2024 Q2 Market Outlook
Already, we find ourselves in the second quarter of 2024, and with the sun out, it is looking to be a great spring here in the Pacific Northwest! As we look ahead, now is a great time to assess what has happened so far and what may be ahead in 2024. Below, I will briefly touch on our expectations, provide a recap of 2024 thus far, and share strategies to manage risk and provide opportunities for your portfolio.
A recap of our expectations in 2024
In our last market outlook, we shared our 2024 expectations. We expected that we would have a decent year with single-digit type returns from January 1 to December 31, 2024. However, we also expect quite a bit of volatility throughout the middle months of 2024.
What has happened so far in 2024
We now find ourselves in the second quarter of 2024, and so far, it has been off to a great start. The S&P was up nearly 11% at the high with a vast discrepancy between how the stock and bond markets view the data. However, in the first couple weeks of the second quarter, the stock market has started to follow suit and now hovers up around 5.5% YTD, a significant pullback from the high-water mark around the end of Q1.
Challenges in 2024: Volatility and Valuations
At the beginning of the year, we discussed that we may see some volatility. It took a bit longer, but we are seeing it now. Looking at a broad stock allocation, a diversified portfolio may include small cap, mid cap, and large cap stocks. This refers to the capitalization, or the size, of the company. Separately, we can also break apart the market by value vs. growth companies. Value stocks typically suggest that the companies in this arena are underpriced and could appreciate over time based on the discount you are purchasing them for. Conversely, there are growth stocks, which are technically “overpriced”, but are expected to do well in earnings and have growth potential. In the case of growth stocks, you are betting on their future growth to expand.
When we focus on this large-cap growth area specifically, at the height of this year, valuations were near 150% of their 20-year average. This price momentum has created a lot of optimism, but anytime valuations suggest the stocks may be 50% above the 20-year average, there should be a pause for concern. In the early stages of Q2, the S&P dropped off by about 4.5% from its high in about a two-week period, and inflation data is higher than expected. Now the market is starting to turn to what the Fed might do ahead (or not do) and how this might translate to the impact on stocks, creating some volatility, especially in these large growth stocks.
One reason we are concerned about these valuations is that it would seem the markets have been priced for perfection, meaning the prices are suggesting nothing can go wrong. There is very little room for any hiccups on the horizon, and when markets are priced in this manner, a small storm can create a very quick reaction to the downside. Our concern has been that there is a lot of potential risk at the moment and how quickly market sentiment can change in this environment.
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Challenges in 2024: Election
The second big risk that we saw on the horizon is probably the most obvious, which is the election. It is still early in the year, but as we get closer to fall, we can certainly expect to see more focus here, and as a result, some shorter-term volatility.
However, we don't expect the election to create long-term volatility. Instead, the market direction after elections will likely depend on any policy or tax changes that may be ahead. The election in and of itself, generally, doesn't have that much of an impact on the markets over the long-term.
Challenges in 2024: The Fed
The third risk centers around the Fed. For those who are following inflation, through February and March, we have seen significantly higher inflation data. As a result, the Fed has changed course and shared they may not be cutting rates as quickly as they had originally anticipated.
Additionally, the markets are starting to take the current rates a little more seriously and starting to think that we might be in a higher interest rate environment for longer. Over the last two years or so, there has been a huge focus on the Fed regarding how long they're going to hike and when they would stop hiking. Now in 2024, that focus has shifted to expecting cuts and wondering when they will begin. At this point, there are discussions about a possibility of zero cuts through this year – a large shift from the consensus coming into 2024.
To put interest rates and stock valuations in perspective, and to help simplify, let’s assume there are only two investment options available: stocks and bonds. If bonds are paying only 0.01% interest, you might be more willing to pay more on the stock side of the equation and take on more “risk” (or pay a higher valuation) because the alternative is very unattractive and provides very little opportunity for return. However, when interest rates shift and bonds pay closer to 5% interest, like they are today, you may not be willing to take on as much risk on the stock side because you have a good return and relatively low risk in the bond investment. You can see how this may have such an impact on stock prices and illustrates the importance of interest rates to market returns.
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What we see ahead in 2024
We still feel the same way now at the beginning of Q2 as we did at the start of the year. We still believe in stocks; however, it is extremely important this year to have diversification within your portfolio. It is especially important in the areas of the market where we are seeing these extremely high stock valuations.
Additionally, bonds are a great asset class to focus on. We expect rates to come down at some point, which can provide a great opportunity in bond investments. That said, we do expect rates to come down a bit slower than many others may suggest. Nonetheless, the current rate environment provides a great risk-reward opportunity if managed correctly.
Cash is also a great asset class to consider in the short run because many money market and cash holdings may be paying near 5% interest now. These holdings provide a great interest rate, defense if markets were to drop, and flexibility if markets were to shift.
Last are commodities. Commodities have been creeping up very quietly so far in 2024. The general commodity asset class provides not only a good hedge against other market risks but can also provide great opportunities while inflation is still persistent.
To summarize, although it has been a fast start to the year, we are not changing our original expectations in 2024. We expect a few more ups and downs, but an overall decent year in the stock markets. To help manage this effectively, we feel it is important to address investments in the year ahead through patience. It is going to be critical to avoid short-term hype as high-flying companies take off. Instead, continuing to focus on quality stocks and diversifying the risk with bonds, cash, and commodities will be key. A thoughtful approach with proper allocation can help not only reduce risk overall, but also provide significant opportunities in this high-inflation, high-interest rate environment we find ourselves in.
If you have questions about any of the above or would like to discuss your risk profile in your investments today, please reach out to us below and we would be happy to evaluate the strength of your current portfolio!