Stock Market Outlook: What To Watch For In The Next 6 Months (2024)

It's been a good start to the year for stock market investors with the S&P 500 (SPX) up more than 7%, and well above the cycle lows. This follows a historically difficult 2022 with the index ending more than -18% lower which featured some extreme volatility. Despite a challenging macro backdrop pressured by stubborn inflation, higher interest rates, and global growth concerns; the setup for stocks today can be best defined by a new sense of resiliency and a more positive outlook.

Indeed, compared to fears last year of deteriorating economic conditions that would translate into surging unemployment and crashing corporate earnings, the story has been the stronger than expected trends overall. Signs that inflation is easing have opened the door for the Fed to back off on its pace of aggressive rate hikes sooner rather than later. Companies emerging stronger and returning to their path of long-term growth potential highlight the bullish case for stocks.

On the other hand, that same optimism should come with a layer of caution. Upcoming indicators will be critical to set the stage for the next leg higher. The main risk for the stock market this year would be an unexpected significant weakening of economic conditions or a sharp re-acceleration of inflation which would work to undermine the positive momentum. We discuss some of the high-level themes to watch for the next six months

Is the stock market expected to rise?

Through a number of published notes, we've been calling for a rally and expect more upside going forward based on many of the trends playing out now. It took some time for the market narrative to come around, but it's clear we've seen a change from the overriding air of pessimism that defined 2022.

Data shows that at the end of December, institutional money managers were the most underweight U.S. equities since 2005. If we fast forward, the latest update through the first week of February shows an ongoing shift toward increasing allocations into stocks by that same group turning more bullish.

By this measure, it's fair to maintain an expectation that stocks will continue to climb which is supported by a combination of both economic fundamentals and market technicals.

What fundamental factors are driving the stock market?

We mentioned what has been a string of better data that has helped to improve sentiment. To be clear, there are plenty of mixed signals, but stocks are responding well to the positive developments:

• Strong labor market data with the January payrolls showing the U.S. added 517k jobs last month, well above expectations.
• Favorable CPI trends, with a clear move lower in the annual inflation rate.
• New messaging from the Fed citing the "disinflationary process".
• An ongoing slowdown in the pace of rate hikes to the latest 25bps move.
• A solid Q4 earnings season for S&P 500 companies on average outperforming expectations.

Even as some high-profile major tech companies have announced layoffs, moving to roll back the hiring sprees going back to 2021, other sectors including services like hospitality and leisure are still adding positions, in what has been an ongoing recovery from the pandemic disruptions.

The data have worked to brush aside the scenario that the U.S. economy was facing a so-called "hard landing", defined by a deepening recession bringing back parallels to the financial crisis back in 2008. If we think back to the pretext when the S&P 500 was trading under the $3,600 level last June, there's a lot less uncertainty today which is a good backdrop for stocks.

In terms of inflation, this was the biggest headache for the market in 2022 when the annual CPI reached a 30-year high of 9.1% in Q2. The just-released January update shows the annual headline figure printing at 6.4%, taking important steps in the right direction.

On this point, there is some question as to how quickly the indicator can approach the official Fed target of 2%, but the big picture is that pace of change in consumer prices that may have been "out of control" early last year is normalizing.

Beyond a correction lower to commodity and energy prices, and easing supply chain conditions, trends in core categories are seen slowing. Over the next few months, the CPI index will begin hitting tough year-over-year comps pushing the annual rate even lower. This narrative was part of the message from Fed Chairman Powell at the February Fed meeting pointing to the disinflation process while recognizing the process is not completely over yet.

Already in this cycle, the Fed has hiked the benchmark Fed Funds Rate to 4.75%, from the zero level out of the pandemic. The understanding is that the quantitative tightening impact intended to bring down inflation is still working through the monetary system and the real economy. Our interpretation is that significantly higher rates from here may not be necessary for the inflation rate to continue trending lower.

The other side to that discussion is the potential negative consequences to the economy of the higher interest rate environment we're now in. In many ways, this has been one of the biggest surprises over the past year, being that economic conditions including consumer spending and corporate earnings have been able to, thus far, manage the impacts well.

What we mean by this is that going back to late 2021 or even when the Fed first began hiking in early 2022, few would have imagined the current labor market strength and even the Q4 GDP data which showed the economy grew by 2.9% against a 4.75% fed funds rate. In other words, interest rates at the current level are not the end of the world.

The path we see playing out is that of a "soft landing" where the Fed will manage to successfully bring down inflation, while the economy averts a deep recession. This considers what is expected to be something of a bumpy ride through the rest of the year where the labor market can still soften, but sets up a stronger "recovery" looking out towards 2024 that can be positive for stocks.

What is the outlook for stock market earnings?

As it relates to corporate earnings pending the final few weeks of the Q4 earnings season, the S&P 500 is on track to reach 2022 EPS of $219.51, up 5% year-over-year as a "bottom-up" aggregate of all underlying companies. The good news is that companies have been beating EPS estimates, on average, with a trend of ongoing profitability, going back to that theme of resiliency.

From the latest Q4 numbers, the headline data shows that the average revenue growth is 4% while EPS is down by -5% suggesting some softness at the end of the year. That being said, the context is important. Keep in mind that the period in Q4 2021 was exceptionally strong for the U.S. economy and corporate earnings which left a particularly difficult year-over-year comparison. The end of 2021 will be remembered as fueled by the wave of federal stimulus and the momentum from the early post-pandemic reopening which worked as a boom for companies at the time.

The point here is to say that the S&P 500 posting just a -5% y/y EPS decline this past Q4 against all the other headwinds can be seen as very impressive, all things considered. From the chart above, what stands out is the level of annual earnings for the full year 2022, 35% higher, compared to EPS of $163.13 in 2019 as a pre-pandemic benchmark.

For this year, the consensus is for 2% EPS growth towards $224.07, a modest number but at least still positive. Some of the themes at play include efforts by companies to cut costs and focus on efficiencies in support of margins. Into 2024, the expectation is for a stronger recovery with EPS climbing by 11% to $249.56.

In terms of valuation, it can be said that the S&P 500 is trading at an 18.5x 2023 consensus earnings or 16.5x looking out towards 2024. Both of these levels are in line with historical averages. We'd argue that given the growing importance of the technology sector, even higher market multiples can be justified particularly in an environment where inflation is trending lower and interest rates stabilizing.

As part of the bullish case, a scenario where economic conditions continue to outperform should be positive with companies benefiting from stronger underlying demand, and we could even see some revisions to estimates higher.

What is the stock market forecast for the next 6 months?

If there was room to be very bullish on stocks going higher at the lows last year, it's fair to say the job is now more difficult considering what has already been a strong rally. Our message today is that we see more upside, but it's not going to be a straight line higher, and the market will need some cards to land right to really drive a true breakout.

It all goes back to the trends in inflation. We can start looking ahead to the next couple of months' worth of data. A bullish scenario would be continuation of the ongoing decline of the CPI, leading the Fed to hold the Fed funds rate steady and marking a key turning point in the cycle. One possibility is that core-consumer prices reflecting goods and services beyond food and energy can surprise lower through components like shelter and transportation prices stabilizing going forward.

While we don't have a crystal ball, we do believe that a "pause" by the Fed can and will occur in the next six months, with the implied easing of policy conditions working as a tailwind for stock market sentiment. We expect two more 25 basis point hikes in the Fed funds rate between the March and May meeting to hold the rates steady from there.

Over the period, we'll get through several months of key economic indicators including payrolls, retail sales, and industrial activity and we want to see conditions remain strong as good news moves us away from a recession. Similarly, getting into Q1 and Q2 earnings seasons, it will be important for companies to demonstrate the ability to maintain margins and drive profitability.

From the price chart, the first step here for the S&P 500 is to climb above the $4,200 level which has worked as an area of technical resistance since last year. While $4,300 is often cited as an upside target going back to the high in August 2022, our sense is that if the index approaches that point, $4,500 would be in the cards as an upside target for the next six months recognizing that conditions are better today than from the same time in 2022.

On the downside, it will be important for the market to hold $4,000 as an area of psychological support in a big round number, while a break under $3,800 would be more concerning and undermine the current momentum.

Will stocks go lower in 2023?

With any bullish case, it's also worth considering what could go wrong and lead to a deeper selloff. We mentioned the risk that inflation re-accelerates higher. Trends in energy and commodities will be key monitoring points. Sharply higher gasoline prices, for example, would force companies to keep passing along the higher costs to consumers as directly impacting inflationary pressures.

What it would take for us to turn convincingly more bearish would be some evidence that corporate earnings, particularly from the major S&P 500 leaders, are falling. This could evolve as a consequence of some financial market imbalance, or reach some type of breaking point where higher interest rates materially impact the company's financials and operating environment.

Going back to that consensus EPS estimate chart through 2024, a scenario where earnings decline significantly on a year-over-year basis would open the door for stocks to reprice lower. Again, we're not there yet, but it's a key risk worth watching.

Finally, we can bring up the still volatile situation in Eastern Europe. The war in Ukraine can be considered as a sort of tail risk where the potential that the conflict escalates would flip the script into a risk-off scenario.

Is it good to invest in stocks right now?

Stocks always have risks, but it's important for investors to not lose track of the big picture and long-term outlook. It's possible that 10-20 years from now we can look back at the events of this time and it will just be remembered as just noise while the stock market is significantly higher.

In our view, it's always a good time to be invested. A strategy that includes a well-diversified portfolio across equities and fixed income with a long-term time horizon can drive capital appreciation over time. For investors that have been sitting on the sidelines, gradual allocations into stocks with regular contributions to savings and retirement accounts is a good starting point.

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