Stock prices are hitting new highs one after another.
The Morningstar U.S. Market Index has rebounded from a sharp selloff in August and is up more than 21% since the beginning of the year. The index has risen about 65% since its bottom in September 2022.
“We have been surprised by the resilience of the stock market in the face of significant volatility over the past few weeks,” said Christy Akrian, head of iShares investment strategy for the Americas at BlackRock. . She points to China’s fiscal stimulus, rising geopolitical tensions, and uncertainty surrounding the close U.S. presidential election. Not to mention concerns about soaring valuations, the recent weakness in the technology sector, and slowing consumer spending. “Theoretically, all of this is flashing warning signals,” Akrian said. But the market is taking everything in stride.
What’s behind the strong rally and what could derail it? Strategists say a surprisingly strong economy has given investors confidence and helped push stocks higher, but they also warn that troubles during earnings season could disrupt the bull market.
Why are stock prices soaring?
“The most important thing about why all markets are doing so well despite facing so much uncertainty is that economic indicators are unexpectedly picking up. ” explains Akrian. “Any discussion of a recession is completely off the table, at least in the short term.”
Inflation has fallen dramatically over the past year, and recent strong labor market data has eased investor concerns about a sharp slowdown in hiring. Consumers are still spending, wages are rising and corporate profits remain resilient. That’s a big change from earlier this year, when employment and inflation data seemed to point to a possible recession. Add to this the Fed’s interest rate cuts and you have a recipe for the massive gains we’ve seen over the past two months.
“As far as the market is concerned, there will be a tailwind for the Fed,” said Yunyou Ma, chief investment officer at BMO Wealth Management. “That’s a lot of encouragement and it gives courage to all sides.” On the other hand, lower interest rates stemming from recession concerns would have a very different impact on investors.
Ma said a soft landing was on the horizon, and he expected future rate cuts to boost the economy again as companies waiting for interest rates to fall accelerate spending.
Expanding the range of rallies
Rising confidence in the economy and interest rates has triggered a recent rotation away from tech stocks and into value stocks and smaller market capitalization stocks. Continuing two years of impressive gains, large-cap growth stocks returned just 2.2% in the third quarter, while large-cap value stocks rose 8.8%.
Source: Morningstar Direct. Data as of September 30, 2024.
Bryant VanCronkite, senior portfolio manager at Allspring Global Investments, said while this is a positive development, it may be painful for some investors to see the decline in artificial intelligence trading. “We want to better distribute profits across a broader group of companies,” he says. This indicates a healthier market and a more sustained bull market.
Dave Sekera, chief U.S. strategist at Morningstar, also sees support for the stock remaining. “As we assess market dynamics, we believe the market will be dominated by tailwinds from lower interest rates, lower inflation, monetary easing, and the recent package of stimulus measures announced by the Chinese government.” Headwinds from slower economic growth It’s blowing. ”
Focus on profits
Earnings season is now underway, kicking off with the major banks’ third-quarter earnings reports. Corporate profits have remained strong overall despite headwinds from inflation, high interest rates and geopolitical uncertainty, but strategists say any major issues could spook markets. I’m warning you.
“We’re a few weeks into earnings season and I think a few high-profile failures could derail things,” says James Regan, director of wealth management research at DA Davidson. “That’s probably the biggest risk in the short term,” he says, but his basic expectation is a decent overall result.
Analysts widely believe that third-quarter profits for companies included in the U.S. market index rose 4.3% overall, according to FactSet estimates. This is lower than the 10.3% growth in the second quarter and the expected 11.7% growth in the fourth quarter. Part of this difference is because the third quarter of 2023 was so strong that the growth rate for the third quarter of 2024 looks smaller by comparison. Analysts call this phenomenon the “base effect.” Lower oil prices are also expected to weigh on energy sector profits, lowering expectations for other markets.
Akrian said he would pay more attention to how companies expect to perform later this year and into 2025. “What I’m worried about, especially coming from the technology sector, is if a lot of forward guidance comes out that’s darker than the market expected,” she says. He said that if companies indicate that their current forecasts for earnings growth in the next or second quarter are “too optimistic,” “this could cause a pullback as the market begins to readjust its expectations for the fourth quarter and beyond.” There is a possibility.”
When will spending on AI pay off?
Investor enthusiasm around AI has sent tech stocks soaring over the past two years. Companies are investing heavily in this technology, but investors are concerned about when they will begin to recoup their spending. “Ultimately, early winners will need to justify their spending through new revenue streams and margin expansion,” VanCronkhite said. “Without that, you have to wonder if we are ready for all these amazing things that are envisioned to happen with AI.”
Akrian said that if investors hear earnings guidance that further heightens these concerns, tech stocks will be heavily weighted within major indexes, and expectations around AI will drive the valuations of many large companies outside of the tech giants. We believe that the market could be depressed due to the fact that it is embedded. . Still, many analysts remain bullish on AI. For example, after Advanced Micro Devices’ AMD “Advancing AI” event, Morningstar equity strategist Brian Colello wrote: Additionally, we receive a lot of questions about what the size of the AI chip market will be in its mature phase (whenever that is likely). I’m sure this industry won’t grow 25% a year forever, but it might not. We’re going to see a slowdown and a flat market over the next five to 10 years. ”
Ma said it’s unlikely that deep-pocketed tech giants will abandon AI anytime soon, adding that anecdotal evidence of the technology’s success is starting to trickle in. “The question is, ‘Will we see anything in return?'” he says.
Bottom line for investors
Nothing is certain when it comes to stocks. A soft landing is now on the horizon, but there is also the possibility that the economy will weaken. “This is a historically atypical cycle,” VanCronkite said. “Our ability to predict the future at a macro level is much more uncertain than in previous cycles.”
Strategists recommend a balanced approach to navigate the many unknowns, including the fate of the economy, the outcome of the presidential election, and geopolitical developments. “The important thing going forward is to diversify,” Akrian said, adding that he still sees a lot of opportunity in the stock market.
Tech trading in giant stocks may have worked well in the past, but investors should expect the mix of profits to be different in the coming months. Ragan said the tech industry’s recent strength means it could be a good opportunity for investors to rebalance into underperforming areas that could potentially benefit as the bull market continues to expand. Then he added. But, he advises, “Stick to high quality.” Stick with companies where you can see a little more continued revenue growth. ”
