The US Stock Market’s Outlook: Further Gains in 2024 Mainly Dependent on Rate Cuts? (2024)

By Alexander Jones, International Banker

This year, US equity markets have demonstrated remarkable resilience in the face of an unforgiving macroeconomic environment. The benchmark S&P 500 (Standard & Poor’s 500) index gained approximately 10 percent this year to mid-May, with large-cap US growth stocks, particularly from the technology and communications sectors, leading the rally. And despite a modest reversal of this trend surfacing throughout much of April, the return of a solid upward trajectory in May has suggested that another buoyant year lies in store for US stock markets. That said, with interest rates still elevated in response to the Federal Reserve’s (the Fed’s) unfinished business of combating inflation, the dimming hopes of rate cuts this year could have the final say by keeping a lid on market performance.

Indeed, the S&P 500 shed 4.1 percent in April to deliver its first monthly decline since October, as economic data during the month revealed that the annual inflation rate in March rose for a second straight month to 3.5 percent, the highest since September. With prices remaining sticky and well above the Federal Reserve’s target rate, then, the raised hopes at the start of the year of five or six rate cuts materialising in 2024 have now decisively dissipated.

Concerns are now elevated over the impacts that the Fed’s higher-for-longer monetary regime is having on the economy, as well as company earnings. Those fears have only been further exacerbated by the return of rising inflation in recent months, even though annual price growth has dramatically improved from this cycle’s peak rate of 9.1 percent in June 2022. Nonetheless, with inflation remaining comfortably above the Federal Reserve’s 2-percent long-term target, traders are currently pencilling in either a sole rate cut this year or even no cut until 2025. Should either of these scenarios transpire, equity markets could well remain muted for the remainder of the year as high interest rates keep borrowing costs for businesses and households elevated. High rates also impact discounted cash-flow valuations, which, in turn, can hurt high-growth stocks.

Irrespective of this year’s monetary policy, some still hope that the US’ more robust economic-growth performance over the last 18 months will prove instrumental in driving equity markets higher. “You have to assess why you could be in a scenario where there’s fewer rate cuts this year,” Zehrid Osmani, a fund manager at global active equity investment specialist Martin Currie, told Fortune magazine on April 29. “If it’s related to an economy being healthier than expected, that could support the rally in equity markets after the typical volatile knee-jerk reactions.”

Indeed, one need only look back to 2023 for such a theory to ring true. Last year saw the S&P 500 return a hefty 26 percent despite the persistence of high (but declining) inflation and a total of four 25-basis-point (bps) rate hikes being administered by the Fed during the year. However, this market growth was achieved against the backdrop of four quarters of solid growth in 2023, including a hefty 4.9-percent rate in the third quarter (Q3).

But even confining the upside argument to economic growth may prove faulty, especially with recent US growth figures proving underwhelming. The first quarter (Q1) saw gross domestic product (GDP) growth slow to an annualised pace of 1.6 percent, less than half of the 3.4-percent expansion reported in the fourth quarter (Q4) of 2023. The Q1 figure was also well below analysts’ consensus expectations of 2.5 percent growth.

It should also be observed that less than one-third of the S&P 500’s constituent stocks outperformed the broader index last year, largely reflective of the outperformances of technology and artificial intelligence (AI) stocks. According to BlackRock, the persistence of themes such as AI “contributed both to high equity index concentration and strong performance of the momentum factor—raising questions over the potential for a reversal”.

Apart from the headline GDP figure for Q1, meanwhile, some commentators have identified other reasons to remain upbeat about US equities. “Consumer spending continued to hold up well with an annualised increase for the quarter of 2.5 percent, though that was shy of expectations near 3 percent,” according to Jeffrey Buchbinder, chief equity strategist at LPL Financial. “Capital investment rose at a solid 2.9 percent annualised pace, while residential investment contributed to growth as demand for housing was strong.”

Accounting for the strong earnings performances by S&P 500 constituents thus far this year has created decidedly more optimism over the equities outlook for 2024. According to earnings figures published in early May by the US financial-data analytics firm FactSet, the S&P 500’s Q1 year-over-year earnings growth rate of 5.0 percent marks the highest annual earnings growth reported for the index since the second quarter (Q2) of 2022 (5.8 percent). What’s more, 77 percent of S&P 500 companies reported a positive earnings-per-share (EPS) surprise, while 61 percent reported a positive revenue surprise.

With constituent companies on course to report their third consecutive quarter of positive earnings growth, stock markets can take much confidence from these earnings trends. “Looking ahead, analysts expect (year-over-year) earnings growth rates of 9.6 percent, 8.4 percent, and 17.1 percent for Q2 2024, Q3 2024, and Q4 2024, respectively,” FactSet reported in its May 3 “Earnings Insight”. “For CY [calendar year] 2024, analysts are calling for (year-over-year) earnings growth of 11.0 percent.

However, according to a Forbes Advisor analysis, high interest rates and tight credit markets are still having pronounced impacts on certain market sectors. “Communication services earnings are up 34.4 percent, and utilities sector earnings are up 23.9 percent in the first quarter compared to a year ago,” authors Wayne Duggan and Paul Katzeff reported on May 2. “On the other end of the spectrum, healthcare sector earnings are down 28.1 percent, and energy earnings have dropped 25.5 percent in the quarter. Technology sector earnings are up 22.2 percent overall in the first quarter, but investors have punished several major tech stocks for not reaching the market’s high bar of expectations.”

Ultimately, there may be no escaping the influence of the Federal Reserve’s monetary policy and its command over the direction of stock markets for the remainder of the year. The Fed itself has all but confirmed the absence of monetary easing any time soon, with Chair Jerome Powell acknowledging in mid-April “a lack of further progress so far this year” on returning to the central bank’s 2-percent inflation target.

“They’ve got the economy right where they want it. They now are just focused on inflation numbers. The question is, What’s the bar here?” Mark Zandi, chief economist at Moody’s Analytics, explained to CNBC on April 17. “My sense is they need two, probably three consecutive months of inflation numbers that are consistent with that 2 percent target. If that’s the bar, the earliest they can get there is September. I just don’t see rate cuts before that… Right now, my base case is two—one in September and one in December, but I could easily see one rate cut, in November.”

Zandi also suggested that the presidential election in November could prove influential for Fed officials. However, the election cycle is unlikely to be directionally meaningful for stock markets in the long run. As has historically been the case, markets are much more likely to respond to market and economic fundamentals, such as corporate earnings, interest rates and other economic factors, than to political cycles. “While political headlines may at times cause short-term ripples in the market, long-term, for stocks, bonds, and other investments, returns seem to be driven much more by the fundamentals of the underlying asset classes,” according to Naveen Malwal, institutional portfolio manager with Strategic Advisers, LLC, the investment manager for many of Fidelity Investment’s managed accounts.

BlackRock forecasted US stocks to outperform bonds again this year but cautioned investors about high current valuations, advising them to be more selective about their stock picks. “The equity risk premium, a measure of relative stock pricing versus bonds, looks more compelling for the equal-weighted S&P 500, sitting near the market’s long-term average,” the asset manager noted in its “Taking Stock: Q2 2024 Equity Market Outlook”. “This implies the need to look beyond the mega-cap stocks that have been dominating the widely cited market-cap-weighted index to source attractively priced names with good long-term prospects.”

More recently, BlackRock also recommended investors pursue greater diversification in market-capitalisation concentration by taking advantage of broadening performance themes, including AI beneficiaries outside of the technology sector. “Today’s expanded opportunity set comes with [a] much higher dispersion in company results than in recent decades, making effective stock selection crucial for generating alpha,” the investment manager advised on April 23. “Looking under the hood, we see opportunities to generate alpha by complementing mega cap tech exposure with AI beneficiaries outside of the technology sector as the theme continues to broaden.”