At the halfway point of 2024, a sense of persistence defined the economic and market landscape. Trends from late 2023 continued, with surprisingly resilient economic growth mixed with stubborn but decelerating inflation. Equity markets thrived in this better-than-expected environment, having regained all the lost ground from 2022, while the bond market continues to grapple with policy uncertainty and remains largely range-bound.
While it’s tempting to forecast a continuation of these trends, our analysis suggests an impending shift. The economy looks poised to cool down in the second half, while volatility is likely to rise off of multi-year lows. Each outcome will impact both policy and markets. Here are a few of our thoughts on the economy, the stock market, and bond markets.
THE ECONOMY:
A TALE OF PROLONGED RESILIENCE, BUT A DELAYED LANDING ON THE HORIZON
A Brief Look Back – The midyear outlook is an opportunity to revisit the forecasts we outlined in December 2023. The views are the same in many ways, but with a bit more nuance. As we said last year, rate cuts “may not come until the latter half of 2024, and the magnitude may not be anywhere near as aggressive as markets think.” Indeed, this is still the case. As last year came to a close, the market’s expectations of numerous Federal Reserve (Fed) rate cuts were overdone in our view because inflation was sticky, and consumers still had money to spend. As of now, the markets perhaps have swung to the other extreme, with some even chattering about potential rate hikes. Again, we believe this is misguided.
As of the writing of our annual outlook late last year, we thought “the U.S. could experience…an economic contraction…but still outperform other markets.” One sizable miscalculation was the extent to which consumers, particularly wealthier ones, could drive the economic growth engine despite high prices.
We Have a Delayed Landing, But Still a Landing – Recent data on refinancing activity provides a clue on why the economy has experienced a delayed landing. The housing market often explains a lot of what is happening in other sectors of the economy, and this time is no different. Roughly one-third of mortgages were refinanced in the quarters following the pandemic recession of 2020.
Because of 2020’s extremely low mortgage rates, these homeowners lowered their monthly payments, increasing their disposable income. Other homeowners took advantage of healthy home equity and took cash out to support more spending. In addition to the oft-mentioned excess savings from stimulus and temporarily curtailed spending, improved household financial conditions from low mortgage rates kept the economy out of the doldrums.
As we look ahead, however, the domestic economy looks to be late cycle, and recent data suggests the consumer has started to slow down. We indeed expect the consumer will slow spending later this year as data from both the Conference Board and the University of Michigan revealed that most consumers have pivoted away from big-ticket buying plans.
A definitive slowdown has proven elusive despite the late-cycle characteristics. This largely can be attributed to the following:
- Surprising Spending Strength: Consumers, particularly wealthier ones, surprised us with their continued spending power despite high prices.
- Varying Degrees of Interest Rate Sensitivity Across the Economy: The refinancing boom experienced during the COVID-19 pandemic has boosted disposable income and further amplified the economy’s resilience.
Despite initial buoyancy, economic data has begun to show signs of deterioration, leading us to anticipate an economic downshift starting in the latter half of 2024. Investors should be prepared for:
- Slower Consumer Spending: Consumers are shifting away from big-ticket purchases, likely leading to broader spending slowdowns.
- Softer Labor Market: Recent data indicates labor demand is weakening. The unemployment rate, though historically low, is expected to rise in the last two quarters of the year.
- A Measured Slowdown: As consumer spending and labor demand slow, a moderate economic slowdown should follow.
- Contained Inflation: Core services inflation is expected to cool as labor costs decelerate, but the overall impact on consumer prices will take time.
- Shifting Federal Reserve Policy: A higher unemployment rate, weaker growth, and contained inflation eventually will provide the Fed with a path to cut rates before the end of the year.
THE STOCK MARKET:
EARNINGS, VALUATIONS, AND VOLATILITY IN FOCUS
Economic Growth Surprised in the First Half – As 2023 ended, recession risk was elevated, and the economy appeared to have little cushion if conditions deteriorated. Now, with the benefit of hindsight, we know the economy enjoyed plenty of cushion – cushion that it hasn’t needed. Stocks were not pricing in enough economic or profit growth.
Gauging Upside Using Historical Market Patterns – Markets tend to move in cycles, as we discussed in Outlook 2024: A Turning Point, so we can use historical patterns to help form an opinion about where stocks might go in the second half of the year. We regularly say history doesn’t always repeat, but it often rhymes.
The S&P 500 has gained 52.8 percent during the current bull market that began on October 12, 2022. It is short of the historical average gain for a two-year-old bull market at 60 percent. It’s right in line with the average if we exclude sharp rallies from the 2009 and 2020 lows (53 percent). Based solely on this analysis, stocks may not be able to deliver much additional upside in the second half of the year, although rising corporate profits and the growing trend in stock buybacks could enhance the backdrop for stocks.
The stock market enjoyed a strong first half. Looking ahead:
- Earnings Growth Will Be Key: The extent of stock market gains in the second half could be influenced by corporate profits continuing to exceed expectations.
- Valuations Are a Potential Headwind: Elevated valuations suggest most good news already is priced in and gains could be modest.
- Volatility Expected: The move higher in stocks has been very steady. However, market corrections and pullbacks are a normal part of the cycle and should be anticipated, particularly as we get closer to the U.S. presidential election.
- Be Patient: Consider a wait-and-see approach to add to equity exposure, potentially buying during market dips.
The Bond Market:
“Boring” Bonds Deserve Another Look
Don’t Forget About Income – While falling interest rates help provide price appreciation in this higher-for-longer environment, fixed income investors likely are better served by focusing on income opportunities, which has been the traditional goal of fixed income investors.
Right now, investors can build a high-quality fixed-income portfolio of U.S. Treasury securities, AAA-rated Agency mortgage-backed securities (MBS), and short-maturity investment-grade corporates that can generate attractive income. For investors concerned about still higher yields, consider laddered portfolios and individual bonds held to maturity to take advantage of these higher yields. We think the current environment is ripe with income opportunities that, when combined with equities, can help reduce overall levels of portfolio volatility and position investors better for longer-term success.
Sharp shifts in interest rate expectations have been a hallmark of the bond market during the last few years, but with volatility comes opportunity, and investors should consider:
- Current Bond Yield Levels Offer Opportunity: Treasury yields are near their highest levels in decades, making fixed income an attractive asset class again. Investors can build diversified portfolios with high-quality bonds offering attractive returns.
- Focus on Income: With rate cuts likely, a focus on income generation becomes more important for fixed-income investors than price appreciation. Consider fixed income over cash.
- Don’t Expect Big Moves in Longer-Term Yields: An inverted yield curve suggests limited potential for significant declines in longer-term bond yields.
The Bottom Line
We are an economy at a crossroads. The global economy is in a late-cycle transition characterized by slowing growth and the potential for increased volatility. This creates a complex environment for investors, requiring a more nuanced approach. Expect increased market fluctuations across assets in the latter half of 2024. This could be driven by factors like central bank policy changes, geopolitical tensions, and election uncertainty. Stay informed and actively monitor market developments.
The LPL Financial Research team provided this information. LPL Financial is located in Chesterfield, Missouri. Contact Jonathan Benner, Certified Financial Planner™ with LPL Financial, at jonathan.benner@lpl.com or 636.200.4204. To view the complete Midyear Outlook 2024: Still Waiting for the Turn, visit lplmycfo.com.
