Is a Market Correction Coming? | U.S. Bank (2024)

“Investors are trying to determine if the market has fully priced in reduced expectations for Federal Reserve (Fed) interest rate cuts,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Dating back to late 2023 and including the first three months of 2024, markets seemed to anticipate that rate cuts were imminent.”

The Fed opened the door to rate cuts beginning late last year, but more recent economic data, including stubbornly persistent inflation, has tempered expectations. This appeared to trigger the market’s April retreat, though the extent or duration of the current pullback is unclear. In fact, slower than expected April jobs market growth again fueled speculation that the Fed could start cutting rates before the end of the year. In the immediate aftermath of the jobs report, markets rallied solidly.

In 2022 and 2023, the Fed raised the fed funds rate eleven times, to a range of 5.25% to 5.50%. The last change in interest rates occurred in July 2023. The Fed has held rates steady since then and projected three rate cuts in 2024.² “April’s downturn showed the market’s reaction to recent Fed indications that rate cuts aren’t on the immediate horizon,” says Haworth.

While the Fed succeeded in its effort to slow inflation, it has had difficulty bringing inflation down to its 2% target range. “Data points indicating still elevated inflation (the Consumer Price Index stood at 3.5% for the 12 months ending in March) 3 corroborate the Fed’s current view that it’s too early to cut rates,” says Haworth. However, along with disappointing April jobs numbers, first quarter economic growth of 1.6% annualized4 was also lower than many anticipated.

What factors are likely to affect the stock market today and for the remainder of 2024?

A shift in market leadership

In 2023, communications services, information technology and consumer discretionary stocks vastly outpaced the rest of the S&P 500.¹ “What kept driving the markets to new highs were companies that are insensitive to persistently higher interest rates,” says Haworth. “Large companies like Nvidia, Microsoft, Amazon and Google that hold a lot of cash and have low borrowing needs are not greatly affected by changes to the interest rate environment.”

The impact of higher interest rates is reflected at the bottom end of the scale for S&P 500 sector performance. The interest-rate sensitive real estate sector, for instance, is down 9% for the year through April.¹

Large-cap stocks continue to dominate

The S&P 500 index of large-cap stocks topped 5,000 for the first time in February and continued to reach new highs through the end of March, before retreating in April. The S&P 500 recovered some of that lost ground in early May.

The environment has been less beneficial for smaller stocks. “The Fed’s interest rate policy matters meaningfully to smaller companies that likely must borrow more to fund operations and business growth,” says Haworth. “As a result, small-cap stocks are under more pressure in the current environment.”

Investors appeared to recognize this based on stock market results in 2023 and 2024, comparing the S&P 500 to the Russell MidCap Index and the Russell 2000 small-cap stock index.⁵

Key stock market drivers in 2024

What are the keys to a sustained bull market? Haworth says three primary considerations deserve the most attention:

• Inflation trends and future Fed policy moves. With headline inflation stubbornly hovering above 3%,³ “There’s some longevity to the inflation story,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management. “It’s not going away as fast as people might like.” In addition, a key measure monitored by the Fed, the core personal consumption expenditures (PCE), stands at 2.8%, little changed since December 2023.⁴ Freedman says “the current fed funds target rate over 5% is not sustainable, but until the Fed sees more clear evidence of inflation moving down, it’s in a tough spot.” As a result, Freedman believes the first fed funds rate cut may continue to be delayed.
• Consumer spending. “Consumers’ willingness to maintain reasonable spending growth has been the linchpin for the economy,” says Haworth. This is likely due in part to the strength of the labor market and more significant wage growth. While the initial read of first quarter 2024 economic growth showed an expansion rate slowdown,⁴ consumer spending still proved to be the main growth driver.
• Corporate earnings. First quarter earnings reports are rolling out, and Haworth says the general direction is positive. “What we’ve seen so far shows earnings as a whole are coming in ahead of estimates,” according to Haworth. However, he says markets are closely watching what happens going forward. “There is some disappointment in the forward-looking earnings expectations that companies provided to this point,” says Haworth.

Additional risks to the market include the impact of global tensions highlighted by the Israel-Hamas conflict and the Russia-Ukraine war. The heated lead-up to what appears likely to be a closely contested presidential election may ultimately draw more investor attention.

Equities still offer opportunity

“It remains a constructive stock market,” says Haworth. “Earnings are still moving in a positive direction, consumer spending has held up, and it still seems clear that at some point, a rate cut will be the Fed’s next interest rate move.”

The biggest potential concern in the current environment is valuation. “Stocks that have dominated the market in the past one year-plus may be reaching challenging valuation levels,” says Haworth. “Investors may consider diversifying with an equal-weighted S&P 500 exchange-traded fund.” Such a fund puts less emphasis on the largest stocks in the Index compared to a traditional S&P 500 fund.

Freedman encourages investors to view markets with a long-term lens. “Timing the markets and trying to be precise on when to be in and when to be out is challenging,” says Freedman. “Markets will do things at the exact opposite time you expect them to.” Freedman says investors can follow a more productive path. “Our best advice is having a plan, a programmatic approach to investing. That takes the emotion out of it.”

In the near term, says Haworth, “expect continued choppiness in the markets, and not necessarily a straight upward path for stocks in the coming months.” He says for those who still have a sense of caution about the stock market, “consider putting a portion of your portfolio to work in equities in a systematic way, such as dollar-cost averaging available cash over a series of months.”

Check in with a wealth planning professional to make sure you’re comfortable with your current investments and that your portfolio is structured in a manner consistent with your time horizon, risk appetite and long-term financial goals.

The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. Diversification and asset allocation do not guarantee returns or protect against losses. The Russell MidCap Index provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500, is designed to measure the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment. The Russell 2000 Index refers to a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index.

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