“The anointed don’t like to talk about painful trade-offs. They like to talk about happy ‘solutions’ that get rid of the whole problem – at least in their imagination.” – Thomas Sowell

“Trade-offs have been with us ever since the late unpleasantness in the Garden of Eden.” – Thomas Sowell

“The end of the summer is not the end of the world. Here’s to October…” – A.A. Milne

Stocks are heading materially higher by year end. This has been our call and remains so as we head into October. Historically, September is the worst month for stock performance while the final two weeks of September is historically the worst two-week stretch for the year. Boy did those statistics play out this year! October, on the other hand, is known as the “Bear Market Killer” and we expect its reputation to be confirmed this year.

Jeff Hirsch, of Almanac Trader, has the following to say about October during this midterm year; “October has been a turnaround month—a “bear killer” if you will. Twelve post-WWII bear markets have ended in October: 1946, 1957, 1960, 1962, 1966, 1974, 1987, 1990, 1998, 2001, 2002, and 2011 (S&P 500 declined 19.4%). Seven of these years were midterm bottoms.” We expect 2022 to be added as the eighth year for midterm bottoms.

Much of our confidence in stocks for the fourth quarter comes from negative sentiment readings. Many sentiment indicators are registering levels not seen since the Great Recession or beyond. When negative sentiment is as high as it is now, stock rallies can be breathtaking. As we have said to clients many times, when everyone who wants to sell stocks have sold them, the only people left are buyers. This is when a solid low can be formed.

Of course, negative sentiment indicators rise for good reason. There is a war in Europe, the Fed is hiking rates, layoffs are happening, etc. However, sometimes sentiment runs extreme, and prices drop too much. Just like there are times when investors get too greedy, they also get too fearful. We think that describes where markets are right now.

While there are any number of financial and economic issues to fear, the fact is that consumer balance sheets, bank reserves, and real estate prices remain solid. Heading into a recession these facts stand in stark contrast to the recessions of ’08, ’90 or ’82. This will allow the Federal Reserve to remain aggressive as they rein in inflation. It is also why any recession will likely be shallow in depth and short in time.

At the heart of what has led to the negative sentiment is the Federal Reserve and its decision to raise interest rates. Many are worried that the Fed will raise rates until the economy breaks and slides into recession. There is a fear that the Fed is now out of sync with the economy and will lose everything from credibility to control of the economy.

We never pass judgement on policy decisions from the Fed or the government. If we did it would do nothing to help us make investment decisions. Rather, we focus on what impact the policy decisions will have on markets so that we can better navigate the investment waters for our clients. That said, we view the Fed’s decisions over the past year and, frankly, since the Great Recession as easy to follow and not as easy to criticize as some do.

Since the Great Recession, the Fed has been fighting DEFLATION using Quantitative Easing and Zero Interest Rate Policy. All along without the help of any fiscal assistance from the government. From 2015 through 2018, the Fed tried to move away from zero interest rates by raising them 9 times by 25 basis points each. Unfortunately, deflation was not yet extinguished, and the Fed was forced to reverse course at the beginning of 2019.

Neither inflation nor deflation are good for the economy. However, deflation is more dangerous and harder to control than inflation. Despite all its effort, the Fed could not destroy deflation with unprecedented stimulus. Then COVID happened.

With the prospect of a total shutdown of the global economy, both the Fed and the U.S. Treasury teamed up to backstop markets. This massive intervention accomplished a few things. First, it prevented the economy from spiraling into the abyss. Second, it finally slayed the deflation dragon once and for all.

However, as the Thomas Sowell quotes above remind us, there are no solutions, only tradeoffs. In this case, the tradeoff to slaying the deflation dragon and staving off an economic Armageddon is now we are dealing with inflation and the recession “can” that was kicked down the road is now upon us.

It makes sense to us that the Fed was late to raising interest rates once inflation showed up. After all, they had just raised rates a few years ago only to see deflation re-emerge. To the Fed’s way of thinking, why not wait for confirmation that deflation was dead before raising rates? After all, they have more tools to battle inflation if the economy runs too hot than they do if we slip back into deflation.

So, here we are. Supply chains are starting to come online, but at the same time demand is starting to slow. Savers who have been waiting for 4% bond rates are getting them but along with 8% inflation. Wages are starting to move up, but layoffs are on the rise. Tradeoffs for sure.

What we think is coming in 2023 and beyond is not far from what we saw following the Spanish Flu pandemic. The last pandemic that led to a global economic contraction and change to our social fabric.

In response to the Global Pandemic of 2020, the entire world effectively sheltered in place. Any textbook written before 2020 taught the student to expect a recession if such an event occurred. After all, the Spanish Flu pandemic of 1918 led to a recession. While no textbook offered a lesson on what would happen if the global economy was shut down for several months, even a “D-minus” student would have answered this “What if?” question correctly that a recession would follow.

However, despite the fact both a pandemic and a global shutdown occurred at the same time, the global economy (United States in particular) suffered only a technical recession that lasted weeks. There was no economic depression. No bread lines formed. No banking crisis developed. No mass bankruptcies developed. Instead, the stock market soared along with real estate and automobile prices.

No such calamity befell the global economy because the coordinated efforts of central banks and governments around the world prevented it. Unprecedented monetary and fiscal stimulus was injected into the economy with the design to offset what the textbooks tell us would have been a devastating recession or worse. While we will never know what would have happened to the economy if no actions were taken, it is safe to say it would have been painful.

Under the heading, “There is nothing new under the sun”, let us look at stocks and the economy during the Spanish Flu pandemic of 1918. I have described in previous client letters that there is more value in identifying what is the SAME between market cycles than focusing on what is DIFFERENT. What is different is readily apparent. What is the same takes some effort to identify. Therefore, recognizing similarities is more valuable and can lead to better decisions in the present.

There are some interesting similarities between the stock markets and economies of the Spanish Flu era and the COVID era. The Spanish Flu ran from February 1918 through April 1920. The Dow Jones Industrial Average gained 10% in 1918, 30% in 1919 and declined 32% in 1920. Inflation followed the end of WWI as troops returned home. The Federal Reserve resisted raising interest rates despite rising inflation. The U.S. economy entered recession in January of 1920 and ran through July 1921.

The COVID pandemic began in February 2020 and “officially” ended in September 2022. The Dow Jones Industrial Average gained 7% in 2020, 25% in 2021, and has declined 23% so far in 2022. Inflation spiked just as COVID was ending but the Federal Reserve held off raising rates until March 2022. Signs of recession are popping up all around the economy even if we are not officially in one.

So, both pandemics lasted 2 years+. Stocks performed “OK” in the first year, tremendously in the second year and flopped in the year following. Inflation rose dramatically at the end of both pandemics. In both cases, the central bank waited to raise interest rates leading to an inflation-induced recession.

What followed the Spanish Flu was the “Roaring Twenties.” A period of growth and prosperity that followed one of the darkest times for this country since its founding. A time when faith in humanity was low and fear of the unknown was high. Economic conditions were weak and cynicism toward the government ran high.

Following are the returns for the Dow Jones Industrial Average during the “Roaring Twenties”:

1921 12.3%
1922 21.5%
1923 -2.7%
1924 26.2%
1925 25.4%
1926 4.1%
1927 27.7%
1928 49.5%

*Source: Macrotrends, LLC

In the eight years that followed the Spanish Flu pandemic, World War 1 and the 1921 recession, the Dow Jones Industrial Average averaged just shy of 20% per year. We know what followed 1928 but that is how cycles work.

A common view today is that corporate earnings are headed lower. After all, inflation will erode profits, the strength of the U.S. dollar is weighing on profits and economic activity is slowing down. We agree with all these observations. However, we think stock prices have largely, if not completely, discounted these negatives.

Stock prices act as a discounting mechanism. The negative headwinds that lie ahead are widely recognized. Investors know that earnings are likely to decline, inflation is back, the midterm election is in November, Russia is at war with Ukraine, etc. If earnings going down is supposed to lead to stock prices going down, why are stocks already down 20% this year when earnings growth has been good this year? The reason is because stocks look beyond the current environment and beyond known risks…eventually. We think “eventually” is upon us.


The end of the downturn in stocks is near. We understand the case some are making for further downside in stocks. There is a case for downside to the 3,400 to 2,800 level on the S&P 500 Index. We see this as a low probability scenario and believe it is more likely that stocks reverse course soon.

Negative sentiment readings have reached levels that are more extreme than those reached during the Great Recession or COVID. We simply do not see corporate fundamentals or policy decisions justifying such negativity from investors. If something other than a total collapse in the global economy happens, we think stocks will turn higher soon.

While the S&P 500 Index ended September on a downturn, the number of stocks making new lows has diminished. This is a signal that the selling pressure is drying up. The Fed is determined to quash inflation, but they are sensitive to being the problem rather than part of the solution. This means they will pause rate hikes once they see damage being done to the job market.

Three of the best quarters, out of sixteen, in the presidential cycle start today. Further, there has never been a negative return for stocks one year out from a midterm election.

Despite all the negative news surrounding inflation, the war in Europe and usual political bickering in the U.S., the American consumer remains strong. Corporate balance sheets are in great shape and the banking system is flush with reserves. None of these positive characteristics are guaranteed to be permanent, but they do offer protection heading into the recession.

Our focus is on sectors and stocks that benefit from a strong dollar, have seasoned management, solid balance sheets, and above average returns on capital. This means we expect to see healthcare, energy, consumer, financial, and industrial stocks outperform.

We have tracked stocks we would like to buy for clients at lower prices during this downturn. Sticking with our discipline, we soon expect to move to fully invested in managed accounts.

Past Performance Does Not Predict Future Results.


Kessler Investment Group, LLC

All information in this presentation is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic performance data is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. Certain statements contained within are forward looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Please consult your adviser for further information.

Opinions shared in this presentation are not intended to provide specific advice and should not be construed as recommendations for any individual. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.