By Jane Swan, CFA and Roraj Pradhananga, CIMA & CPA

The first half of 2024 has brought significant volatility to stock markets, expectations about possible interest rate cuts, and to our political process in the United States. In our summer letter we aim to make sense of this volatility and help shed light on some of the possibilities in the months ahead. 

The US economy remains resilient, but growth is starting to slow, as many households have depleted their excess savings and as the labor market has begun to soften. Elevated interest rates, tightening lending standards and slowing consumer credit growth are expected to continue to be headwinds. US consumer sentiment has decreased to a 7-month low in June as higher prices continue to weigh heavily on Americans’ finances and impact their living standard.¹

Inflation: Consumer Price Index (CPI)

The disinflationary trend continues as headline inflation edged down to 3.0% year-over-year from 3.5% in March. Core CPI also continues to trend downward at 3.3% with the lowest reading since April 2021. Shelter costs were a notable factor in the slowdown in inflation, registering the smallest rise since 2001. While inflation remains above the Fed’s 2% target, recent inflation readings have bolstered expectations that the Fed is on a path for the first rate cut in September. However, the Producer Price Index (PPI), a leading indicator of consumer price inflation, climbed in June slightly more than forecast, suggesting inflation pressures remain and the Fed continues to be data dependent before cutting rates. 

data representing Consumer Price Index (CPI) Year over year percentage changes from Q3 of 2019 through Q2 of 2024. Data sourced from Bureau of Labor Statistics.

Source: Bureau of Labor Statistics²

Labor Market Activity

The US labor market is starting to soften based on indicators such as the unemployment rate, Jobs Openings and Labor Turnover Surveys (JOLTS), job openings-to-unemployed ratio, quits, and hires rates. The US unemployment rate increased for the third consecutive month to 4.1% in June, following 27 consecutive sub-4% readings. The three-month moving average of non-farm payroll gains of 177,000 is at the lowest level since January 2021.Unemployment rates ticked up across all races with Black Americans experiencing the highest at 6.7% in June. That is the highest unemployment rate impacting Black communities in the US since August 2022.

Data showing unemployment rates among Asian, Black, White, and Latinx workers in the US from Q3 20219 through Q2 of 2024. Data representing trends in Jobs and Unemployment in the US from 2005 through the end of Q2, 2024. Source: US Bureau of Economic Analysis, FRED, and US Bureau of Labor Statistics.

Sources: U.S. Bureau of Economic Analysis, FRED, and U.S. Bureau of Labor Statistics³

Consumer Debt Trends

Consumer spending was mostly flat as the bottom 80% of households have depleted most of their excess savings and are taking on more debt. The household debt service ratio increased from 8.3% in March 2021 to 9.8% in June 2024.⁴ As the unemployment rate rises, delinquency and default rates are expected to rise at a faster pace across all consumer loans. After reaching historical lows in Q2 2021, credit card delinquency rates have been steadily increasing and have surpassed pre-pandemic levels.⁵ Higher delinquency rates will likely further hinder credit availability and result in decreased consumer spending. 

Index returns data comparing Q2 2024, year to date 2024, and 3 year returns across sectors. Sources: Morningstar Quarterly Index Returns Report, FRED, and US Department of the TreasuryQ2 Market Activity

Public equity markets had mixed returns in Q2 as high inflation in April sent stocks falling but improving inflation data bolstered the stock market by the end of the quarter. US Large Cap benefited from gains in the mega cap tech stock as market exuberance about artificial intelligence (AI) continued to dominate. Emerging Markets generated relatively outsized positive returns in Q2 driven by Taiwan which benefited from the AI theme and supportive policy measures from China. Strong economic data from India also helped. Bond markets generally had positive returns as investors anticipated the Fed will cut rates in the second half of 2024.

Sources: Morningstar Quarterly Index Returns Report, FRED, and US Department of the Treasury⁶

S&P 500 “Magnificent Seven to Magnificent Five”

Seven US large-cap companies – Microsoft, Apple, Nvidia, Meta, Amazon, Tesla, and Alphabet – were responsible for more than half of the gains in 2023 but are more dispersed in 2024, with Nvidia and Meta leading and Tesla and Apple lagging. Despite that, the “Magnificent Seven” represented ~32% of the S&P 500 Index weight and accounted for ~61% of the S&P 500 Index YTD returns. Nvidia rose ~150% contributing to 30% of the gains in the S&P 500 in 2024. Actively managed portfolios without exposure to these companies, particularly Nvidia, have trailed their benchmarks in recent years and concentration risk is severely elevated in passively managed portfolios with exposure to the Magnificent Seven.

Source: Morningstar, J.P. Morgan Asset Management⁷ 

Chart comparing S&P Sector Returns in Q2 2024 and year to date 2024. Morningstar Quarterly Index Returns Report, S&P Global, MSCI Stock Market Update – Sector Focus

Technology, Communication Services, and Utilities had the strongest returns in Q2, but these sectors mask some striking trends. Artificial intelligence has propelled stocks since late 2022, and the second quarter of 2024 was no different. Within the S&P 500, companies related to the theme gained 14.7% in market value this past quarter, whereas the rest lost 1.2%. Six out of 11 sectors – healthcare, real estate, financials, energy, industrials and materials – lost market value.

Source: Morningstar Quarterly Index Returns Report, S&P Global, MSCI⁸

What Will the Fed Do? Economic Indicators to Pay Attention To

Along with volatility stemming from the concentration of market returns from a very small number of stocks, markets over the last year have reacted to expectations of actions by the Federal Reserve that have not come to be. At the end of 2023 market consensus was that the Fed would reduce interest rates 3 times in 2024.⁹ Meetings in the first half of the year came and went with no rate cuts and little signaling by the Fed of imminent rate cuts as inflation remains above the Fed’s target and the labor market remains strong despite some softening. As we examine market volatility and what may lie in the months ahead, it may help us to understand more about economic indicators and their relationship to market expectation. In looking at the economy and its relationship to market volatility, there are three economic indicators we want to understand:

  • Economic growth as measured by GDP. 
  • Inflation as measured by the Consumer Price Index (CPI) and Producer Price Index (PPI). 
  • Unemployment – measured primarily by the unemployment rate. 
Data comparing rate hikes, unemployment data, and recession periods in the US 1990 through 2024. Sources: U.S. Bureau of Economic Analysis, FRED, and U.S. Bureau of Labor Statistics
Chart showing changes in US GDP from Q3 2019 through Q1 2024. Sources: U.S. Bureau of Economic Analysis, FRED, and U.S. Bureau of Labor Statistics

Sources: U.S. Bureau of Economic Analysis, FRED, and U.S. Bureau of Labor Statistics¹⁰  Note: RS and LS refer to the right and left series in the chart 

We look at these because of the relationships they have with each other, and because they are some of the most important inputs the Fed considers when considering adjustments to interest rates. 

  • When economic growth is very high, it is likely that unemployment will be low. Economic growth that may be too high, and with unemployment too low can lead to high inflation. 
  • When economic growth is low, it is likely that unemployment will be high, and inflation is not likely to be a problem. 

When unemployment or inflation are high, the Federal Reserve may consider adjustments to the Fed Funds Rate in effort to change the trajectory of economic growth, which can then reverse a problem with unemployment or inflation. Higher interest rates are thought to discourage high spending because borrowing money is expensive, so spending decreases. Lower interest rates are thought to encourage spending because borrowing money is cheap, so spending increases.

How Stock Markets May Respond

Understanding these relationships is important both because they help us understand where we are, where we have been, and where we may be going, but also because of how the market responds to each of these bits of economic details. Stock markets typically respond well to data that support reducing interest rates because of the stimulating effect low interest rates have on spending which then can lead to higher corporate earnings and valuations of companies. 

  • Stock markets will often surge when unemployment increases, when the increase in unemployment may support the Fed reducing interest rates. 
  • Likewise, markets will often react negatively when inflation is high because high inflation is likely to encourage rate hikes or discourage rate cuts. 

Increasing interest rates create a headwind for the stock market because lower spending can slow earnings growth. These relationships are fragile, as the markets can also react negatively if they think the Fed is wrong in how it is responding to economic forces. If markets think the Fed is slow at reducing rates or raising rates too quickly, the market may worry that this incorrect action will increase chances of a recession. In those cases, the market may respond more erratically to news such as increasing unemployment. 

Economic Indicators, the Fed, and the Stock Market

This is all made more complex because of the “long and variable lag” associated with the economic impact of changing data. New events such as reductions in tariffs, taxes, or interest rates, all put more money in consumer’s pockets which can eventually lead to higher demand and inflation. It is thought that these impacts can take 6-18 months to impact economic growth because of the time it takes for these changes in prices or availability of cash flow to impact spending behaviors and accumulate to an extent that it impacts the economy. 

This long and variable lag can be analogized as steering a giant ship in that when you begin your turn, little happens for some time. And when you straighten out your steering, the ship continues to drift in its turn. This is what makes the Fed’s job so challenging. When they first enact a change to rates, little or nothing happens. Whichever problem they are trying to solve may continue getting worse. If they act too fast or for too long, they may overcorrect and could contribute to a recession. If they reverse course too early or act too slowly, they may not make the corrections they are attempting to make, solving either high inflation or high unemployment. The pursuit of the perfect economic correction, without over-correction or under-correcting, is often referred to as a “soft landing.”

The lag along with the fact that other contributors to inflation, unemployment, or economic growth can work against or exacerbate the Fed’s action. This makes it hard to evaluate and attribute economic success and failure to specific policies and government actions. A tax cut or stimulus checks can accelerate economic growth, inflation, and can reduce unemployment. If the Fed also reduces interest rates to stimulate growth, the factors can compound leading to unsustainable growth that can contribute to inflation. A tax hike or increased regulation could slow economic growth. If these happen at the same time as the Fed is raising rates to cool inflation, the efforts can compound and cause risk of recession. The next administration’s policy on tariffs could impact economic growth or inflation.

Volatility Likely to Continue – Questions and Potential Actions to Consider

We think the expectations of Fed actions and uncertainty of election outcomes are likely to contribute to ongoing volatility throughout 2024. The potential wide range of economic policies of the leading political candidates can make it difficult for corporations to make plans. Will regulations increase or decrease? Will taxes go up or down even further? Will tariffs increase, decrease, or stay roughly the same? Will changes to immigration policy decrease unemployment, or increase labor shortages? Will the Federal Reserve remain largely independent? Or will a new president attempt to reduce the independence of the Fed? Each of these could have significant impacts on economic growth, unemployment, inflation, and the stock market. As such, we invite all clients to consult with your advisor to be sure your asset allocation supports your spending expectations through what could be an ongoing stretch of volatility.

Jane Swan is a Partner and Senior Advisor at Veris Wealth Partners and holds the Chartered Financial Analyst (CFA®) designation.

Roraj Pradhananga is a Partner and Co-CIO and Managing Director of Investments at Veris Wealth Partners and a Certified Investment Management Analyst (CIMA®) and Certified Public Accountant (CPA).

Disclaimer

The information contained herein is provided for informational purposes only and should not be construed as the provision of personalized investment advice, or an offer to sell or the solicitation of any offer to buy any securities. Rather, the contents including, without limitation, any forecasts, projections, and forward-looking statements simply reflect the opinions and views of the authors. 

All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change without notice. There is no guarantee that the views and opinions expressed herein will come to pass. Additionally, this document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such third party sources and take no responsibility therefore. Information related to the performance of certain benchmark indices is provided for illustrative purposes only as investors cannot invest directly in an index. Past performance is not indicative of or a guarantee of future results. Investing involves risk, including the potential loss of all amounts invested.