The first half of 2024 has been eventful, with Q1 characterized by higher-than-expected inflation and strong labor market dynamics, followed by a moderation in both factors in Q2.
Additionally, a key theme that persisted into Q2 was the enthusiasm for artificial intelligence (AI) and growth-oriented stocks, which helped propel the S&P 500 Index to gain over 4% for the quarter. In contrast, value, small-cap, mid-cap, and international developed stocks underperformed, while emerging markets rebounded from a weak Q1.
A notable surprise for 2024 has been the shifting expectations for rate cuts. Investors started the year expecting six or seven cuts for 2024 but are now only expecting one to two. Despite this yield volatility, equity markets have shown resilience, with the S&P 500 advancing over 15%, while a 60/40 portfolio is up nearly 9% by mid-year.
In terms of what the Federal Reserve (Fed) has been focused on, we saw good progress on the inflation front in 2023, but the first quarter of 2024 posed some challenges with higher-than-expected numbers. The latest figures, however, have been more encouraging, showing inflation easing over the last quarter.
The June Consumer Price Index (CPI) report was significant, showing progress in shelter costs, a focus area for the Fed. We also saw softening in service costs and supercore inflation—a key data point for the Fed, with supercore even dipping into deflation for the month. The labor market is also coming back into better balance, with the supply of jobs and demand returning to pre-pandemic levels. From the Fed's viewpoint, the latest data helps to reinforce that their policies are working to bring down inflation and cool the labor market.
Our current forecast is for one 25 basis points (bps) cut in December. However, given the recent encouraging data, there is the potential for two cuts in 2024.
Fed Chair Jerome Powell recently stated that the U.S. Economy is no longer overheated and highlighted the two-sided risks of keeping monetary policy too tight. Although the unemployment rate remains low, he acknowledged that overly tight monetary policy could unduly weaken economic activity and employment, suggesting a stronger case for cuts. With two more months of data before the Fed's September meeting, we expect the Fed to continue to be data-dependent and we may revise our forecasts accordingly.
A key feature in equity markets has been the momentum in AI and growth-oriented stocks, leading to market concentration in the largest companies. While the "Magnificent Seven" have benefited from optimistic investor sentiment, these outsized returns are also on the back of outsized results in both the top and bottom-line earnings for these companies.
Moving forward, the rest of the market is expected to produce positive earnings. Additionally, we are on the cusp of interest rates cuts. We think these could both be catalysts for a broadening of the market, benefiting areas that have lagged their large-cap growth peers like small and mid-cap stocks, as well as value stocks.
With elections approaching, we would expect some short-term volatility as they inherently create uncertainty. However, historically, the political party in power has had minimal impact on market performance. The average annual return, irrespective of whether it's a Democrat or Republican in the White House, has been close to 10% going back to the early 1930s.
A few final thoughts for investors:
Try to focus less on trying to pinpoint when the first rate cut will take place, and more on the direction of rates. We expect the Fed funds rate will be 200 bps lower than it is currently by the end of 2025, which is significant. This will likely create opportunities outside of just growth stocks, like small and mid-cap or value stocks. Fixed income investors will also potentially benefit from capital appreciation in the event of rate cuts. So, stay invested, filter out the noise and short-term volatility, and focus on your wealth plan to achieve your financial goals.
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