The Halloween season is a time for tricks and treats. For those going door to door in costume, the effort is expected to yield nothing but treats. But for investors trick-or-treating in financial markets, the outcome is less guaranteed. Will we get full-sized candy bars, or will we be left empty-handed? Based on our list of key themes below, it is decidedly a year for tricks. Read on if you DARE!

Possibility of additional Fed rate hikes

Contrary to consensus expectations, we believe the Federal Reserve (Fed) is committed to “higher-for-longer” interest rate policy, which could include further tightening if necessary. With interest rates at restrictive levels, equity valuations are under pressure, adding to the market’s headwinds.

Consumers could finally crack

If consumer spending slows due to elevated interest rates, it would help drive inflation back toward the Fed’s long-term target of 2%. However, dramatically reduced consumer spending and lending activity would likely lead the U.S. economy into a recession. To us, it begs the question, how long can consumer strength continue in this environment?

Normalizing yield curve warrants caution 

When an inverted yield curve normalizes, as it recently started to do, it typically signals the business cycle is facing imminent contraction, although that is not always the case. As long-term yields rise more than short-term yields, this “dis-inversion” process could turn out to be the market responding to a reacceleration of the U.S. economy, although we assign this a low probability.

Margin compression seeping in

For the past two years, earnings and margins have benefited from elevated inflation as companies passed on increased costs to the consumer. However, decelerating inflation is likely to become a headwind for further price increases, while cost pressures remain from wages and the tight labor market, which could lead to operating margin compression.

China poised for slowdown

Due to an overleveraged real estate sector, rapidly rising fiscal deficits and shrinking foreign investment from traditional trading partners, China’s policymakers have limited options to help stimulate the economy and avoid an economic slowdown.

Political noise in the background

With the looming potential for a government shutdown, Moody’s Investors Service indicated a shutdown could have a negative impact on its U.S. sovereign credit rating, possibly leaving the United States without a “AAA” credit rating from any of the three major agencies.

Valuations more reasonable, at a price

Rapid price-to-earnings multiple expansion from last year’s lows, followed by an equally fast decline from the July equity market peak, has driven global equity valuations back to their 10-year average. Valuations are moving lower as the result of the recent rise in long-term interest rates, which has been a headwind for the mega-cap leaders driving equity market returns this year.

Murky inflation outlook

The Fed signaled the potential for another rate hike this year, given that inflation remains above its 2% long-term target. With the tight jobs market and positive real (inflation-adjusted) wage growth, consumers may be able to withstand rising prices, which would keep inflation elevated.

Oil price volatility

Crude oil price volatility has jumped in October given heightened geopolitical risks, ongoing OPEC+ production cuts and rapidly slowing gasoline demand. While rising volatility does not necessarily mean rising oil prices, the path of prices will have a material impact on the fate of near-term inflation.

Geopolitical pressures rising

With the Israel-Hamas war rapidly unfolding, combined with the ongoing Russia-Ukraine war, we continue to expect elevated commodity price volatility relative to the prior business cycle. While most geopolitical events do not influence markets over the long term, we believe their inherent inflationary influence will impact the market’s path forward.

Gray rhinos and black swans

Including, but not limited to:

  • The labor market cracks under the strain of restrictive monetary policy.
  • A material credit event takes place in the private debt market (non-banking financial institutions).
  • One or more central banks commit a policy gaffe.