The Stock Market is Up, but Investor Behavior is Unsteady. Has the Bull Market Just Begun?

As the U.S. stock market transitions into a new month, bullish investors are eager to overcome persistent concerns about inflation and rising interest rates. The S&P 500 ended last Friday with a weekly decline due to the increase in the 10-year Treasury yield, breaking a streak of five consecutive weeks of gains. This rally had helped the index achieve a 4.8% gain in May, marking its best monthly performance since February and leaving it up 10.6% for the year so far.

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Andrew Slimmon, senior portfolio manager for U.S. equities at Morgan Stanley Investment Management, noted that it’s still early in the cycle for equities. He pointed out that many investors are content to stay on the sidelines, benefiting from yields over 5% from cash-like securities in money-market funds. According to Slimmon, the fear of missing out ("FOMO") hasn’t fully kicked in yet. He suggested that FOMO might only emerge after the S&P 500 records another year of double-digit gains in 2024. He predicted that the index could see gains in the mid-teens this year, potentially sparking more enthusiasm for equities.

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Currently, investors’ behavior is quite fragile, with a greater concern about losing money in equities rather than missing out on gains, which is typical in the early stages of a bull market. Last Friday, U.S. stocks experienced a volatile day as investors digested new inflation data from the Federal Reserve’s preferred gauge. Despite a dramatic late-afternoon turnaround that led to a solid gain for the S&P 500, it wasn’t enough to erase the week’s losses.

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Slimmon anticipates another good year for U.S. stocks in 2024, which could help soften the perception of high market risk. The U.S. stock market has been on a strong upward trend since its 52-week low in October. The S&P 500 closed at 5,277.51 last Friday, just 0.8% below its record close on May 21, and has risen 28% since October 27, according to Dow Jones Market Data.

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Jeff Buchbinder, chief equity strategist for LPL Financial, remarked that the first-quarter earnings season was excellent. Corporate America delivered strong results when needed, especially as stock valuations had become more elevated after a strong run without much support from lower interest rates. Companies’ earnings have exceeded expectations this year, leading analysts to raise their estimates for 2024 and 2025.

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Even though the U.S. economy shows signs of slowing, with the Bureau of Economic Analysis reporting a 1.3% annual growth rate in the first quarter, down from 3.4% in the fourth quarter, the stock market remains resilient. FactSet senior earnings analyst John Butters noted that analysts actually increased their aggregate estimate for the S&P 500’s earnings per share in the second quarter during April and May.

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Michael Fredericks, chief investment officer at Wealth Enhancement Group, observed that the economic backdrop remains positive, though there are signs of stress among low-income consumers. Consumers play a significant role in the U.S. economy, and their spending habits are closely monitored amid ongoing high inflation, which has eased significantly from its 2022 peak but remains too high for the Federal Reserve to start cutting interest rates.

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Fredericks believes progress on inflation is steady, reducing the likelihood of a stagflation scenario. Slimmon added that consumers have become more selective about their spending, resisting price increases, which is beneficial for bringing inflation down.

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Despite a strong start to the year for U.S. stocks, the expectation of Fed rate cuts has shifted significantly. Investors now anticipate fewer rate cuts than earlier expected, yet the stock market has shown resilience. Jeffrey Sherman, deputy chief investment officer at DoubleLine, explained that the volatility in the U.S. rates market has been closely tied to inflation readings. With progress in reducing inflation, the market had hoped for Fed rate cuts, but sticky inflation readings have led to rising rates in the bond market.

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Looking ahead, Sherman plans to closely watch upcoming U.S. economic data, including the latest services data and the highly-anticipated U.S. jobs report for May. He believes that the U.S. economy is currently experiencing a soft landing, although historically, such scenarios are rare and challenging to engineer.

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Slimmon expressed concern that summer inflation readings might not improve due to tougher year-over-year comparisons, which could delay expectations for Fed rate cuts and potentially unsettle the stock market. However, he views any pullbacks as temporary setbacks in a continuing bull market.

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