After a Record Market Run, Investors Face a Gut-Wrenching 3 Months Ahead

U.S. stocks reached new record highs following the Federal Reserve’s first interest rate cut since the 2020 pandemic, though they ended the week mixed. On Friday, the three major U.S. equity indexes hovered near record territory, with the Dow Jones Industrial Average closing at a fresh peak. This marked the first time the Dow surpassed the 42,000 level, further emphasizing the strength of the recent market rally.

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Now, the challenge lies in whether the momentum seen in September can carry through to the end of the year. Investors are eyeing the coming months, particularly with the November U.S. presidential election on the horizon. Keith Lerner, co-chief investment officer at Truist Advisory Services, sees the recent stock market highs as an indicator of the continued positive trend in equities. He emphasized that the Fed's decision to cut rates by 50 basis points was necessary, calling it a "makeup cut" after the central bank kept rates steady in July despite growing concerns over a weakening labor market.

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Lerner noted that job openings have become scarcer, and the unemployment rate has crept up to over 4% from its pandemic lows. "There’s this debate between a hard landing, a soft landing, or no landing at all," he said, highlighting the uncertainty around the U.S. economy's trajectory. While the stock market isn't a perfect reflection of the economy, concerns about a potential slowdown remain top of mind for many investors. Lerner anticipates market volatility over the next three months but believes that a recession will be avoided. His expectation is for the economy to stabilize, growing at around 2% to 2.25%.

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The U.S. economy expanded at an annual rate of 2.8% in the second quarter, according to official data. If the labor market remains stable, Lerner predicts that the S&P 500 could reach new highs around 6,000 by the end of the year. However, he warns that the path forward will not be without challenges, noting that investors should expect “gut-checks and bumps along the way.”

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The market has been increasingly reactive to economic data this year. After a relatively calm start to 2024, equities have been swinging sharply in response to economic indicators that previously had little impact on stock prices. Gennadiy Goldberg, head of U.S. rates strategy at TD Strategy, observed that investors are now scrutinizing every piece of data more than they would have in the past. Goldberg expects upcoming reports on the labor market, particularly the September and October jobs data, to be critical as they will be released before the Fed's next policy meeting in November.

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Goldberg also pointed out the uncertainty surrounding the Fed’s next moves. He stated that while the central bank's first rate cut was significant, future cuts could vary in size depending on economic conditions. The Fed’s messaging, however, has reassured the equity markets that policymakers are prepared to respond quickly to any signs of economic deterioration. In the past year, the Fed kept rates near their highest level in two decades to combat inflation, but now, they seem intent on adjusting their policy stance as conditions evolve.

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Inflation concerns have faded in recent months, but Fed Governor Christopher Waller reignited the discussion in an interview with CNBC on Friday. Waller remarked that inflation was "softening much faster" than he had expected, which convinced him that the 50 basis-point rate cut was the right decision. This revelation sheds light on why Fed policymakers were willing to make such a substantial cut despite mixed signals in the broader economy.

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Goldberg mentioned that the uncertainty in the Fed’s future actions has led some investors to seek opportunities to lock in higher yields while they can. Many are focusing on 2-year and 5-year U.S. Treasurys, which tend to be the most sensitive to Fed rate cuts. On Friday, the yield on the 2-year Treasury note fell to 3.57%, down from a peak above 5% earlier in the year. Meanwhile, the 10-year Treasury yield ended the day at 3.727%, slightly higher than the one-year low of 3.622% recorded earlier in the week.

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Goldberg emphasized that predicting the Fed’s next steps is challenging because even the central bank officials themselves might not know the precise path forward. He suggested that navigating the current economic environment requires taking it “one day at a time” as the market continues to digest new data and assess the implications of Fed policy changes.

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As investors brace for the remainder of the year, the interplay between interest rates, inflation, and economic data will remain in focus. With uncertainty still looming, the ability to adapt quickly to changing conditions will be key for both policymakers and market participants alike.

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