Q4 market outlook: Will stocks rebound?

Oct. 16, 2023

Most investors were glad to see the third quarter come to an end. Ultimately, markets gave way to weaker historical patterns and stocks moved lower due to persistently high interest rates and a challenging investment environment.

Overall, Q3 left investors in a sour mood. While it’s understandable why investors may let this pessimism seep into Q4 — there’s also substantial reason for optimism as the final quarter begins. Here’s a breakdown of headwinds and tailwinds, as well as our outlook for stocks in Q4:

Headwinds moving into Q4

After the S&P 500 Index hit its closing year-to-date high of 4,589 on July 31, stocks quickly spent the rest of Q3 moving lower. September — a month notorious for its historically poor market performance — lived up to its negative reputation due to the following factors:

Stubbornly tight monetary policy impedes economic activity

The standout items that moved markets lower in Q3 centered around generally hawkish commentary from global central banks and, specifically, a higher-for-longer rate message from the Federal Reserve. Notably, fewer rate cuts projected in 2024 currently have investors starting to believe the Fed could turn the economy into a recession despite growing evidence that inflation is indeed cooling and economic activity is normalizing. We believe backward-looking data on business and consumer trends could complicate the Fed's policy trajectory. Given the recent backup in interest rates, elevated recession risks, corporate earnings crosscurrents and forecasts for weaker economic activity in Q4, a well-diversified/slightly defensive portfolio approach remains prudent for most tactical investors, in our view.

Challenging external environment continues

The investment landscape is clouded by stubbornly tight monetary policy, higher energy prices and weakening consumer trends. Plus, the resumption of student loan payments, an ongoing United Auto Workers strike and a potential government shutdown in November complicates the picture.

Tailwinds moving into Q4

While the above headwinds are unlikely to fade away at the start of Q4, there are reasons to remain constructive as the year winds down. Here’s the case for a strong Q4:

Seasonality factors are favorable for markets

Stocks are higher year-to-date and tend to finish positively in the final quarter when up this late in the year. In addition, seasonality factors should improve as the year ends, economic fundamentals remain sound and earnings growth is trending higher. Stocks entered October oversold. The push higher in interest rates has acted like a wet blanket on risk sentiment, and there are few identifiable near-term catalysts (outside of rates stabilizing) to incentivize the bulls off the sidelines. The Q3 earnings season could be one catalyst, but outlooks must remain constructive for the fourth quarter, which carries some downside risks. Until government bond yields stop moving higher and possibly see some mean reversion back lower, we believe stocks are susceptible to further selling pressure over the near term.

Core inflation is improving

Core inflation metrics should trend lower in the fourth quarter, particularly for shelter costs, which are over 40% of the core Consumer Price Index. In our view, jobs should remain steady, and while we project spending patterns and economic growth to slow in the current quarter, it should remain positive.

Bearish sentiment lays the groundwork for a potential bounce back

Investor sentiment and professional portfolio positioning are very bearish presently, offering contrarian signals to those willing to stay patient and balanced. Notably, bond yields have quickly soared higher and stocks are technically oversold. Thus, stock and bond prices could be in store for a bounce higher sometime in Q4 if Fed messaging begins to sound less hawkish and earnings conditions do not disappoint expectations. For now, we believe a smart path forward for investors is to stay the course and avoid deviating from a well-established investment strategy. In our view, the next few months should provide more clarity on rate policy, economic conditions and earnings trends, which could help establish an investment roadmap heading into 2024.

Simply put, stocks are not taking too kindly to higher rates as the quarter kicks off. While it's difficult to time, and we won't pretend to know when markets will mean-revert, large spikes in rates and pressure across stocks should eventually subside. This could bring stock and bond buyers back into the market, which could help stabilize prices, even if it is just a temporary condition through year-end.

The final quarter is historically a strong time for stocks

As the Ameriprise chart below highlights (and shown in the monthly volatility averages at the bottom of the chart), the percentage of weeks with +5%/-5% weekly moves in the S&P 500 tend to rise in August and crest around mid-to-late October, before falling lower into year-end. Translation: Large moves in the market, which tend to increase volatility, historically are lumped together in the late summer and early fall period. Yet, stocks are now in the October through December period, which is the strongest three-month stretch for equities on average during a calendar year. And while the percentage of large weekly moves in the S&P 500 tends to crest in October, the month as a whole tends to produce a positive return on average.

Sources: American Enterprise Investment Services Inc. and FactSet. These figures are shown for illustrative purposes only and are not guaranteed. It is not possible to invest directly in an index. Past performance is not a guarantee of future results.

Bottom line: Will stocks rebound in Q4?

August, September and October historically produce large swings in the market, but that volatility tends to decrease as the year winds down. Historical patterns aside, investors need to feel confident the rate environment has peaked before stocks and bonds can stabilize and possibly see better trends in the months ahead. In the meantime, investors should look through the volatility and maintain balance across equities, fixed income, cash and alternatives in accordance with their risk profile and investment strategy.

As you think about the final months of the year, reach out to your Ameriprise financial advisor. In addition to providing a personalized perspective on your portfolio, they can also identify year-end strategies that may benefit you.