Q2 2024 Market Update: Navigating the “Last Mile” of Recovery

It’s hard to believe that four years have passed since the onset of the global pandemic, and we are still dealing with the fallout. Perhaps it was a bit foolish to believe there was a silver bullet to easily return us to an economy of low unemployment, modest inflation and rational decision-making from our leaders. While we have made considerable progress in these efforts, the “last mile” is proving challenging and a bit elusive with unknown consequences.

Consumers remain frustrated by stubbornly high prices for food, energy, housing and basic necessities, while the overhang of the exploding government debt adds another layer of concern to long-term growth and stability. Still, we should take comfort that the economy is growing reasonably well, the employment picture looks good, inflation is still high but has receded, and the stock market has reached all-time highs.

Consumer resilience and labor market dynamics

Although resilient, there are modest signs of an economic slow­down in certain sectors. It appears that consumers are getting exhausted from the persistently high inflation over the past few years. On the positive side, the employment picture remains quite strong, with an unemployment rate hovering around 4 percent, wages growing above the rate of inflation and over one million jobs created so far this calendar year. Still, more people have filed for initial unemployment claims over the past few months as compared to the start of the year and the unemployment rate is expected to trend higher over the next few quarters.

Another bright spot is the services sector, which includes various industries, such as transportation, information services, arts and entertainment and health care, making up more than 70 percent of the economy. Activity has rebounded recently with gains in employment and new orders. However, businesses are increasingly worried about the effects of elevated inflation and high interest rates.

Finally, amidst modest economic growth and the hype surrounding new artificial intelligence trends, investors have bid up several stock indices to new record highs. These wealth gains should lead to improved consumer spending and additional business invest­ments, further adding to economic activity.

Challenges in manufacturing and housing markets

While generally positive, some areas of the economy continue to struggle due to high interest rates and muted consumer demand. The manufacturing sector has been contracting for nearly two years and the latest data suggests that this trend will continue. In fact, the manufacturing gauge of new orders slid 3.7 points in May, the biggest drop since June 2022. While about half of the sub-sectors reported contracting activity, the other half reported growth. Yet, demand remains elusive as companies demonstrate an unwillingness to invest in supplier order commitments, inven­tory and capital expenditures due to current monetary conditions and general uncertainty.

The housing market also continues to struggle from spotty demand, limited supply and high mortgage rates. In the latest report, new home construction slumped to the slowest pace in four years as housing starts decreased 5.5 percent to an annualized pace of 1.28 million units. Also, building permits, which point to future construction, fell 3.8 percent, the weakest since June 2020. The main culprit impeding homebuilding activ­ity is restrictive monetary policy leading to high mortgage rates. Further complicating the issue is a huge housing shortage, which is keeping prices elevated and locking out many Americans from homeownership.

Federal reserve caution and market performance

Although economic trends are mostly favorable and inflation contin­ues to trend lower, the Federal Reserve is reluctant to aggressively cut short-term interest rates too soon and risk another flare-up of inflation. For now, expectations are for one or two interest rate cuts by the end of the year, much lower than the six cuts antici­pated at the start of the year.

In this environment, stock returns were vastly different over the past quarter, depending on market capitalization, sector and growth expectations. The technology-heavy S&P 500 Index returned 4.28 percent for the quarter, while mid- and small-cap stocks returned -3.5 percent and -3.1 percent, respectively. Further, growth stocks generally outperformed value stocks. In bonds, slightly lower interest rates helped bonds produce slight returns, with the Bloomberg Aggregate bond index returning 0.07 percent for the quarter.

Our outlook

Looking ahead, modest economic growth, along with improving corporate earnings and lower inflation, should help offset some of the negative trends and lead to a wider economic expansion. Further, it appears the Federal Reserve is poised to begin the cycle of lowering interest rates at some point this year, which should comfort investors and buoy returns in the capital markets.

While stock returns are generally very good so far this year, we expect more muted returns over the next few quarters. In bonds, if infla­tion continues to moderate and the Federal Reserve cuts rates, bond returns should finally turn more positive.