Polarized Sentiment

Investor sentiment has become polarized this week as the Fed provided little insight into a potential rate cut next month and concerns over AI valuations continue to mount.

Could we be reaching an inflection point in this bull market? The inspiration for this week's musings is the 1985 movie, "St. Elmo's Fire". Here’s some trivia about the movie:

• This movie was released in the Summer of 1985 and featured several members of the "brat pack" as they were known at the time. The budget for the film is estimated at a paltry $10 million, while the film earned more than $37 million at the box office. This film actually won an Oscar for "Best Album of Original Score Written for a Motion Picture." The Oscar went to David Foster for his composition. Foster would go on to be nominated for 3 other Oscars and won other awards for songs he composed for "The Secret of My Success" and "The Karate Kid Part II."

• This movie launched the careers of several young actors: Emilio Esteves had a breakout role in "The Outsiders" prior to this movie; Rob Lowe starred with Esteves in "The Outsiders" but also had roles in "Class" and "Oxford Blues" prior to this film; Andrew McCarthy had only one major role prior to "St. Elmo" and that was starring with Lowe in "Class;" Demi Moore was a new-comer to Hollywood who had a recurring role on "General Hospital" as Jackie Templeton; Ally Sheedy had done some work on TV and was also in "War Games," and "Oxford Blues" with Lowe prior to "St. Elmo;" Judd Nelson was relatively unknown until "St. Elmo's" and "The Breakfast Club" were released in the same year; and finally, Mare Winningham had parts in numerous TV shows such as "Starsky and Hutch," "Police Woman," and "Family" before getting her big break on "St. Elmo's."

• St. Elmo's Bar is fictional, but was based on "The Tombs," a popular watering hole among Georgetown University students.

• All of the major characters in the story attended Georgetown University. However, after reading the script, Georgetown refused to allow any filming on its campus. All of the on-campus scenes were filmed at the University of Maryland.

• Actresses Jodie Foster, Jennifer Beals, Tatum O'Neal, and Joan Cusack were all offered the role of Jules, but turned it down. Demi Moore got the part after Director Joel Schumacher saw her walking down the hall in his office building as she had just left a casting call for a John Hughes film.

• Some other potential actors who read for various roles, but were not selected: Anthony Edwards, Robert Downey, Jr., Lea Thompson, Brooke Shields, Meg Ryan, Jamie Lee Curtis, Jennifer Jason Leigh, & C. Thomas Howell.

Here's what we've seen so far this week...

There Is No Rate Cut (St. Elmo's Fire). Rob Lowe's character in "St. Elmo's Fire" correctly points out that there really is no St. Elmo and the phenomenon is really just

atmospheric flashes of light that appear around sharp objects to giver the appearance of fire. So too, is the Fed's promise to cut rates 3 times in 2025. Back in September, the Fed's "Dot-Plot" showed 3 rate cuts down to 350 basis points for the Fed Funds Rate. The current futures show only a 39% probability of a rate cut in December. A market that started Thursday higher with welcome news of Nvidia's earnings beat and positive forward guidance, saw a greater than 1% drop by the end of the day because the Fed can't explain why a 3rd rate cut is now off the table.

It all started before the market opened with the release of Nonfarm Payrolls for September that showed more jobs added than expected, along with a drop in Initial

jobless claims. That caused some to question a December rate cut, then Fed Governor Cook spoke at 10 am CST at Georgetown University. She curiously stated that the U.S. financial system is resilient, yet, she also stated, "Sees increased likelihood of outsized asset price declines." Around the time her speech was concluding, Morgan Stanley issued a revision to its interest rate projections removing the December rate cut by the Fed. It's one thing for the Fed to revise their outlook on the markets/economy, but it's another thing altogether to float "asset price declines" while not supporting or rejecting a December rate cut that was included in their September Dot-Plot. Of course assets dropped as equity prices were pushed higher when markets perceived 3 rate cuts that have now turned into only two.

In case you might be wondering just how correlated are asset prices and interest rate expectations, since September 25th, the S&P 500 Index has followed December rate

cut probabilities in fairly similar fashion. Since the end of October, as the odds of a December rate cut began to decline, so too has the price of the S&P 500. However, the rate decision next month goes beyond just equity prices - it also affects monetary plans made by consumers and corporations that involve interest rates. Those plans are now in flux, which could further affect equity prices to the downside. The Fed has made a December rate cut the equivalent of St. Elmo's Fire.

Polarized Market. The characters in "St. Elmo's Fire," while all college friends, have vastly different personalities and perspectives. Kevin and Wendy are more reserved, while Billy and Jules are wild extroverts. Kirby, Leslie, and Alec fall somewhere in-

between. It's not unlike today's investor. As we've stated many other times during periods of volatility, risk is the price of admission when it comes to investing. The good news is, historically, when the S&P 500 has fallen 15% (like it did this year in the Spring), and still made new all-time highs, any secondary drawdowns stayed below 10%. So far, the market is off 5% from the October 28th high. In this scenario, the average secondary drawdown is -5.7%, so perhaps we are getting close to a bottom. That, however, may very well be dependent on the Fed's next move.

The fundamentals seem to have been abandoned, especially during yesterday's sell-off. We finally received the jobless claims from the last several weeks during the government shutdown and all things being equal, the numbers are actually quite good. Prior to the shutdown, Initial Jobless Claims were at 218,000. The latest number for last week came in at 220,000 claims, so not much of a change overall. In addition, the September report for Nonfarm Payrolls showed 119,000 jobs added to the economy. We're still missing the October report, but in light of some of the headline layoff reports, the labor market is holding up so far.

For those investors not on the bearish side, there is good news. Since 1950, there have only been 8 trading days where the S&P 500 Index opened the day up 1% or more, only to finish the trading day in the negative (as it did yesterday). One month later, the S&P was higher in 6 out of 7 cases, with the average return +4.7%. If the markets can hold ground today, perhaps a bottom will set in. On the other hand, today is a massive options expiration day, with more than than $3 trillion set to expire. Anything can happen.

The song & movie that shaped a generation...

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