By Saqib Iqbal Ahmed
NEW YORK (Reuters) – While U.S. stock markets have had a solid first half, investors are speculating whether political uncertainty, possible policy changes from the Federal Reserve and the market dominance of big tech companies could make the rest of 2024 more difficult.
The S&P 500 is up 15% since the start of the year thanks to strong corporate earnings, a resilient U.S. economy and enthusiasm about artificial intelligence driving huge gains in stocks like chipmaker Nvidia. The index’s steady advance delivered 31 new highs in the first half, the most for the first half of a year since 2021.
The first half was “a real Nirvana period for stocks,” said Tim Ghriskey, senior portfolio strategist at Ingalls & Snyder. “The economy has been stronger than many people expected, including the Fed.”
If history is any guide, momentum in U.S. stocks is likely to continue: A positive first half was followed 86% of the time by additional gains in the rest of the year, according to a CFRA survey of markets during election years since 1944.
But the ride could be bumpy. Political uncertainty is likely to be a more powerful force on asset prices as investors focus on the U.S. presidential election. A recent JPMorgan survey found that investors see political risk in the U.S. and abroad as the biggest potential destabilizer for stocks.
Investors are also increasingly concerned about the narrowness of the market’s rally, which has been concentrated in a handful of tech giants. Nvidia alone — whose shares have soared 150% this year — accounts for about a third of the S&P 500’s total returns, said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
Another key uncertainty is whether the economy can maintain the balance between gradually cooling inflation and resilient growth, which has boosted investor confidence. A sharp departure from that so-called Goldilocks scenario could disrupt the Fed’s plans to cut rates later this year.
“Given the wide range of possible macroeconomic outcomes in 2025, partly due to the US election outcome, market volatility is likely to increase,” said Jason Draho, head of asset allocation for the Americas at UBS Global Wealth Management.
POLITICAL UNCERTAINTY
While investors have focused on factors like earnings and monetary policy this year, the politics are expected to heat up as the showdown between President Joe Biden, a Democrat and a Republican challenger, and former President Donald Trump intensifies in the coming months.
Futures linked to the Cboe Volatility Index reflect increased demand for protection against stock swings around the November election, as polls continue to show the candidates neck and neck.
Signs that one candidate is gaining the upper hand could filter through to asset markets. For many, it comes down to divergent tax policies: A Democratic assault on the White House and Congress could give the party a freer hand to raise taxes, which are generally seen as negative for stocks, according to UBS Global Wealth Management.
The first live debate on the 2024 election race late Thursday sent U.S. stock futures and the dollar higher, a move some investors interpreted as a reaction to a strong performance by Trump.
A potential wild card, according to strategists at Janus Henderson, is a contested or extended election. “Any commentary suggesting it is a real threat could trigger periods of volatility in the coming months, and that volatility is likely to persist until a winner is declared,” they wrote.
CONCENTRATION AI fever and strong earnings boosted stock prices in the first half of the year, but the gains were driven largely by technology and growth stocks including Nvidia, Microsoft and Amazon.
The S&P 500 equal-weight index — a measure of the average stock — is up just 4% this year, a fraction of the S&P 500’s gain. Many investors believe the dominance of big tech companies is well-deserved, given the strong balance sheets and leading positions at the top of their sector. But their growing weight could make markets unstable as the case for holding tech and growth stocks weakens and investors rush for the exit all at once. “It’s understandable why everyone has adopted these names, but it’s a bit of a game of musical chairs. When the music stops, there’s a problem,” said Stephen Massocca, senior vice president at Wedbush Securities. Meanwhile, the tech-heavy Nasdaq 100’s annual price-to-earnings ratio has risen to 26 from 20 two years ago, according to LSEG data.
Some investors are looking at parts 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, focuses on “quality dividend companies” and small caps.
“We think large cap may have gone a little too far and we may now see a broadening,” Ablin said.
GROW
Most investors have welcomed signs of cooling inflation and moderating growth this year, as they bolster the Fed’s case for cutting rates from multi-decade highs. But a more pronounced economic slowdown could fuel concerns that high interest rates are weighing more heavily on the economy.
Fed officials have slashed their forecasts from three to just one rate cut this year, citing the strength of the economy and unexpectedly persistent inflation.
Market reactions to previous rate cut cycles have largely depended on whether the cut occurred during a period of relatively strong economic performance or in response to a sharp growth slowdown.
Although the S&P 500 has risen an average of 5.6% in the 12 months following the start of a cycle, the cuts that accompanied a challenging economic environment have been accompanied by much worse returns, according to an Allianz study of rate cuts since the eighties. For example, a rate-cutting cycle that began around the burst of the dot-com bubble in 2000 caused the index to fall 13.5% a year later.
“Every landing is a soft landing until it isn’t,” said Julia Hermann, global market strategist at New York Life Investments.
(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Diane Craft)
