The S&P 500 is experiencing another surge, fueled by positive developments in inflation and interest rates. Despite the upbeat momentum, several leading strategists predict potential disruptions ahead.
Wednesday was a day of celebration for investors as inflation figures for May came in below expectations, paving the way for the Federal Reserve to maintain its plan for a rate cut later this year. This forecast of lower inflation and interest rates is seen as a buffer to sustain the US economy.
US equities, particularly the growth-driven Nasdaq Composite and the S&P 500, reached new heights, with the latter up 14% in 2024 following a 24.2% increase the previous year. However, this rally could soon face challenges.
Adam Phillips, Managing Director of Investments at EP Wealth Advisors, expressed concerns that the robust performance of a few large-cap growth stocks is overshadowing underlying weaknesses across numerous smaller companies. This narrow market breadth might be disguising potential vulnerabilities, and any pullback in these leading stocks could lead to significant market adjustments.
Phillips noted, "In the past month, we've observed nearly a 3% increase in the S&P 500, with over 60% of this gain attributed to Nvidia alone. An equal-weighted view of the index actually shows a negative return over the same period. This is a critical indicator of the market's true health beneath the surface."
Until a broader array of stocks demonstrates strong performance, Phillips remains skeptical of the current rally. While companies have the potential to catch up with tech giants through impressive earnings reports, the true test will not come until the second-quarter earnings season begins in mid-July.
Amidst this, Phillips is wary of the overly optimistic sentiment prevailing among investors, given the mixed economic data and lack of substantial market drivers.
On a related note, Anthony Saglimbene, Chief Market Strategist at Ameriprise Financial, highlights concerns over the potential slowdown in economic growth. The moderate inflation rates are promising, yet they also suggest that the economy might not be as robust as desired.
"If the economy shows signs of decelerating more sharply, which might indicate that the Federal Reserve has misjudged the growth trends, we could be looking at a correction of 5% to 10%," Saglimbene explained.
He also emphasized the adverse effects of persistently high interest rates on the economy, advocating for quicker rate reductions to alleviate economic strain.
Despite potential market downturns, Saglimbene believes investors shouldn't be overly concerned. He predicts any forthcoming corrections to be modest, presenting a buying opportunity for those who have not yet participated in the rally. He also pointed to the substantial liquidity in money market accounts, which suggests there's still ample investment capital available.
Gene Goldman, Chief Investment Officer at Cetera Investment Management, commented on the high valuation of the S&P 500, which trades at a forward earnings multiple of 21 times. "Given our current environment of neither low interest rates nor low inflation, these valuations assume a perfect scenario," Goldman stated.
He further noted that the market's overall valuation is propped up by high-expectation growth stocks, which are particularly vulnerable in election years. Unless these stocks continue to outperform expectations, a significant correction may be imminent this summer.
Nevertheless, a market downturn is likely to be short-lived, according to Goldman. He predicts that the S&P 500 could revert to its 200-day moving average, which would represent an 11.5% decline—still below the average historical pullback.
Conversely, some strategists maintain a positive outlook. Shep Perkins, Chief Investment Officer at Putnam Investments, believes US stocks will steadily ascend despite prevailing skepticism. This confidence is bolstered by resumed earnings growth, which is crucial for further market gains.
Garrett Melson, a Portfolio Strategist at Natixis Investment Managers, anticipates the S&P 500 could increase by an additional 10% from its current position, as investors overcome their hesitation.
In preparation for potential downturns, Saglimbene continues to favor US equities, particularly large caps, given the prevailing high interest rates. He finds consumer staples attractive due to their defensive qualities and pricing power, and remains selectively optimistic about technology stocks due to their impressive growth.
Both Saglimbene and Goldman see value in European and Japanese equities, which have performed well this year and are likely to remain resilient if US stocks falter. Goldman also sees potential in value-oriented and small-cap stocks, given their attractive valuations.
Phillips is particularly bullish on sectors such as energy and industrials. Energy companies are benefiting from robust free cash flow and net income, making them a hedge against inflation and geopolitical risks. Industrials stand to gain from increased infrastructure spending, with defense firms within this sector also poised for growth.
