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Written by: Kevin McCreadie, CFA®, MBA | AGF
The S&P 500 Index and several other global indexes are trading at all-time highs again, but not every stock listed is participating in the rally to the same extent.
What’s next for equity markets now that major global indexes like the S&P 500 Index are at all-time highs once again?
There’s something powerful about recovering from a bear market and finally hitting new highs. It instills confidence in investors and often ends up being its own catalyst for future gains. This time may end up being no different, but the rally to date is somewhat unique and there are certain nuances of the current trajectory in equity markets that could determine the continuation of it going forward.
In particular, it’s important to remember that not all stocks have participated equally in the climb higher over the past year. In fact, a disproportionate amount of the gains has been realized by just a handful of the world’s biggest technology names. And this trend has continued to define markets – more or less –through the first two months of this year, largely because these companies are seen as being at the vanguard of the Artificial Intelligence (AI) boom that is currently captivating investors.
Yet, there may be another reason that market returns have been so concentrated. Also at play has been the ongoing uncertainty about what central banks are going to do next and how their actions may end up impacting the global economy. What this has done is create a crowding effect, whereby investors gravitate towards stocks that they feel more certain about it.
So, while investors may feel good about equity markets hitting new highs, the question now is whether the U.S. Federal Reserve (Fed) and other central banks can navigate a soft landing. If they can get inflation to fall back to their target of 2% without causing a recession, we believe it is much more likely that we see a broadening out of stock returns where more than just a small percentage of names are responsible for the gains overall. Indeed, this may be the key to a bull run that can be sustained longer term.
To that end, investors seem reconciled to the idea of fewer interest rate cuts from the Fed than was expected earlier this year. How will this impact markets going forward?
Yes, there’s been a rather large shift on this front over the past few weeks. Up until recently, market expectations were for as many as seven rate cuts by the end of this year, even though the Fed has never suggested it would loosen policy that aggressively. But after the release of the past two inflation prints in the U.S. – both of which showed slight upticks in price levels – these expectations have been drastically tempered and are more in line with what the U.S. central bank has been saying, which is more like two or three cuts at the most. Moreover, while investors originally believed the Fed would start cutting rates this month, they now seem resigned to the idea that interest rates won’t budge from here until the second half of 2024 at the earliest.
Oddly, this reconciliation – if you want to call it that – hasn’t really disrupted markets the way some might have thought it would. Yes, it’s created some volatility day-to-day, but if markets were rallying in part from the expectation of six to seven rate cuts, then it’s reasonable to have assumed that markets would pull back now that it’s widely believed the Fed is only going to cut two or three times.
Yet, that hasn’t quite happened. Major global indexes like the S&P 500 have just kept rolling. Perhaps that’s a testament to the power of the AI trade or, better yet, maybe it reflects a growing confidence among investors that the economy is resilient enough to survive a slower path to lower rates than originally expected.
Either way, it’s still tough to think that equity markets can keep climbing higher at their current pace and a pullback of some sort wouldn’t come as a surprise – especially if the Fed starts to signal that it may delay rate cuts even longer than what is now anticipated or, worse, has to actually raise rates because inflation isn’t falling fast enough and/or continues to rise from here.
Finally, another potential rally killer is the U.S. election in November. While election years tend to be positive for equity markets, this time around may be different given the general disdain for both presidential candidates and the lack of confidence in their ability to govern the world’s largest economy through the next four years.
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The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
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