As we entered 2024, our outlook was focused on the U.S. Fed beginning to cut rates and the positive catalyst that it would provide to equity markets. Rate markets projected 6 cuts for 2024 with the first cut set to occur in March. With rate cuts as a catalyst, reasonable valuations as an underpin, and a return to double-digit earnings growth providing a potent mix, we forecasted S&P 500 returns to be higher by between 10-15%.
With the first half of 2024 behind us it’s time to take stock and re-evaluate what to expect from equity markets in the second part of the year. As we exited June, the S&P 500 was up about 18%, with AI-related stocks driving performance. We have yet to see any rate cuts as inflation is proving stickier than initially thought in the beginning of the year, and the U.S. economy remains resilient.
As we head into the second half of 2024, we have confidence that equity markets can continue to deliver solid performance. It has been 12 months since the last rate hike in July 2023, and the chances of a September cut are strengthening. At the time of writing rate markets are forecasting two 25bps cuts in 2024; one in September and a second in December. Followed by four further cuts in 2025.
While the Fed remains “data dependent” we are becoming increasingly confident that inflation is about to resume its downward fall toward the Fed’s target of 2%; with CPI expected to break through the 3% level after several months of being range bound at 3.4%. Several components within CPI have begun to roll over, particularly shelter, vehicle prices and energy.
We are also starting to see signs of the U.S. economy slowing down, which will not be missed by the Fed governors.
The U.S. consumer remains will placed despite wage growth slowing and excess savings being whittled away.Real income remains positive and consumer net worth continues to increase, given the appreciation in the stock market as well as house prices over the last 12 months.
By way of example the S&P 500 has added $15trl in market cap in the last 12months, almost equivalent to 2023 total consumer spending.
We continue to believe that the beginning of the rate cutting cycle will add further fuel to equity markets; allowing stocks to continue to move higher into year end. As we pointed out in our 2024 outlook report, history suggests that equity markets perform strongly after the Fed are done hiking and we enter the cutting cycle. Historically, the S&P 500 has rallied between 20-30% and 40% over the subsequent 12 and 24 months after the last interest rate hike, respectively. Currently, the S&P 500 is up 22.25% since July 2023; if history is any guide, we still have more upside to go.
Bearish investors may point to current valuations limiting any further upside and increasing downside risks. It is no secret that on the surface forward PE of the S&P 500 may look stretched at 21x.
However, as we have pointed out before, looking at valuation in this manner is too simplistic given the gravity-defying run of high multiple AI-related stocks; which are causing the average S&P 500 valuation multiples to skew to the upside compared to history. Digging a bit deeper, the forward PE of the Magnificent 7 is 33x, and have a weighting in the index of approximately 35%. Given the S&P500’s forward PE multiple of circa 22x, this gets you to a forward PE multiple of 16x for the remaining S&P 493.
We would argue that the 33x PE for the Mag 7 is justified, given the secular growth those companies are experiencing. If we look at the S&P 500 PE-to-growth multiple (PEG), valuation looks much less of an issue.
With multiples looking fair, it is more likely that earnings growth will be a major component of returns going forward. After several years of mid-single-digit to no-growth, earnings growth among the S&P 500 is about to see a step change into the mid-teens. This can be seen in the charts below, earnings growth ramps up as we approach 4Q24 and moved into 2025. Any fears that this growth may be in jeopardy due to the Fed waiting too long to cuts rates, will negatively impact equity markets.
Conclusion
As we head into the back half of the year, we continue to believe that rate cuts will support further upside performance in equity markets. While the tech names have been the main source of returns to date, rate cuts should see cyclical and value orientated names in favour. We continue to believe the best strategy going forward is to have a diversified portfolio with exposure to the secular growth within the technology space as well as positioned within the consumer cyclical interest rate sensitive names which should see multiple expansion driven by rate cuts.