2nd Quarter 2024: Market and Economy

Stocks continued their upward march in 2024’s second quarter, with the S&P 500 marking its third consecutive quarter of gains. Through the first half of the year, the S&P 500 has already posted an impressive 15.3% gain, reflecting strong investor confidence and economic resilience. However, the outperformance by a handful of large companies continues to be a major investment theme.

As we discussed last quarter, the gap between large-cap stocks and every other asset class has only widened. Over the past three months, small- and mid-cap stock prices took a hit, underperforming the S&P 500 by more than 7.5 percentage points. Among the different stock segments, only emerging markets kept up with US large cap in the second quarter, though their year-to-date returns are less than half those of the S&P 500. Likewise, bonds have continued to struggle in 2024, pressured by a rise in interest rates since the start of the year.

Growth is always uneven and we’ll take it where we can find it, but it is unusual to see such a lopsided market.

All Eyes on the Fed

Beyond concentrated market returns, the big story of 2024 has been the anticipation surrounding when the Federal Reserve will start cutting interest rates. The Fed began hiking rates in early 2022, continued through mid-2023, and has held rates steady since last summer. If you have borrowed money in the past year, you’ve undoubtedly felt the pinch of higher interest rates, along with consumers and business owners everywhere. Likewise, higher rates also influence our valuation models, pushing stock values lower.

Historically, such aggressive rate hikes have pushed the US economy into a recession, forcing the Fed to release its grip and cut interest rates. But so far, the US has avoided a recession, which is good news, but it complicates the Fed’s decision-making.

They are walking a tightrope, waiting for the economy to slow just enough. Cut too soon and inflation can take off again. Wait too long and we could still end up in a recession. It’s a delicate balance, and we’re watching to see how they manage it.

Economy Hitting the Right Middle Ground

On that note, the economy does seem to be settling into a more sustainable balance. Growth has slowed this year to align more with what we saw throughout the 2010s. Real GDP in the US grew by 4.9% and 3.4% in the third and fourth quarters last year, respectively. That has moderated this year, with real GDP growing 1.4% in the first quarter of 2024 and the Atlanta Fed projecting a 1.7% growth rate for the second quarter.

The labor market has shown remarkable resilience. Usually, high interest rates lead to lower business investment and fewer new hires. Yet, the US economy has added 2.8 million new jobs over the past year. Unemployment has been at or below 4.0% for the last two and a half years—the longest stretch since the 1960s. Unemployment ticked up to 4.0% in May, the highest mark during that period, and though job openings still outnumber unemployed workers, the gap has narrowed, suggesting a return to normalcy, not seen since before the pandemic economy threw the labor market off balance.

Of course, inflation itself has been the focal point. Prices may be rising at a slower pace, but the Fed is still watching for inflation to slow further. The Consumer Price Index (CPI) has fallen from a peak of 9.1% in the summer of 2022 to 3.3% through May. The Fed’s preferred inflation measure, the Personal Consumption Expenditures Price Index (PCE), has dropped from 7.1% to 2.6% through May. While both measures remain above the Fed’s 2% target, they are trending in the right direction.

The Big Question

So, when will the Fed cut rates already? Despite all their forecasting and planning, Fed officials are often a reactive bunch and tend to wait too long to act. They likely expected a recession and have had to adjust their expectations, just like the rest of us observing from the sidelines. But now, Fed officials seem to be warming up to the idea of rate cuts. The outlook has bounced around dramatically over the past six months—from expecting six cuts at the start of the year to contemplating a rate hike in April—but as of today, it appears we might get two rate cuts by year end.

Can Stocks Continue Higher?

Despite inaction from the Fed, the current market rally has been supported, in part, by continued optimism for AI but largely by strong earnings growth across the board. Companies have successfully navigated higher interest rates and any rate cuts would only improve their earnings outlook. FactSet projects S&P 500 earnings to grow 11.3% in 2024 and 14.4% in 2025. Additionally, S&P 500 companies are on pace for record stock buybacks, reflecting manager optimism.

Whenever the market goes on a run as it has, there’s always a concern that prices have peaked, leading to fears of a looming sell-off. Over the past nine months, the S&P 500 has surged 28.8%. However, these returns have been concentrated in a narrow slice of large tech stocks, leading to the highest level of market concentration ever seen.

The ten largest companies now account for 37.5% of the value of the S&P 500, though only accounting for 26.8% of the index’s earnings. Predicting short-term market movements is nearly impossible but such concentration generally leads to more unpredictability and more volatile stock fluctuations, for better or worse.

Valuations of the largest stocks have been rising much faster than the rest of the market, leaving large pockets of opportunity. When the current trend stalls—and it will eventually—there is plenty of value to be found elsewhere, which could make way for a broader market rally. Plus, any move lower in interest rates will boost returns in fixed-income investments.

Market dynamics suggest there is still room for growth and opportunities ahead but challenges remain. We expect more volatility surrounding the upcoming election. An unforeseen change in the economy or underperformance by a single mega-cap company could send stocks in a different direction. We remain cautiously optimistic but will continue to closely monitor the path of interest rates and the imbalance in the stock market.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.