Through the first five months of 2024, U.S. economic data remained relatively strong. During this period, U.S. stocks continued to rise, driven by growth and technology sectors. The S&P 500^® Index posted gains in six of the past seven months, despite interest rates being at decade highs and no rate cuts anticipated in the near future. Year to date through May 31, the S&P 500 returned 11.3%, reaching a new all-time high of 5,321 on May 21. Additionally, May saw the Dow Jones Industrial Average top 40,000 and the Nasdaq Composite surpass 17,000, with both setting all-time highs. Virtually every U.S. equity index recorded positive returns for the year so far. In contrast, bonds underperformed, with the Bloomberg U.S. Aggregate Index down 1.6% year to date, as yields on the 10-Year Treasury are 0.62% higher than at the beginning of this year.

There are multiple issues continuing to shape the financial markets as the halfway point of 2024 nears. These include the U.S. presidential election which is just six months away and has no clear frontrunner, persistent inflation along with uncertain timing for rate cuts by the U.S. Federal Reserve, ongoing geopolitical conflicts between Israel and Hamas and Russia and Ukraine, and tensions over how best to address domestic border issues.

Equity Markets Bloom in May

After a brief pause in April, equity markets rebounded in May. Over the first five months of 2024, equity markets delivered impressive returns: the S&P 500 gained 11.3%, the Nasdaq rose 11.8%, the Dow increased 3.5% and the Russell 2000^® Index was up 2.7%. Despite higher bond yields, the market remained resilient, driven by robust economic growth and strong corporate earnings.

Growth stocks outperformed value stocks during this period, with the Russell 1000^® Growth returning 13.1% compared to 7.6% for the Russell 1000^® Value. Small-cap stocks, as measured by the Russell 2000, returned 2.7% during this period but continued to lag behind large-cap stocks. The valuation gap between small-cap and large-cap stocks is the widest it has been since April 2003. Based on forward estimates, the S&P 500 trades at 21 times earnings, while the Russell 2000 trades at 17 times. Additionally, the Russell 2000 represents 6% of the Russell 3000, the smallest percentage since November 1990. We highlight this valuation gap because that gap should close especially when the economy reaccelerates.

Bonds Are a Drag

The bond market faced a different scenario due to higher-than-expected inflation data driven by a stronger economy, resulting in increased yields and decreased prices. The 10-year Treasury yield rose from 3.88% at the end of 2023 to 4.50% by the end of May, while the 2-year Treasury yield climbed from 4.25% to 4.87%. Year to date, the Bloomberg U.S. Aggregate Index recorded a negative return of 1.6% and the Bloomberg Corporate Index was down 1.1%.

Strong GDP and Earnings

According to a Bloomberg survey of 74 economists, the U.S. Gross Domestic Product (GDP) is predicted to expand by 2.4% in 2024 and 1.7% in 2025. The same survey indicates a 30% chance of a recession over the next 12 months. Additionally, the Atlanta GDPNow is currently predicting 1.8% growth for the second quarter of 2024. The key takeaway is that while the economy is slowing, it doesn't appear to be on the brink of a recession. Corporate earnings were solid for the first quarter, with 80% of S&P 500 companies reporting earnings above consensus expectations. Earnings growth for the quarter is now expected to come in at a robust 6%, beating the initial expectations of 3.5%.

Inflation Still Above 2%

While inflation remains uncomfortably high, April’s Consumer Price Index (CPI) reading of 3.4% helped ease investors’ fears of a new wave of inflation. Additionally, April’s Core PCE data—which is the U.S. Federal Reserve’s preferred inflation gauge—came in at 2.7%, which is still above the Fed’s target of 2%. Fed Governors continue to have differing views on inflation, with some suggesting that a rate hike is still possible and others advocating for loosening monetary policy before inflation reaches the 2% target. Inflation has proven to be sticky in the near term, likely keeping the Fed inactive regarding rate cuts through the summer, as the consensus is that inflation will gradually decline over the remainder of the year.

Stimulus Keeps Coming

Three bills passed by Congress—the Infrastructure Investment and Jobs Act (2021), the Inflation Reduction Act (2023) and the CHIPS and Science Act (2022)—are expected to continue to stimulate the economy over the next 5 to 10 years. While these laws are deemed essential for the country, they are also likely to exert upward pressure on inflation, contributing to its persistence. This situation highlights a potential conflict between the Federal Reserve, which controls monetary policy through Federal Funds Rates, and the U.S. Congress, which enacts fiscal policy through Acts such as those noted above.

Geopolitical Concerns Remain

On the international stage, persistent trade tensions between the U.S. and China, the ongoing Russia–Ukraine conflict and instability in the Middle East continue to present uncertainties and risks in 2024. Although the direct impact on the U.S. economy has been minimal so far, there is significant concern that potential supply shocks in crucial commodities and goods—such as energy, food and semiconductors—could have a major impact on global politics, especially given the current climate of heightened political tension in the United States.

Election Fears

The upcoming Presidential election is just half a year away, unfolding amid intense polarization among Americans. Core topics such as the economy, healthcare, immigration and climate change are poised to define the discourse. Analysts predict that Democrats will retain the Senate while Republicans maintain control of the House of Representatives. Regardless of the outcome of the Presidential election, the victor will serve only one term. With Congress potentially deadlocked, markets could benefit from limited legislative action.

Markets Pricing in a Soft Landing

This holds particular significance given that the S&P 500 is currently trading at 21 times the projected earnings for 2024, notably higher than the 25-year average of 16.4 times. Although the 21 times figure is historically high, it’s worth noting that in March 2000, the S&P 500 peaked at 25.2 times earnings before plummeting nearly 50% over two years. Remarkably, the top 10 companies in the S&P 500 index are trading at a multiple of 28.4 times. Achieving further multiple expansion from this point would necessitate either a soft landing or no landing at all. Presently, the equity markets seem to have already priced in a considerable degree of optimism; therefore, a hard landing would not bode well for stocks.

What Goes Around Comes Around

Taking a look at the oil industry, it experienced significant merger and acquisition activity in both 2023 and 2024. Notable transactions include Conoco and Marathon, Exxon Mobil and Pioneer Natural Resources, and Chevron and Hess. What’s particularly striking about this surge is that many of the deals involve fragments of John D. Rockefeller’s Standard Oil, which was dismantled in 1911 into 34 separate entities. This isn’t unexpected, considering that Standard Oil once held a staggering 90% share of the U.S. oil market.

Summary and Outlook

The U.S. economy has displayed resilience in the first five months of 2024, with stocks continuing their upward trajectory, notably driven by growth and technology sectors. Despite decade-high interest rates and no anticipated rate cuts in the near future, the S&P 500 has recorded gains in six of the past seven months, reaching a new all-time high. Other indices, including the Dow and Nasdaq, have also reached significant milestones. Equity markets have outperformed bonds, which have struggled amid rising yields.

Looking ahead, various factors, including the looming U.S. presidential election, persistent inflation and international tensions, continue to shape market dynamics. Additionally, recent legislation aimed at stimulating the economy poses inflationary risks, potentially complicating the Federal Reserve’s monetary policy decisions. With these factors in mind, investors should remain cautious, as the financial markets may face pullbacks, given the elevated valuations and the need for sustained economic growth to justify the optimism priced in to equity markets.