Even a Hollywood director couldn’t have scripted better developments for investors last week

ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL

WEEKLY MARKET PERSPECTIVES — May 6, 2024

Bottom line: The Fed remains on pace to cut rates this year, employment in the U.S. is softening but remains strong, and Big Tech (the main driver of S&P 500 profit growth in 2024) continues to drive forward on all cylinders. In our view, investors couldn’t have asked for better developments last week. And to throw a little more sunshine on how the week went, 2-year and 10-year U.S. Treasury yields fell sharply as bond prices rallied. Along with building uncertainty regarding Fed policy and rising geopolitical tensions in the Middle East, higher bond yields in April challenged stock prices last month. However, with the Fed continuing to acknowledge that their next move is likely a rate cut, yields headed lower last week, giving stocks some needed breathing room to move higher.

As a result, the S&P 500 Index logged its second consecutive week of gains, rising +0.6% last week. The NASDAQ Composite jumped +1.4%, while the Dow Jones Industrials Average and Russell 2000 Index gained +1.1% and +1.7%, respectively. Bond proxy sectors such as Utilities and Real Estate outperformed the S&P 500, as did Information Technology and Consumer Discretionary. 

Gold finished the week lower by 1.6%, while West Texas Intermediate (WTI) crude fell 8.6%, for its worst weekly performance since February. With geopolitical tensions in the Middle East recently moving to the backburner from a market perspective and growth trends in the U.S. showing signals of slowing, crude has fallen nearly 10% from its early April highs.

Fed leaves funds target rate unchanged 

Notably, with the Fed leaving its fed funds target rate unchanged at 5.25% to 5.50% for the sixth consecutive meeting and signaling it’s unlikely the committee will need to raise rates further to tamp down inflation, we see investors growing less anxious about incoming data and its impact on rate policy – at least over the coming weeks. In April, U.S. nonfarm payrolls rose by +175,000, below the +235,000 jobs expected and far below the +315,000 jobs created in March. In addition, job growth in March and February was revised lower by 22,000 jobs in total, while the unemployment rate in April bumped up to 3.9% from 3.8% in March. Importantly, annual average hourly earnings (a measure of wage inflation) grew at +3.9% last month, its lowest level since May 2021. Combined with job openings in March falling to their lowest levels since March 2021, the labor market appears to be cooling, which is exactly what Fed officials want to see to help drive inflation lower.

Helping add further color to a cooling economy are ISM manufacturing and services updates that showed each unexpectedly falling into contraction in April. For the services component (which has been a strong driver of keeping inflation elevated in the U.S.), the measure recorded its first sub-50 reading, marking contraction in activity, for the first time since December 2022. While other measures of services activity last week continued to point to a growing and expansionary environment, building sets of signals in the U.S. (including consumer confidence) are beginning to paint a picture of cooling activity and an economy on a path toward normalization.

Outlook for stocks 

So, what’s the outlook for stocks from here? From a corporate earnings and economic growth perspective, we believe the broader S&P 500 is not overpriced at the moment, but with a few caveats. We see U.S. economic growth increasing by +2.2% in 2024. In addition, analysts forecast S&P 500 earnings to grow by roughly +11.0% year-over-year. At roughly 20.5x this year’s earnings, the S&P 500 certainly isn’t cheap but could support its valuation as long as the U.S. economy is growing and corporate profits are positive. But here’s the caveat. In our view, we see economic growth decelerating in the back half of the year, and at the same time, analysts see profit growth accelerating. Outside of improved year-over-year comparisons in the back half, a lot of this year’s profit growth is expected to come later in the year from a broader set of industries. If Big Tech earnings continue to drive the profit bus for the S&P 500 through all of 2024 (like they are currently), this mismatch in economic and profit expectations may be overlooked by investors. However, should profits disappoint across mega-cap tech stocks later this year or a broader profit recovery fails to materialize, then stocks could see more headwinds later in the year.
 
In addition, if fundamental conditions remain constructive and the next move from the Fed is a rate cut (even if it’s just one and done in 2024), government bond yields should ebb lower as the year progresses, possibly providing additional support for stock prices. Obviously, areas of Technology are expensive today. However, profit growth in these benchmark heavyweights appears secular and visible over the coming quarters, while the rest of the market isn’t that expensive based on profit expectations, in our view.

Bottom line: We continue to see a path higher for stock prices as long as fundamental conditions remain stable and profit growth remains on a positive trend. That said, elevated interest rates and sticky inflation, along with the Fed holding monetary policy at restrictive levels for longer than most expected at the start of the year, introduce some added risks to asset prices at current levels. As has been our position since the beginning of the year, a 5,200 to 5,400 level by year-end in the S&P 500 remains achievable if macroeconomic conditions unfold as we expect. To help insulate risks if those conditions unfold less favorably, a portfolio focused on high-quality assets, a strategy for locking in higher yields, and a diversified approach could help hedge against the unexpected.

The week ahead

This week, the Q1 earnings parade begins to slow, with 56 S&P 500 companies scheduled to report. With 80% of S&P 500 first quarter reports now complete, blended earnings per share (EPS) growth is higher by an impressive +5.0% year-over-year on revenue growth of +4.1%. Notably, since the end of March, Q2 S&P 500 profit estimates have risen modestly, given the generally positive outlooks and tones from corporate America in the current earnings season.

On the economic front, investors will receive a well-deserved reprieve after last week’s head-spinning, market-moving releases with a rather quiet calendar this week. March consumer credit, initial weekly jobless claims, and a preliminary look at May Michigan Sentiment line the week.