Key Takeaways
- Investors will be paying close attention to the Federal Reserve’s actions later this year.
- Consistently strong earnings could support growth, but the upcoming election and weakening consumer sentiment could make the stock volatile.
- Some analysts said a “soft landing” could send shares soaring further.
Investors have a lot to track when it comes to predicting what will happen to U.S. stocks, including the presidential election, the latest corporate earnings reports, and economic data.
But the focus is likely to be primarily on the Federal Reserve and the likelihood and timing of interest rate cuts in the second half of 2024. Expectations of rate cuts have helped power the S&P 500’s roughly 18% gain this year through Friday.
But some analysts have warned that lower interest rates may not translate into a similar rise in stock prices.
Historically, rallies have weakened after the Fed cuts interest rates
The S&P 500 has also risen in the first half of this year after rising more than 24% in 2023. The gains have been fuelled by investor hopes that signs of calming inflation will allow the Fed to cut interest rates, which are still at multi-decade highs.
But the Fed has yet to pull the trigger, and if it does, stocks could face a more difficult upside.
Including its most recent hike, the Fed has conducted seven interest rate hiking campaigns since 1989. During the past six rate hikes, the average time between the last rate hike and the first subsequent rate cut was about nine months, and the S&P 500 rose an average of 15.5%. In the six months since the Fed began cutting rates, the benchmark index’s return has fallen to just 5.4%.
“Most of the rally is coming ahead of the first rate cut,” Sam Stovall, chief investment strategist at CFRA Research, said in a recent conference call highlighting his firm’s outlook. “We need to prepare for more volatility in the second half of the year.”
Are rate cuts on the way?
U.S. stock indexes, including the S&P 500, hit new record highs again this week but have been declining recently after June inflation data showed consumer prices fell for the first time in two years. Earlier, the Labor Department reported that job growth slowed in June and the unemployment rate rose to 4.1%, the highest level since November 2021.
The latest economic data has strengthened expectations that the Federal Reserve will cut interest rates soon, and while some investors believe the battle to bring inflation back to the Fed’s 2% target is not over yet, most investors expect the central bank to start cutting rates in September, according to CME’s FedWatch tool.
The Fed hopes it can cut interest rates to a level that will tame inflation without disrupting the economy.
“The latest data suggest that the labor market has cooled significantly,” Fed Chairman Jerome Powell said in testimony before Congress this week. “We are well aware that there are risks on both sides right now. … We are determined to strike that balance to the best of our ability.”
Market breadth, election-related volatility and other stock market themes to watch
There are other warning signs for the stock too, here are a few:
Market size: Since early May, the S&P 500 has risen, but the cumulative number of rising stocks relative to the number of falling stocks has fallen, according to Bespoke Investments. That’s a departure from last year, when these indexes moved more closely together.
A handful of technology stocks, led by AI chip maker Nvidia (NVDA), Apple (AAPL) and Microsoft (MSFT), have accounted for most of the gains in the S&P 500. An equal-weighted version of the index is up just 4.1% in the first half of the year.
“Leadership in the United States [stock market] “It’s unsettlingly narrow,” said Rob Botard, managing director at Houston-based Crossmark Global Investments.
US ElectionsMeanwhile, as Stovall noted, volatility could increase, especially as the U.S. election approaches. Some studies suggest that stock market volatility could increase by around 20% in the weeks leading up to the election.
Consumer sentimentU.S. consumer sentiment fell to its lowest level in seven months in June. Some companies are reporting signs of a “marginalized” consumer, with PepsiCo (PEP) CEO Ramon Laguarta reporting earlier this week that there are “challenging” consumers looking for value.
“Consumers are becoming more cautious,” Stovall said.
Supported by strong earnings
Still, Stovall and many others don’t expect the U.S. economy to fall into recession this year or next.
The Atlanta Fed projects that second-quarter annualized U.S. gross domestic product (GDP) growth will rise slightly to 2% from 1.4% in the first quarter (the government will release its first GDP estimate for the quarter in late July). But even amid relatively flat and slow growth, corporate earnings growth continues to expand.
Second-quarter earnings season got underway in earnest this week, with FactSet projecting that second-quarter profits from S&P 500 companies will rise 8.8% from a year ago, up from a 6% increase in the first quarter. If correct, this would be the biggest year-over-year increase since the first quarter of 2022, just before the Fed began raising interest rates.
“What’s surprising is how consistent the earnings growth has been,” Botar said.
Soft Landing
Markets that start the year strong tend to do better later on, according to JPMorgan analysts. The S&P 500 is up 11% in the first 100 trading days of the year. Since 1950, when the index has surged 10% or more over that period, it has subsequently generated an average annual return of 9%.
Julian Timmer, director of global macro at Fidelity Management & Research, said in his firm’s interim equity outlook that the fourth year of a presidential election cycle tends to produce relatively strong returns, which bodes well for the rest of the year, especially as earnings expectations continue to rise.
“We’ve been following this four-year pattern very closely,” Timmer said. “If it continues, it could signal that the bull market could continue through the rest of the year.”
But most analysts are still keeping an eye on interest rates. Lisa Shalett, chief investment officer of asset management at Morgan Stanley, said recent weakness in bond yields, which fall as prices rise, signals growing confidence that the Fed will achieve its desired goal, known as a soft landing.
That could boost some of the less-popular stock sectors. Investors got a real sense of that last week when the latest Consumer Price Index data led to a decline in some tech stocks and a rise in the blue-chip Dow Jones Industrial Average.
“If a soft landing occurs as we expect, the equity market rally will likely be more broad-based, with high-quality cyclical and defensive stocks driving the market higher,” Sharrett said in a recent report.
