As U.S. stocks lock in a solid first half, investors are speculating whether political uncertainty, potential Federal Reserve policy shifts and big tech's market dominance could make the rest of 2024 a tougher slog.
The S&P 500 is up 15% year-to-date thanks to strong corporate earnings, a resilient U.S. economy and enthusiasm over artificial intelligence that powered massive gains in stocks such as chipmaker Nvidia (NVDA.O). The index’s steady march upward produced 31 new highs in the first half, the most for first half of any year since 2021.
The first half has been "very much a Nirvana period for stocks," said Tim Ghriskey, senior portfolio strategist at Ingalls & Snyder. "The economy has been stronger than many people anticipated including the Fed."
If history is any guide, the momentum in U.S. stocks is likely to continue: a positive first half has been followed by additional gains in the rest of the year 86% of the time, according to a CFRA study of markets during election years since 1944.
But the ride could get bumpy. Political uncertainty is likely to be a more powerful factor on asset prices, as investors focus on the U.S. presidential election. A recent JPMorgan survey showed investors see political risk in the U.S. and abroad as the top potential destabilizing factor for stocks.
Investors have also become increasingly concerned about the narrowness of the market’s advance, which has been concentrated in a handful of tech powerhouses. Nvidia alone - whose shares are up 150% this year - has accounted for about a third of the S&P 500's total return, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
Another key uncertainty is whether the economy can maintain the balance of gradually cooling inflation and resilient growth that has fueled investor confidence. A sharp deviation from that so-called Goldilocks scenario could upend the Fed’s plans to cut rates later this year.
"With a wide range of potential macro outcomes in 2025, partly due to the U.S. election result, market volatility is likely to increase," wrote Jason Draho, head of asset allocation, Americas, for UBS Global Wealth Management.
POLITICAL UNCERTAINTY
While investors have mostly been focused on factors such as earnings and monetary policy this year, politics are expected to loom larger as the matchup between President Joe Biden, a Democrat, and Republican challenger and former president Donald Trump intensifies in the coming months.
Futures tied to the Cboe Volatility Index (.VIX) reflect increased demand for protection against equity gyrations around the November vote, as polls continue to show the candidates neck and neck.
Signs that one of the candidates is gaining the upper hand could ripple out into asset markets. For many, it comes down to divergent tax policies: a Democratic sweep of the White House and Congress could mean the party would have a freer hand to raise taxes, generally seen as a negative for equities, according to UBS Global Wealth Management.
The first live debate of the 2024 election race late Thursday spurred a rise in U.S. stocks futures and the dollar in a move some investors interpreted as a reaction to a strong showing by Trump.
One potential wildcard, according to strategists at Janus Henderson, is a contested or prolonged election.
"Any commentary suggesting it's a real threat could create bouts of volatility in the coming months, and that volatility would likely continue until a victor is announced," they wrote.
CONCENTRATION
AI-fever and strong earnings have helped drive up equities in the first half, but gains have been concentrated in tech and growth stocks, including Nvidia, Microsoft (MSFT.O) and Amazon (AMZN.O).
The equal weight S&P 500 index - a proxy for the average stock - is up just 4% for the year, a fraction of the S&P 500’s gain.
Many investors believe big tech dominance is well deserved, given strong balance sheets and leading positions at the top of their industries. But their growing heft could make markets unstable if the case for holding tech and growth stocks weakens and investors head for the exit all at once.
"It's understandable why everyone has drifted to these names, but it's a bit of a game of musical chairs. If the music stops, there's going to be a problem," said Stephen Massocca, senior vice president at Wedbush Securities.
Meanwhile, 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 areas of the market that have underperformed in recent months, expecting the rally in tech to spread out into other sectors. Jack Ablin, chief investment officer at Cresset Capital, has been focused on "quality dividend companies" and small caps.
"We think that perhaps the large cap has run a little too far and that we'll now see perhaps a broadening," Ablin said.
GROWTH
Most investors have cheered signs of cooling inflation and moderating growth this year, as it bolsters the case for the Fed to cut interest rates from a multi-decade peak. But a more pronounced economic slowdown could fuel worries that elevated interest rates are weighing more heavily on the economy.
Fed officials have trimmed their projections to just one rate cut this year from a previous forecast of three, thanks to the economy’s strength and unexpectedly sticky inflation.
Market reactions to past rate cutting cycles have largely hinged on whether the cut came during a period of comparatively strong economic performance or in response to a sharp slowdown in growth.
While the S&P 500 has risen by an average of 5.6% in the 12 months after a cycle has begun, cuts that came along with a challenging economic environment coincided with far worse returns, an Allianz study examining rate cuts since the 1980s showed. For example, a rate cutting cycle that kicked off around the collapse of the dotcom bubble in 2000 saw the index down 13.5% a year later.
"Every landing is a soft landing until it is not," said Julia Hermann, global market strategist at New York Life Investments.
