What To Watch in the Stock Market in the Second Half

Investors have plenty to track as they contemplate the path ahead for U.S. stocks, including a presidential election, a fresh round of corporate earnings reports and economic data.

But the focus will likely remain largely on the Federal Reserve and the possibility and timing of interest-rate cuts, which investors increasingly expect to land in the second half of 2024. Rate-cut expectations have helped power a roughly 18% year-to-date surge for the S&P 500 through Friday.

Some analysts, however, warn that lower rates may not lead to similar stock gains.

Historically, Rallies Fade After the Fed Cuts

The S&P 500 climbed in the first half of the year after rising more than 24% in 2023. Investors’ hopes that signs of cooling inflation would allow the Fed to cut rates, still at multi-decade highs, fueled those gains.

But the Fed has yet to pull the trigger, and stocks may face a more challenging uphill climb if it does.

The Fed has embarked on seven rate-hike campaigns since 1989, including the most recent. In the previous six, the S&P 500 has increased an average of 15.5% between the last hike and the ensuing first cut, a period that averaged about nine months. In the six months after the Fed began cutting rates, the benchmark index’s return fell to just 5.4%.

“Most of the advance comes in advance of that first rate cut,” Sam Stovall, chief investment strategist with CFRA Research, said on a recent call highlighting the firm’s outlook. “Prepare yourselves for more volatility in the second half.”

Are Rate Cuts Getting Closer?

U.S. stock indexes, including the S&P 500, once again scaled all-time highs this week, although they cooled more recently after June inflation data showed consumer prices falling for the first time in two years. That followed a Labor Department report that jobs growth slowed in June, with unemployment rising to 4.1%, the highest level since November 2021.

The latest economic data has firmed up expectations that the Fed may soon cut rates. While some investors think the fight to bring inflation back toward the Fed’s target of 2% is far from over, the vast majority of investors expect the central bank to start cutting in in September, according to the CME’s FedWatch Tool.

The Fed hopes it can bring interest rates to a level that cools inflation without knocking the economy off course.

“The latest data do show that we’ve had considerable cooling in the labor market,” said Fed Chairman Jerome Powell in testimony before Congress this week. “We’re very much aware that we have two-sided risks now. … We’re determined to balance those as best we can.”

Market Breadth, Election-Related Volatility Among Other Stock-Market Themes To Watch

Other warning signs for stocks also exist. Here are a few.

Market breadth: Since early May, according to Bespoke Investments, the S&P 500 has risen even as the cumulative number of advancing stocks compared with falling stocks has declined. That marks a departure from the past year, during which those metrics tracked each other closely.

Led by AI-chip powerhouse Nvidia (NVDA), a small group of technology stocks—Apple (AAPL) and Microsoft (MSFT) among them—has accounted for the bulk of the S&P 500’s gain. The equal-weighted version of the index advanced just 4.1% in the first half.

“Leadership in the U.S. [stock market] is uncomfortably narrow,” said Rob Botard, managing director of Houston-based Crossmark Global Investments.

The U.S. election: Meanwhile, as Stovall noted, volatility could increase, particularly as the U.S. election approaches. Some studies show that stock-market volatility can increase by about 20% in weeks near elections.

Consumer sentiment: U.S. consumer sentiment fell to a seven-month low in June. Some companies have reported signs of a “stretched” consumer emerging. PepsiCo (PEP) CEO Ramon Laguarta reported a “challenged” consumer in search of value earlier this week.

“Consumers are getting a little more cautious,” Stovall said.

Resilient Earnings Provide Support

Nonetheless, Stovall and many others don’t expect the U.S. economy will fall into recession this year or next.

The Atlanta Fed forecasts U.S. annualized gross domestic product (GDP) in the second quarter increased 2% (the U.S. government will release its first GDP estimate for the quarter in late July) up slightly from 1.4% in the first quarter. But even amid that relatively flat, sluggish growth, corporate earnings growth continues expanding.

The second-quarter earnings season kicked off in earnest this week. FactSet estimates second-quarter earnings for S&P 500 companies increased 8.8% on a year-to-year basis, up from 6% in the first quarter. If correct, that would mark the biggest year-to-year increase since the first quarter of 2022, just prior to the beginning of the Fed’s rate increases.

“The surprise has been just how consistent earnings growth has been,” Botard said.

Sticking a Soft Landing

Strong markets early in the year tend to stay strong, according to JPMorgan analysts. Thec S&P 500 gained 11% in the first 100 trading days of the year; Since 1950, when the index surges 10% or more in that time frame, it has posted a median return of 9% for the rest of the year.

Jurrien Timmer, director of global macro for Fidelity Management & Research, said in the firm’s midyear stock outlook that the tendency for the fourth year of a presidential cycle to bring relatively strong returns bodes well for the rest of the year—especially because earnings estimates continue rising.

“We’ve been tracking this fourth-year pattern very closely,” Timmer said. “If we continue to do so, that might suggest that the bull market could continue for the remainder of this year.”

Most analysts, though, remain focused on interest rates. Lisa Shalett, chief investment officer of wealth management for Morgan Stanley, said recent weakness in bond yields, which fall as prices rise, suggests increased confidence that the Fed will achieve its desired goal, known as a soft landing.

That could lift some out-of-favor stock sectors. Investors got a taste of that notion last week when the latest Consumer Price Index (CPI) data contributed to a pullback in some technology shares and strength in the blue-chip Dow.

“If a soft landing materializes, as we believe it will, stock-market gains should become more broad-based, with quality cyclicals and defensives likely driving markets higher,” Shalett said in a recent report.”