While reading bedtime stories over the Labor Day weekend to my twin six-year-old grandsons, I came to Goldilocks and The Three Bears and, of course, the economic metaphor was not lost on me.

An increasing number of analysts currently contend that we’re enjoying a “Goldilocks” phase of not-too-hot, not-too-cold economic growth. The thinking is that after the Federal Reserve’s expected rate hike later this month, the pace of monetary tightening will ease.

There’s merit to this argument, as evidenced by recent economic reports. Keep in mind, though, that the government always revises initial reports up or down, sometimes significantly, and the markets respond accordingly.

The bear market probably bottomed in June, but due to headline risk, we still face a rocky finish to the year. With the U.S. midterm elections approaching and the two major political parties hurling the epithet “fascist” at each other, we’re a news chyron away from another selloff.

Getting it “just right”…

COVID lockdowns in China, the bloody quagmire in Ukraine, and the brewing energy crisis in Europe are major headwinds afflicting the global economy. And yet, here in the U.S., there’s lots of news that’s positive…but not too positive.

Interest rates are on the rise, but the American economy’s continuing strength should help cushion the blow. In the U.S., jobs growth continues (but has slightly slowed); wages are rising (but not too fast); consumer sentiment and retail sales have weakened but show resilience; and the manufacturing and services sectors are expanding (but not at a torrid pace). And inflation, while still elevated, seems to have peaked.

On Tuesday, the latest Services ISM Report On Business economic activity showed that the services sector grew in August for the 27th month in a row, with the Services PMI registering 56.9%, 0.2 percentage point higher than July’s reading of 56.7 percent.

The Business Activity Index registered 60.9%, an increase of 1 percentage point compared to the reading of 59.9% in July.

Another (modestly) bright spot is corporate earnings. Profit growth has decelerated but remains on a growth trajectory.

For the second quarter of 2022, with 99% of S&P 500 companies reporting actual results, 75% of companies have posted a positive earnings per share (EPS) surprise and 70% have posted a positive revenue surprise, according to FactSet.

The blended Q2 EPS growth rate year-over-year for the S&P 500 is 6.3%. In a sign that corporations are finding ways to cope with inflation, the blended net profit margin for the S&P 500 for Q2 is 12.3%, which is above the five-year average of 11.2% and equal to the previous quarter’s net profit margin of 12.3%.

For calendar year 2022, the consensus of analysts calls for EPS growth of 7.9% and revenue growth of 10.8%.

We’re continuing to get signals that inflation is on a downward slope. In the reading for August, the ISM Services Sector Prices Paid subindex decreased for the fourth consecutive month in August, down 0.8 percentage point to 71.5%.

Also for August, the ISM Manufacturing Prices Paid subindex fell to the lowest levels of the year. The subindex fell to to 52.50 points in August from 60 points in July 2022. It’s the lowest reading since June 2020, below forecasts of 55.5 (see chart).

Helping curb inflation are falling U.S. gasoline prices, with the national average currently hovering at $3.77 per gallon. Political partisans who were screeching about high gas prices have suddenly grown silent on the topic.

What’s more, according to researchers at the University of California at Berkeley, overall labor income per working-age adult, adjusted for inflation, rose 3.5% from January 2021 to July 2022. The combination of lower gas prices and rising wages is boosting consumer morale.

Goldilocks and the gorilla…

The 800-pound gorilla in this tale is the Fed’s policy-making arm, the Federal Open Market Committee (FOMC). Economic gains this year could be thrown away if the FOMC overdoes it and takes an ultra-hawkish turn to fight inflation.

The problem that inflation hawks tend to ignore is that the Fed can’t do much to solve the major causes of inflation, which are supply chain disruptions and shortages caused by COVID and the Russia-Ukraine war.

Hence the continuing jitters on Wall Street. U.S. stocks on Tuesday started the holiday-shortened week by closing lower after three consecutive weeks of losses. In pre-market futures contracts Wednesday, the indices were trading in the green.

The analyst consensus calls for a rate hike of 75 basis points (bps) at the FOMC’s next meeting September 21-22, but depending on the latest inflation data leading up to the meeting, that hike could be as high as 100 bps.

Watch This Video: Powell Reminds Wall Street: Don’t Fight The Fed!

At the conclusion of the two-day confab, alongside with the policy statement, the FOMC will release its committee members’ quarterly economic projections. This will be the third such release this year and should provide insight into how committee members’ outlooks have shifted over the past three months.

Wall Street had expected a more dovish stance this month but recent hawkish commentary from Fed Chair Jerome Powell flipped that expectation upside down.

Historically, September and October are weak months for the markets, especially in election years. However, markets tend to rebound once the voting is over, regardless of which party wins control.

As the midterms approach and the demagoguery reaches a fever pitch, remember this truism: basing investment decisions on your political preferences is a recipe for disaster.

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John Persinos is the editorial director of Investing Daily.

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