by year-end after rising 45% through the first three quarters.

"A rally in tech stocks should be positive for the market's upward momentum," said Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors, whose firm is adding exposure to small cap stocks as well as industrials, materials and energy companies. "But if it comes at the expense of breadth, I wouldn't take that as a healthy sign."

Very short-dated options over the next few weeks appear expensive given that the S&P 500 is at records and there's a lack of strong catalysts, such as key economic data or earnings releases. But contracts that look a bit further out are pricing in a slew of events that have the potential to whipsaw markets.

In a span of six weeks, investors will contend with two crucial jobs reports, a blitz of earnings from some of America's biggest companies, the US presidential election on Nov. 5, and then the Fed's next interest-rate decision on Nov. 7.

Traders are split on the size of the next rate cut, with swaps markets pricing in increasing odds of another half-point reduction. There are risks to either approach.

"If they were to continue at a pace of only 25 basis points, given the trajectory of the economy, we think that that would raise the risk of a recession next year," said Tony Roth, chief investment officer at Wilmington Trust. That said, he still sees the S&P 500 reaching 6,000 by year-end. "With a growing expectation for a soft landing in the economy, there's nowhere else for stocks to go."

-With assistance from Alexandra Semenova and Brad Skillman.

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