David Hagee Executive Vice President, Chief Investment Officer
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Key Highlights
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After setting multiple market highs during the first seven months of 2024, the S&P 500 Index dropped 8.5% through the first five trading days in August. The market’s volatile start to the month appears to be a reaction to a confluence of factors.
- In July, stock market performance started to shift from the leadership of mega-cap stocks to more interest-rate sensitive sectors of the S&P 500 like real estate and utilities. Small-cap stocks also benefitted from this shift, gaining 12% in July, as measured by the Russell 2000 Index. Both of these equity areas had underperformed technology-oriented stocks for several quarters.
- July’s weaker-than-expected U.S. manufacturing and employment reports heightened investors’ concerns that the U.S. economy, which has been cooling, could be signaling more serious challenges.
- Rising interest rates in Japan caused an unwinding of the yen carry trade, a popular currency trading strategy that involves borrowing the Japanese yen or a similar low-interest currency and reinvesting the proceeds in higher-yield assets elsewhere.1 This action added to the S&P 500 sell-off and sent sharp declines in Japan’s Nikkei 225 Index, as well as other global capital markets.
- In addition, the Federal Reserve (Fed) took no action on interest rates at its July meeting. This fueled investors’ fears the U.S. central bank may have been too slow on initiating rate cuts.
Was this market sell-off the start of a bear market? Commerce Trust doesn’t believe so. While the 8.5% drop in early August was the largest decline in the S&P 500 since October 2023, Commerce Trust views this recent volatility as expected behavior of a bull market rather than a broader drawdown or start of a bear market. In fact, the U.S. equity benchmark had rallied by the August 9 market close, erasing nearly all losses from earlier in the week.
Looking at the performance of the S&P 500 since 2002, market volatility resulting in intra-year drawdowns occurs nearly every year. The index routinely recovers some of those losses during the year, with annual returns that exceed the worst declines. It’s worth noting the years following those with the most dramatic drawdowns typically delivered strong annual returns.
Figure 1 - S&P 500 Index intra-year drawdowns vs. total annual returns (2002-present)
Market expectations for the rest of 2024
While we anticipate volatility to remain elevated in the near term, equity markets are likely to deliver positive returns through the end of the year based on several variables.
- Slow and steady economic conditions. As previously stated, the U.S. economy is cooling. The unemployment rate has been steadily rising in recent months, currently standing at 4.3%. However, rather than an uptick in job losses, this rise in unemployment reflects a growing labor force participation rate as more people return to the workforce post-pandemic. Commerce Trust believes the U.S. economy could grow by 2% for calendar-year 2024, which would be supportive for equity markets.
- The Fed finally moves to cut interest rates. After nearly two years of maintaining its restrictive monetary policy to curb inflation, the Fed will likely begin to lower interest rates, with the first rate cut coming at the September meeting. The market has priced in three rate cuts for the rest of the year, and we tend to agree with that assessment.
- Corporate earnings and valuations. We expect profits to remain healthy for S&P 500 companies, with second quarter earnings up about 9% on a year-over-year basis. Commerce Trust projects corporate earnings could increase nearly 10% for the 2024 year. In addition, corporate earnings and stock market valuations are likely to be bolstered if the Fed reduces interest rates in the third quarter as expected.
While it’s likely equity markets could remain volatile into the fall, we believe the outlook for diversified portfolios is generally positive through the end of 2024. Commerce Trust encourages investors to view the markets from a long-term perspective. Recent market developments offer investors the chance to reevaluate their portfolios to ensure those strategies are constructed in a manner consistent with their longer-term financial goals.
[1] “Explainer: What is the yen carry trade?” Reuters, August 7, 2024; www.reuters.com.
Past performance is no guarantee of future results, and the opinions and other information in the commentary are as of August 21, 2024. This summary is not intended to provide general information only and is reflective of the opinions of Commerce Trust. This material is not a recommendation of any particular security, is not based on any particular financial situation or need and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional.
Diversification does not guarantee a profit or protect against all risk. Commerce Trust does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product and specific financial situation. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Commerce Trust is a division of Commerce Bank.
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