3 Things Investors Need to Watch in the Fourth Quarter

This year has turned out to be much more volatile for the stock market than in recent memory, and market observers say there are plenty of factors to watch going into the end of 2018.

The S&P 500 stock index was up nearly 11 percent this year before giving most of its gains back last week. Trade tensions, monetary policy shifts, a rising U.S. dollar, changes in tax policy and regulations are just some of the factors affecting market returns. Many events could shape market direction in the fourth quarter, and analysts say they’re watching a few key factors.

Midterm elections. Jeff Mills, co-chief investment strategist at PNC Financial Services Group in Philadelphia, says there are several topics he’s watching between now and year’s-end, but the one that comes up with clients more than anything else is the midterm election.

[See: 10 Reasons Warren Buffett Is a Better Investor Than You.]

“By and large, the biggest concern at this stage I think is that the results of the election are somehow going to put the shift we’ve seen in this pro-business climate in jeopardy,” Mills says. “I think regardless of your politics, the fact is that the tax and the regulatory environment have changed more in the past year and a half or so than they have a very, very long time.”

Mills says the change in the taxes and regulations have been “a really powerful effect as it relates to what the market’s been able to do.”

He says although some of his clients are concerned if Congress’s makeup changes it could mean a rollback of some of the tax and regulatory changes, the markets don’t seem to be reflecting that worry, and he doesn’t think that’s a likely outcome, whether or not Republicans maintain control of Congress.

“I think if the Democrats take control of the House and Republicans keep the Senate, [which is] more likely what’s priced in right now, the old mantra ‘gridlock is good’ as it relates to the market, probably holds true in that … we’ve already gotten the tax cuts,” Mills says.

If Democrats were to take control of both houses of Congress, he doubts there would be immediate policy changes, but rather a look to the 2020 presidential election and whether it could foreshadow a return to the previous policies.

“The markets may react to that,” Mills says.

Interest rates. Kevin Logan, chief U.S. economist at HSBC in New York, says the Federal Reserve signaled repeatedly that it would raise rates 25 basis points in December, following the September rate hike. The Fed has also repeatedly said the committee thinks that gradual increase in the federal funds rate will be appropriate given the labor market conditions, allowing it to reach its inflation target, which could mean two to three hikes in 2019.

[See: 7 Ways the Midterms Could Affect Investors.]

With a strong economy and labor market, and focus on other factors such as the fiscal stimulus, tariffs and possible trade wars, the laser-like focus on the Fed might be receding, which officials there may be happy about, Logan says.

“Given the way they’re proceeding with gradual increases, it’s not disturbing markets at all,” he says.

However, Logan says, if the December rate hike occurs, it will for the first time in a long while put short-term interest rates in positive territory, in real terms — that is above the inflation rate. That could be finally good news for savers as banks may start to offer a slightly better return on their short-term rates. But that means higher borrowing costs.

“The question is, when does that begin to bite?” he says.

Logan is watching where the neutral rate may be — not too accommodative and not too restrictive. Some economists and others are suggesting it could be 2.5 percent to 2.75 percent. For the rest of this year, he says he’ll keep an eye on markets that are directly affected by changes in interest rates, like motor-vehicle sales and housing, as mortgage rates are creeping higher as the yield curve flattens.

“So what to look for as we approach the end of the year is what’s happening in the interest-rate sensitive sectors of the economy and is the Fed approaching neutral sooner than some of the policymakers think; are things getting a little restrictive earlier or not,” he says.

Trade and tariffs. Tim Courtney, chief investment officer of Exencial Wealth Advisors in Oklahoma City, says the uncertainty produced by the U.S. seeking to renegotiate trade deals and putting tariffs on certain imports have put pressure on international markets.

“The markets have really favored the U.S. in all of these discussions and really punished international markets unfairly,” he says.

He points to the recent agreement on the renegotiated North American Free Trade Agreement, now known as the U.S.-Mexico-Canada Agreement, as signs that these talks may get worked out. He expects deals to get worked out with Europe and other partners, leaving China without a deal.

“That’s the big wild card,” he says. “Exactly what is this going to do to global growth, and how much of a hit are these countries [U.S. and China] going to take.”

[See: Top Momentum Stocks From 9 Different Sectors.]

Because U.S. stock markets have enjoyed such a big run up, Courtney says he’s taking profits by selling some U.S. positions and moving some of that money into bonds for clients who need liquidity and income, where yields are 2 to 3 percent. He says he’s also looking at some international sectors, and U.S. financials and industrials sectors which haven’t seen as much as a run up as some technology or health care names.

“We want to go buy some of those areas that haven’t participated (in the stock-market rally) because even though their earnings are coming in at all-time highs, the stock market is just not rewarding them,” Courtney says.

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3 Things Investors Need to Watch in the Fourth Quarter originally appeared on usnews.com

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