The first half of the year has been marked by a resilient economy, persistent inflation, and strong equity markets. As we approach the midpoint of the year, it’s a good time to review lessons learned, and consider potential opportunities and risks for the remainder of 2024.

The U.S. economy has shown remarkable strength, with robust job growth, solid consumer spending, and a housing market that has defied expectations despite high mortgage rates.

However, inflation remains stubbornly high, prompting the US Federal Reserve to maintain higher interest rates. The Fed’s decision on whether to implement previously signalled rate cuts will impact the economic trajectory in the second half of the year.

The relatively positive economic news has led US equity markets to push higher through the year, showing resilience through one of the most aggressive Fed tightening cycles in decades.

The rally has been fundamentally supported by rising corporate profits and revenue, which tend to be durable drivers of stock prices over longer periods. After declining in 2022 as high inflation squeezed margins, S&P 500 earnings have reaccelerated and now stand above prior peaks.

This resulted in first half earnings exceeding consensus estimates, with full year S&P500 earnings projected to grow around 11% in 2024, according to Bloomberg consensus estimates. The trend in profits provides a foundation for potential further equity gains.

Clouds on the horizon

One area of concern is that although major US indices have reached new highs, it has been driven by increases in a handful of mega technology names.

It remains to be seen if more cyclical sectors like energy, financials and industrials will play catch-up.

Small and mid-cap stocks have also underperformed large-caps. A broadening participation across stocks, sectors and styles would be viewed as positive for ongoing market strength.

Over time, the transformative impacts of technologies like artificial intelligence are also expected to spread beyond just the leading tech giants.

Another market driver has been the gradual moderation in inflation readings.

The latest U.S. inflation data for May was below expectations and showed consumer prices rising 3.3% year-over-year, which provided relief that price pressures may be easing. Core inflation was also lower than forecast at 3.4%.

The Fed cited moderating housing/rent costs and cooling services inflation from a softer labour market as potential factors that could bring inflation closer to the 2% target over the coming years.

The Fed projects a “soft landing” scenario with GDP growth above 2% through 2026, steady unemployment between 4-4.2%, and inflation falling to 2% by 2026, even as growth remains solid. Productivity gains and AI could support this outlook.

Lower inflation should allow the Fed to eventually pivot from restrictive policy to a more supportive stance through lower interest rates.

While the path to a 2% inflation target may not be smooth, a gradual economic slowdown could further relieve inflation pressures. With policy rates likely peaking, this could provide a positive backdrop for risk assets to build on recent gains.

When will rates be cut?

Internationally, most major central banks are expected to begin cutting rates next year as inflation decelerates worldwide. This coordinated global monetary easing cycle should help reaccelerate economic growth, particularly in lagging regions like Europe and China.

While the U.S. is expected to maintain its leadership in economic and earnings growth, relatively attractive valuations in international developed markets could justify investment allocation to those regions.

One risk that could spark bouts of volatility in the months ahead is uncertainty around November’s US election. However, the likely candidates have both previously served, providing some familiarity.

Importantly, history shows stocks have tended to perform well in election years regardless of the outcome.

Over longer periods, fundamentals like economic growth and corporate profits have proven to be more powerful drivers of returns than politics.

While regular pullbacks are expected, the combination of rising profits, economic expansion and potentially lower yields creates a constructive environment for this aging bull market to continue.

A disciplined, diversified approach can help investors navigate any volatility and take advantage of opportunities.

Market Opportunities

With interest rates still high in Australia and the US, fixed-income investments such as corporate bonds offer attractive yields. Investors may consider investment grade bonds if they want to lock in higher rates while providing predictable cash flow.

If inflation continues moderating, the Fed may signal more rate cuts in 2024-2026. With the terminal rate likely 3-3.5%, bonds offer attractive yields.

In Australia, May’s higher than forecast inflation data is likely to encourage the RBA to keep rates on hold longer than expected. The new data prompted NAB economics to push out its forecast first rate cut from November this year to May next year.

Bond investors can consider extending bond durations, given these could perform well as the economy normalises and rates gradually decline.

Equity valuations remain elevated in AI names. Investors concerned that US technology names are over-priced could consider rebalancing their portfolios to lock in gains and maintain an appropriate risk profile.

Conclusion

Investors who are looking to reduce risk in their portfolio can consider hedging strategies as well as adding diversification through uncorrelated assets. Working with your investment specialist to explore options and identifying opportunities is important.

Investors should consider complementing traditional portfolio exposures with alternative investments, such as income derivatives and real assets, to enhance diversification and potentially mitigate risk.

To discover more call 1300 683106 or email us on investordesk@nab.com.au

Important information

The information contained in this article is gathered from multiple sources believed to be reliable as at April 2024 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. NAB does not guarantee the accuracy or reliability of any information in this article which is stated or provided by a third party. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article. ©2024 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.