What to monitor in the stock market for the second half
Discover key factors to watch in the stock market during the second half of the year, including trends, economic indicators, and investment opportunities.
Investors have a lot to monitor as they consider the future for U.S. stocks, including the upcoming presidential election, new corporate earnings reports, and economic data.
However, the primary focus will likely remain on the Federal Reserve and the anticipated timing of interest rate cuts, which investors increasingly predict will occur in the second half of 2024. Expectations for rate cuts have contributed to an approximately 18% rise in the S&P 500 year-to-date as of Friday.
Nonetheless, some analysts caution that lower interest rates may not necessarily result in the same level of stock market gains.
Historical trends show rallies often fade after fed rate cuts
The S&P 500 saw gains in the first half of the year, rising over 24% in 2023, driven by investor optimism that cooling inflation would prompt the Federal Reserve to cut rates, which are currently at multi-decade highs.
However, the Fed has not yet made any cuts, and stocks could face a tougher path if they do.
Since 1989, the Fed has implemented seven rate-hike campaigns, including the latest one. In the previous six instances, the S&P 500 averaged a 15.5% increase from the last rate hike to the first cut, which typically took about nine months. However, in the six months following the Fed's initial rate cuts, the index's return dropped to just 5.4%.
"Most of the gains occur before the first rate cut," said Sam Stovall, chief investment strategist at CFRA Research, during a recent call discussing the firm’s outlook. "Get ready for increased volatility in the second half."
Are rate cuts on the horizon?
U.S. stock indexes, including the S&P 500, reached all-time highs this week, though they recently pulled back after June's inflation data indicated a decline in consumer prices for the first time in two years. This came alongside a Labor Department report showing slower job growth in June, with unemployment rising to 4.1%, the highest rate since November 2021.
Recent economic data has strengthened expectations that the Federal Reserve may soon lower rates. While some investors believe the battle to reduce inflation to the Fed's 2% target is far from finished, most expect the central bank to begin cutting rates in September, according to the CME's FedWatch Tool.
The Fed aims to adjust interest rates to cool inflation without destabilizing the economy.
“The latest data indicate significant cooling in the labor market,” said Fed Chairman Jerome Powell during testimony before Congress this week. “We are very much aware of the two-sided risks we face and are determined to manage them as effectively as possible.”
Market breadth and election-related volatility: Key stock market themes to monitor
There are several warning signs for the stock market worth noting:
Market breadth: Since early May, the S&P 500 has risen, but the number of advancing stocks compared to declining ones has decreased, according to Bespoke Investments. This contrasts with the previous year, where these metrics closely aligned.
A small group of tech stocks, primarily driven by Nvidia (NVDA), along with Apple (AAPL) and Microsoft (MSFT), has contributed significantly to the S&P 500's gains. In comparison, the equal-weighted version of the index increased by only 4.1% in the first half.
“Leadership in the U.S. stock market is uncomfortably narrow,” stated Rob Botard, managing director at Crossmark Global Investments.
U.S. election: As Stovall pointed out, market volatility may rise, especially as the U.S. election nears. Research indicates that stock market volatility can increase by about 20% in the weeks surrounding elections.
Consumer sentiment: U.S. consumer sentiment dropped to a seven-month low in June. Some companies are noticing signs of a "stretched" consumer base. PepsiCo (PEP) CEO Ramon Laguarta recently described consumers as "challenged" and seeking value.
“Consumers are becoming more cautious,” noted Stovall.
Strong earnings provide stability
Despite concerns, Stovall and many analysts do not anticipate a recession for the U.S. economy this year or next.
The Atlanta Fed predicts that the U.S. annualized gross domestic product (GDP) rose by 2% in the second quarter, slightly up from 1.4% in the first quarter. The government will release its initial GDP estimate for the quarter in late July. However, even with this modest growth, corporate earnings continue to expand.
The second-quarter earnings season officially began this week, with FactSet estimating that S&P 500 companies' earnings grew by 8.8% year-over-year, an increase from 6% in the first quarter. If accurate, this would represent the largest annual increase since the first quarter of 2022, just before the Fed initiated its rate hikes.
“The consistency of earnings growth has been surprising,” said Botard.
Maintaining a soft landing
According to JPMorgan analysts, strong markets early in the year tend to maintain their momentum. The S&P 500 rose by 11% in the first 100 trading days, and historically, when the index increases by 10% or more in that period, it has achieved a median return of 9% for the remainder of the year.
Jurrien Timmer, director of global macro for Fidelity Management & Research, noted in the firm's midyear stock outlook that the fourth year of a presidential cycle typically yields strong returns, which is promising for the rest of the year, especially as earnings estimates continue to rise.
"We've been closely monitoring this fourth-year trend," Timmer said. "If it holds, it could indicate that the bull market may persist through the end of the year."
Most analysts, however, are primarily focused on interest rates. Lisa Shalett, chief investment officer of wealth management at Morgan Stanley, stated that recent declines in bond yields— which indicate rising prices—suggest growing confidence in the Fed's ability to achieve a "soft landing."
This scenario could benefit some underperforming stock sectors. Investors experienced this last week when the latest Consumer Price Index (CPI) data led to a dip in certain technology stocks while boosting the blue-chip Dow.
"If a soft landing occurs, as we expect, stock market gains should broaden out, with quality cyclicals and defensive stocks likely driving the markets higher," Shalett remarked in a recent report.
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