Market Commentary: Seasonality, Pessimism, and a Passive Fed Still Favor Stocks

Stocks remain positioned for a year-end rally because extreme pessimism and strong private-sector growth outweigh near-term concerns about inflation and monetary policy.

• The S&P 500 fell 0.9% in October, but breadth was strong: the equal-weight index gained 4.9%, the median stock rose 7%, and 349 constituents posted positive returns.
• Hedge funds suffered a 4.2% one-day decline in their long-versus-short positioning on October 22, while short interest approached a five-year high; the authors argue that crowded defensive positioning could amplify a rally.
• November and December are seasonally favorable for stocks, and recent surges into money-market funds and cash-like ETFs have historically preceded equity rebounds, although a catalyst would still be needed.
• Real GDP grew 3.4% annualized in Q3, while final sales to private domestic purchasers rose 4.9% annualized and 3.3% year over year, indicating strong household and business demand.
• AI-related investment is a major growth engine: IT-equipment investment rose 37% annualized in Q3 and software investment 10%; together they contributed 0.91 percentage points per quarter to growth over the past seven quarters.
• Inflation remains broad, with headline PCE at 6.1% annualized in September, core PCE at 3.9%, and year-over-year core PCE above 2.5% for 66 consecutive months, while the Fed keeps rates at 4.0% despite nominal GDP growth of 5.9% year over year.

Takeaway: The authors favor stocks into year-end because seasonal support, strong growth, and bearish positioning could drive a rally, but warn that the Fed’s tolerance of a hot economy may eventually require a harsher response that creates greater economic and market pain.