Dollars and Sense: Investors happily bid third quarter farewell

Weak employment report. The news everyone was waiting for last week, the monthly unemployment report, came on Friday. It was a pretty weak report. The unemployment rate held steady at 5.1 percent, a healthy level. But the number of unemployed persons remained at 7.9 million. The civilian labor force participation rate, already at historically low levels, declined even further, to 62.4 percent in September. Still, the Dow climbed 200 points on Friday. Go figure.

A weak quarter. Also last week, we rolled from September into October and from the third quarter into the fourth. A lot of investors will be glad to have the third quarter in the rear-view mirror. The markets had their worst third quarter in four years. The final numbers for Q3 are stark: The Dow fell 7.7 percent, and the S&P 500 dropped 6.9 percent. The Nasdaq more or less split the difference, giving back 7.4 percent for the three-month period ending in September.

Ugly, but not surprising. Of course, the dip in the second quarter was not surprising. In fact, what was surprising was just how long the markets continued upward. In 2007, the Dow was at 7,000. In May of this year, it was over 18,000. That’s a rise of 11,000 points, far more than doubling in value. We’ve given back about 10 percent of that 250 percent since May, but what we’ve seen is no cause for panic. I should note, though, the CBOE Volatility index, known as Wall Street’s “fear gauge,” was around 25 most of the week, firmly above its long-term average of 20.

Not over yet? It’s also possible the correction is not over yet. This pull-back was more than just a statistical correction. Investors remain worried about the health of China’s economy and its impact on the timing of a U.S. interest rate increase. Last week, Congress temporarily solved one problem causing market jitters by finally passing a plan to keep the government funded past last week’s Sept. 30 deadline. But we got news late on Thursday from Treasury Secretary Jack Lew that the government will run out of cash on Nov. 5 if Congress doesn’t raise the debt ceiling. The national debt already stands at $18.1 trillion. It will be interesting to see how the new speaker of the House, likely California’s Kevin McCarthy, will handle this challenge just days after he’s scheduled to take office.

Positive sign. All of the above duly noted, we should also mention a bright spot: A report last Tuesday showed the consumer confidence index rose to 103 in September, topping economists’ expectation of 96.1. Consumer confidence is at its highest level since January. This number is significant because consumer spending either directly or indirectly fuels about 70 percent of the U.S. economy.

The week ahead. Government reports will be light this week, but with the change in the quarter, we’ll quickly be back into earnings season. Alcoa announces on Thursday, after the markets close. Alcoa is a Dow component and a proxy of sorts for the global economy, as it does business all around the world. Even with the nearly 10 percent drop in the markets, the price-to-earnings ratio of the S&P 500 is still above 20. That’s 10 to 15 percent above the historical average. Last quarter, so many things were going on around the world that we hardly paid attention to earnings. But this earnings season is pretty important. Stock prices always revert to the mean. If we don’t see pretty strong earnings, and almost no one is predicting that, we could see further declines in market values. So for the next two weeks, I’ll be watching earnings closely.

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