2024 Takes a Turn

For much of 2024, it has been relatively quiet – that changed the past few weeks. We have been cautioning investors that volatility was likely to increase throughout the remainder of the year, and sure enough, volatility arrived and somewhat dramatically.

The recent volatility affected most major U.S. stock indices, but let’s focus on the broad market: the S&P 500. Except for an April pullback, the S&P 500 has spent much of 2024 achieving new record highs, the most recent being July 16, pushing the market into high valuation territory, especially the technology sector.

So, what changed and led to the recent pullback? Let’s review some important areas and provide some color:

First, U.S. economic growth concerns surfaced. The weaker-than-expected job increase numbers followed a deep contraction in the ISM report and a one-year high in jobless claims. More recent jobless claims numbers improved and eased some of these fears. We believe this is consistent with an expected slowdown, especially due to the increase in unemployment caused by an increase in the labor force.

The bottom line is the U.S. economy is slowing but still growing. Businesses are not hiring as many people, but they’re not firing many people either. The Fed is primed to lower interest rates at the September meeting and could provide a 50 basis point cut if deemed necessary.

Next, the corporate earnings outlook appears not as bright as it was. And while the majority of S&P 500 companies that have reported have posted a positive earnings per share, and positive revenue surprise, the magnitude of these surprises are below the average levels we’ve seen in the past five years. And despite the positive surprises and overall above expectation growth, earnings takeaways are leaning a bit more negative as talk about underwhelming revenue beat rates suggest concerns over a slowdown in consumer spending.

The third item: Election dynamics have changed. Harris replaced President Biden as the Democratic nominee, and momentum has shifted from Trump to Harris as swing state polls have narrowed and the betting odds of a Republican sweep have dropped from 51% to 34% – House controls now leaning Democratic. This development led some sector rotation as the so-called “Trump trade” unwound. But we have a long way to go until November, and the degree of uncertainty is likely to remain.

Next item, it was what was likely the most frequently asked question in early August is, “What the heck is the yen carry trade?” It’s simply a divergence in U.S. and Japanese monetary policy. The U.S. set to lower rates and the back Bank of Japan raised rates. This throws cold water on those investors borrowing in low interest rate Japanese currency to invest in higher yielding assets, for example, U.S. stocks.

And then finally, an escalation of tensions in the Middle East combined with the seemingly no-end-in-sight war in Ukraine further frayed investor nerves.

Now, all of these combined with a market that was trading at high valuations, which increased the probability of volatility as well as the magnitude. And again, it has been a relatively calm summer. It is easy to be lulled into complacency when the stock market is regularly reaching new highs. We can forget that volatility is common even during a rising market.

Chart 1, 3:52— In fact, this is the third 5% or more pullback in the past 12 months, including an outright 10% correction from August to late October last year.

It would be better for everyone’s nerves if the market simply moved up 20+% in a smooth, linear manner, but like many wedding reception dance floors, its rhythm is far more freeform.

Equity markets have stabilized for now, and the S&P 500 still stands in double digit territory as of filming. The most recent jobless claims number eased earlier employment fears. The yen carry trade appears to have run its course, and valuations, while still rich, are more reasonable. In addition, while the earnings growth outlook has softened, City National Rochdale still expects corporate profit growth to be between 9% and 12% in 2024 and 8% and 12% next year.

Important upcoming economic data on inflation, retail sales, and housing will be watched closely. We advise that you stay prepared for additional bouts of volatility through the remainder of 2024. We do not recommend reducing portfolio equity allocations, and we maintain our focus on high quality, reasonably valued U.S. companies with durable franchises and strong management.