As U.S. stocks have locked in a solid first half of 2024, investors are speculating about the challenges that lie ahead. The combination of political uncertainty, potential shifts in Federal Reserve policy, and the dominance of big tech could make the second half of the year more turbulent. Let’s delve deeper into the factors at play.
Robust First Half Performance
The S&P 500’s performance in the first half of 2024 has been impressive, with the index climbing 15% year-to-date. This rally was driven by strong corporate earnings, a resilient U.S. economy, and the excitement surrounding artificial intelligence (AI), which powered massive gains in stocks like Nvidia. Nvidia alone, with its shares up 150% this year, has accounted for about a third of the S&P 500’s total return, highlighting the outsized influence of a few tech giants. The index achieved 31 new highs in the first six months, marking the most for any first half since 2021.
Tim Ghriskey, senior portfolio strategist at Ingalls & Snyder, described this period as “very much a Nirvana period for stocks,” pointing out that the economy has been stronger than many anticipated, including the Federal Reserve.
Historical Context and Future Expectations
History suggests that the momentum in U.S. stocks is likely to continue. According to a CFRA study of markets during election years since 1944, a positive first half has been followed by additional gains in the second half 86% of the time. However, the second half of 2024 could face unique challenges that may disrupt this trend.
Political Uncertainty
Political factors are expected to become more influential as the U.S. presidential election approaches. The matchup between President Joe Biden, a Democrat, and Republican challenger and former President Donald Trump, is intensifying. This political rivalry could lead to significant market volatility. A recent JPMorgan survey showed that investors view political risk, both in the U.S. and abroad, as the top potential destabilizing factor for stocks.
Investors are particularly concerned about the potential implications of divergent tax policies. A Democratic sweep of the White House and Congress could lead to higher taxes, which is generally seen as a negative for equities. The first live debate of the 2024 election race spurred a rise in U.S. stock futures and the dollar, which some investors interpreted as a reaction to a strong showing by Trump. However, a contested or prolonged election could create significant market instability. Strategists at Janus Henderson have warned that any suggestion of a real threat of a contested election could trigger bouts of volatility until a clear victor is announced.
Concentration in Big Tech
The market’s advance in the first half has been heavily concentrated in a few tech powerhouses, raising concerns about market stability. Nvidia, Microsoft, and Amazon have been major drivers of the S&P 500’s gains. This concentration means that any weakness in these tech stocks could lead to broader market declines. The equal weight S&P 500 index, which serves as a proxy for the average stock, is up just 4% for the year, a fraction of the S&P 500’s overall gain.
While many investors believe that big tech’s dominance is justified due to their strong balance sheets and leading industry positions, there is a risk that the market could become unstable if the case for holding tech and growth stocks weakens. Stephen Massocca, senior vice president at Wedbush Securities, likened the situation to a game of musical chairs, warning that if the music stops, there could be a problem.
The 12-month forward price-to-earnings ratio of the tech-heavy Nasdaq 100 has risen to 26 from 20 two years ago, according to LSEG data. Some investors are looking to diversify into areas of the market that have underperformed in recent months, expecting the rally in tech to spread to other sectors. Jack Ablin, chief investment officer at Cresset Capital, has been focusing on “quality dividend companies” and small caps, suggesting that the large cap stocks may have run too far ahead and that a broadening of the rally could be on the horizon.
Economic and Federal Reserve Policy
Another key uncertainty is whether the economy can maintain the current balance of cooling inflation and resilient growth, which has fueled investor confidence. The so-called Goldilocks scenario—where inflation is cooling while growth remains strong—has been crucial in supporting the market rally. However, a significant deviation from this scenario could disrupt the Federal Reserve’s plans to cut interest rates later this year.
Signs of cooling inflation and moderate growth have bolstered the case for the Fed to cut interest rates from a multi-decade peak. However, a more pronounced economic slowdown could raise concerns that elevated interest rates are weighing heavily on the economy. Fed officials have trimmed their projections to just one rate cut this year, down from a previous forecast of three, thanks to the economy’s strength and unexpectedly sticky inflation.
Market reactions to past rate-cutting cycles have varied depending on the economic context. Cuts that came during periods of strong economic performance generally led to positive market outcomes. However, cuts in response to sharp slowdowns have often resulted in negative market performance. For example, a rate-cutting cycle that began around the collapse of the dotcom bubble in 2000 saw the S&P 500 down 13.5% a year later.
Conclusion
The second half of 2024 presents a complex and uncertain environment for U.S. stocks. While the first half’s robust performance and historical trends suggest continued gains, the potential challenges of political uncertainty, market concentration in big tech, and shifts in economic conditions and Federal Reserve policy could lead to increased volatility. Investors will need to navigate these challenges carefully, keeping a close watch on key developments that could impact market performance. As always, balancing risk and reward through diversification and prudent investment strategies will be crucial in managing the uncertainties ahead.