Q4 2024 Equities Forecast: SPX, Nasdaq, Dow and DAX

It’s tough to be a contrarian in equities of late.

As I’ve written in these forecasts for the past year, bulls have continually put in massively strong showings and there’s been little reason to doubt their ability to continue doing the same. To be sure, the prospect of rate cuts coming online was a dominating factor, as the backdrop for corporates eases considerably as lending rates go down. This enables easier access to cheaper capital, less friction on margins, and a greater ability grow and adapt as that cost for non-revenue producing R&D is lessened.

Nonetheless, actual rate cuts haven’t always a been a directly bullish factor for stocks. It takes just one spin around social media to see several charts for why equities might be primed for a pullback. If rates are dropping that means bond prices are moving higher, by and large, and that creates an opportunity cost for capital that can spell a more daunting backdrop if looking to chase stocks near fresh all-time-highs.

There are counter-cases, to be sure, as there’s also a number of charts and scenarios pointing to prior periods of rate cuts (without a visible recession at the time) in which stocks continued their upward advance.

There’s but one problem with both scenarios and it’s lacking sample size. And the market of today seems vastly different than markets pre-2007 because, at this point, central banks have figured out that they can amass massive balance sheets to help soften the edges of the business cycle. There’s also the more widespread employment of algorithmic trading which can have a strong impact in counter-trend scenarios, such as we saw on the morning of August 5th. That produced the third-highest reading in the VIX index – ever – after only the financial collapse and Covid yet it became a pristine buying opportunity as stocks put in a spectacular rally thereafter.

So, rather than look and adhere mainly to historical precedence, I want to try to focus as much as possible on the forward-looking environment.

The Wealth Effect is the Game Changer

The Fed has a dual mandate but there’s also an implied (or perhaps, inferred) third mandate, and this is something that we learned from the Financial Collapse.

When markets were spiraling lower there showed a type of self-fulfilling prophecy. As regular everyday investors and consumers opened their 401k statements and saw reductions of 5, 10 or 20%, there was a rise in fear. That fear compelled consumers to spend less, to tighten up, to take on a more risk averse nature. And that then had a knock-on effect with lessened consumer activity and an even dimmer economic backdrop.

The wealth effect is the idea that when people feel wealthier, they spend more money. It’s not a foreign concept at the Fed as this was a term coined in 1943 by economist Arthur Pigou. If you open your 401k statement and see a steady gain of 5, 10 or 20%, it’s going to have a markedly different impact in how most people behave with financial decisions moving forward. It’s also something that was spoken of in the financial collapse, and, in that episode, it took a few years for the bank to reverse the mood from sour and dour to aggressive and risk taking. A big part of that was multiple rounds of Quantitative Easing in which the bank essentially subsidized government bond yields by adding the assets to their own balance sheet. And, of course, low interest rates were a major driver as we went almost a decade with only a couple of rate hikes.

Since then – there hasn’t really been a recession in the United States, save for a two-month period ahead of the onset of Covid which, of course, was quickly offset by massive stimulus and a ballooning in the Fed’s balance sheet. In short order, despite global markets essentially being shut down for the pandemic, stocks were able to throttle up to fresh all-time-highs.

This isn’t to say that we’ve reached a form of financial utopia because we haven’t. Those without assets or those with little invested can’t reap the same gains and benefits as those that are. This leads to further hollowing out of the middle class and a greater tilt towards inequality. It also leads to more vitriol from those that aren’t benefitting because they’re constantly being told that they should be happy with stocks surging to fresh all-time-highs, driving innovations like Artificial Intelligence that will continue to change the way that we all live. Yet, they’re forced to stand by the wayside while those with excess reserves benefit more and more from loose, growth-driven policy.

This isn’t a social critique, by the way, as my role in the process is to observe and adapt. But I find this explanation necessary to define the reasons why I’ve remained bullish over the past year, and continue to do so, despite a continued rise in what otherwise feels like obvious risks. To me, it makes little sense to be anything more than tactically bearish. And we’re in one of those scenarios where that may soon come into the equation. But – I’m not looking for a full-scale collapse, or re-pricing, or any admonishment of the wealth effect or FOMC policy. If anything, I’d see a larger pullback as more of a long-term bullish opportunity than anything else.

Recession Risks

This is one of the big factors to account for because, again, save for a two-month period leading into Covid the US economy hasn’t really seen a recession since the global financial collapse. The reason behind that, a central bank willing to take on market assets to their own balance sheet, continues to be a factor as I would not be surprised to see the Fed spring back to action with QE in an adverse scenario.

The US election is of course a risk, as well, but the one thing that both parties seem to agree on is the need for the US government to continue spending more money. I expect this to continue until there’s some adverse reaction in global sovereign bond markets; and that’s a scenario that I do not expect to come to fruition until or unless there’s a greater geopolitical quagmire with China. Needless to say, I don’t have that on my bingo card, at this point.

But, the larger question must be asked: Has the Fed (and Treasury) figured out a way to beat the business cycle?

With no deep recessions in the past 15 years, it’s a worthwhile question. It’s also one that’s impossible to answer as we’re still stuck in that small sample size scenario. As of this writing, the Fed’s yield curve model does highlight that potential for a recession in the next 12 months with their last update in early-September showing a 61.8% probability of such. That sounds bad but to buffer that fear we can take the fact that this same model has shown a greater than 50% probability of such for more than a year. To date, it hasn’t happened.

Traditionally speaking it’s when the Treasury spread normalizes that pain can show in stocks. Because the very nature of 3-month T-bills seeing yields drop that quickly denotes a massive influx of capital into the very short-end of the curve. And that capital will probably come from somewhere and with stocks stretched and even market darlings like NVDA trading at elevated valuations, like 30x sales, that can be a pragmatic shift for institutional investors.

This is one of the obvious risks alluded to above. But the bigger question is whether that’s a pullback or a full-fledged reversal and, at this point, I’m expecting any such scenarios to lead into pullbacks that could put stocks at more attractive valuations.

 

Federal Reserve Probability of US Recession Based on 10-year/3-month Spread

Chart from New York Federal Reserve, ‘Yield Curve as a Leading Indicator’

Stocks Strategy into Q4

As I’ve written in the past two quarters, there’s strong potential for pullbacks. That’s shown in both of the past two quarterly outings with a sizable pullback appearing in the first three weeks of Q2 trade, and another larger pullback showing in the middle of Q3 trade. This can help to inform strategy as we move into Q4 where chasing whilst near highs could be a suboptimal way to go and, instead, looking for pullbacks with initial showings of support as a setup scenario for bounce plays.

There’s one more factor of concern that remains a viable point, as of this writing, and that’s rotation…

If you ask ten analysts their opinion on equity market rotation, you’re likely to get them falling into one of two camps: Either rotation is a sign of a healthy equity market rally expanding across the space. Or it’s a harbinger of a larger pullback as the prior leaders start to become the laggards.

With the Dow having set a fresh all-time-high in the aftermath of the Fed’s first cut, while the Nasdaq remains below its lower-high established in July, that’s a factor of contention.

In my case, I go back to the small sample sizing argument looked at above and instead look at the scenario with a gigantic question mark. It’s impossible to know and thinking otherwise could be misleading. I would like to avoid getting too deeply into either bullish or bearish camp around the answer to the question as it can hinder adaptation through Q4 when these themes continue to get headlines. But, from a strategy perspective, this does highlight the fact that, if looking for larger pullbacks or sell-offs, the Nasdaq may be a more opportunistic venue. And if looking for steady continuation, the Dow can make a stronger case.

For my forecast into Q4, I’m expecting that US equities finish the quarter higher than they start it, so, a bullish forecast. Early-2025, however, could be a different story and like what we saw in 2022, the turn into a New Year can bring a new motivation in equities as rate cuts dominate the fundamental backdrop. But that remains to be seen and the way that the 4th quarter prices stocks will likely be telling as far as that is concerned. So, we’ll get there when we get there but, for now, I’m looking for pullback potential ahead of any possible Santa or Santa-like rallies into the end of the year.

 

S&P 500

The SPX index has been up as much as 64.21% from the Q4, 2022 lows, and 39.71% from the Q4, 2023 lows.

In Q3 of 2024 we did see a sizable pullback appear in in July, leading into August. Many headlines pointed the finger at the unwind of the Yen carry trade, which likely played some role. But, I’m dubious on the fact that it was the dominant driver as there was also a fast move-lower in yields as market participants tried to get in front of inevitable rate cuts from the FOMC, speaking to the opportunity cost factor looked at earlier.

But, from this simple analysis in the paragraph above one thing should be clear: Pullbacks can be attractive when they finally begin to find support. And to be sure, each of those pullback scenarios was met with some supportive central bank speech, further illustrating the importance of the wealth effect to policy.

Chasing the S&P 500 from current levels is a challenge especially given that I’m writing this just a couple of days after the Fed’s first rate cut in more than four years. But, like we saw in August, or April, or Q4 of 2022 or 2023, waiting for that pullback could be a more opportunistic venue for establishing bullish exposure.

For levels or where to look – the August pullback was a 23.6% retracement of the 2022-2024 rally (at the time) and support showed soon after a test of 5,155, so it remained relatively light, all factors considered, even if it did start to push a bit of panic with some notable market voices calling for ‘emergency rate cuts’ at the time.

The 5400 level remains of interest as this provide a higher-low in early-September trade. Below that, I’m tracking a confluent spot of Fibonacci levels around the 5,200 level. The 5k psychological level is key below that, but there’s one more zone of interest in my opinion, taken from the 2022 high up to the 38.2% retracement of the 2022-2024 rally, plotted between 4,818 and 4,877.

If bulls can’t hold that zone, then larger problems (or pullbacks) may be ahead.

SPX Weekly Price Chart

Chart prepared by James Stanley; data derived from Tradingview

Nasdaq

While the S&P 500 is currently grinding through the 161.8% Fibonacci extension of the 2022 pullback, the Nasdaq has so far held a near-perfect high at its similar mark.

And – it held a lower-high after the August bounce, with bulls unable to test through the 20k psychological level. That same lower-high has come back into the picture after the FOMC’s rate cut and this is what I had alluded to earlier with the fact that the prior leader has now become the laggard.

So, for those that are looking for larger pullbacks or, perhaps even those looking for wider-scale reversals, the Nasdaq appears to hold more attraction given the current technical backdrop.

Given when I’m writing this and when you’re likely to read it, it’s a bit more difficult to try to perfectly time a support inflection. But, as far as levels are concerned it’s the zone from 18,416-18,485 that’s key for bulls to hold to keep the door open for a test of the 20k psychological level. Below that, there’s a wider zone from 16,764-16,969. The bottom of that area is currently about -15% away from current prices so that would be a moment-of-truth for Q4 equity themes if it does come into play.

Nasdaq Weekly Price Chart

Chart prepared by James Stanley; data derived from Tradingview

Dow

While the Nasdaq lags behind the S&P 500 the Dow has been leading the way-higher.

I’ve written a lot about the 40k level here over the past few quarterly forecasts and it took quite a bit of effort for the Dow to finally break above that. Most recently, in early-September, it functioned as support as bulls were able to quickly respond to a pullback while driving up to another fresh all-time-high.

Some analysts have ascribed this as a positive macro factor while others look at it as bulls that have been late to the party chasing a market that hasn’t been as stretched. Again, I’m dubious on both scenarios as this is a small sample sizing sort of situation. Instead, I want to merely follow and adhere to price, so that 40k level is a key spot for buyers to hold to retain control of the trend.

With that said, there is now an argument for resistance as we’ve just started to test the 161.8% extension of the 2022 sell-off. This is the same marker that has so far caught the top in the Nasdaq and is being grinded through in the S&P 500. So, the key here will be buyers steadying the ship on pullback scenarios.

I would be careful of getting suddenly bearish on tests below 40k however, as the 39,208 level could suffice as support and, in-turn, highlights bear trap potential if it does come into play. Again, for bearish equity pushes I’d be more partial to the Nasdaq setup looked at above.

Dow Jones Weekly Price Chart

Chart prepared by James Stanley; data derived from Tradingview

-- Written by James Stanley, Sr. Strategist

Follow James on X: @JStanleyFX