Is a Market Correction Coming? | U.S. Bank (2024)

After reaching a new record high in late March 2024, the S&P 500 slipped nearly 4% in April’s opening weeks. While the S&P 500 remains in positive territory for the year, questions surrounding the timing of Federal Reserve interest rate cuts appear to be dampening investor enthusiasm for equities in April.

“It’s notable that this is the first real pause in the current bull market rally since October 2023,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Investors appear to be resetting their positioning.” Haworth notes that markets are adjusting to a new interest rate paradigm. The Fed raised the fed funds rate eleven times, to a range of 5.25% to 5.50%. The last change in interest rates occurred in July 2023. The Fed’s held rates steady since then and projected three rate cuts in 2024.¹ “Markets are reacting to recent Fed indications that rate cuts aren’t imminent,” says Haworth. “Even as the Fed projects three rate cuts in 2024, markets priced in as many as six.” Haworth says now it’s possible that no more than one or two rate cuts might occur this year, depending on what economic data emerges.

A primary reason for the Fed’s hesitancy to initiate rate cuts is the surprising strength of the U.S. economy. While the Fed succeeded in its effort to slow inflation, it has had difficulty bringing inflation down to its 2% target range. “Data points like a strong jobs report (more than 300,000 jobs created in March) and still elevated inflation (the Consumer Price Index stood at 3.5% for the 12 months ending in March)² corroborate the Fed’s current view that it’s too early to cut rates,” says Haworth.

What factors are likely to affect the stock market today and for the remainder of 2024?

A modest shift in market leadership

For all of 2023 and in the opening months of 2024, communications services and information technology stocks outpaced most of the S&P 500.³ “What kept driving the markets to new highs were companies that are insensitive to persistently higher interest rates,” says Haworth. “Large companies like Nvidia, Microsoft, Amazon and Google that hold a lot of cash and have low borrowing needs are not greatly affected by changes to the interest rate environment.” In contrast, smaller companies that often need to borrow or issue debt to raise capital, face higher interest costs. As a result, small-cap stocks lagged large-cap stocks in 2024’s opening months.⁴

The impact of higher interest rates is reflected at the bottom end of the scale for S&P 500 sector performance. Utilities and real estate stocks suffered, for example, as both sectors are interest-rate sensitive.

Large-cap stocks continue to dominate

The S&P 500 index of large-cap stocks topped 5,000 for the first time in February and continued to reach new highs through the end of March, before retreating in April.

The environment has been less beneficial to smaller stocks. “The Fed’s interest rate policy matters meaningfully to smaller companies that likely must borrow more to fund operations and business growth,” says Haworth. “As a result, small-caps stocks are under more pressure in the current environment.”

Investors appeared to recognize this based on stock market results in 2023 and 2024, comparing the S&P 500 to the Russell MidCap Index and the Russell 2000 small-cap stock index.

Key stock market drivers in 2024

What are the keys to a sustained bull market? Haworth says three primary considerations deserve the most attention:

• Inflation trends and future Fed policy moves. With headline inflation stubbornly hovering above 3%,² “There’s some longevity to the inflation story,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management. “It’s not going away as fast as people might like.” Yet Freedman thinks the Fed won’t wait for inflation to reach 2%, its stated inflation target, before it begins cutting the fed funds target rate. “The current fed funds rate over 5% is not sustainable, but until the Fed sees more clear evidence of inflation moving down, it’s in a tough spot,” says Freedman. That means the first fed funds rate cut may continue to be delayed.
• Consumer spending. “Consumers’ willingness to maintain reasonable spending growth has been the linchpin for the economy,” says Haworth. This is likely due in part to the strength of the labor market and more significant wage growth. Freedman anticipates more differentiation among consumers in the months ahead. “Higher end consumers still have the ability to spend, but those on the lower end of the income spectrum are more challenged,” says Freedman.
• Corporate earnings. While fourth quarter 2023 earnings showed year-over-year growth for the second quarter in a row, initial reports of first quarter 2024 earnings are “off to a mixed start.”⁵ However, most companies have yet to report first quarter revenue and profits. Haworth notes that earnings results are not providing a lot of fuel for a continued market rally. “Technology stocks performed very well through March, due to speculative enthusiasm around those stocks, tied in large part to excitement over artificial intelligence advancements,” says Haworth. “Without more concrete information to build on, many of these stocks may have limited, near-term upside potential.”

Additional risks to the market include the impact of global tensions highlighted by the Israel-Hamas conflict and the Russia-Ukraine war. The heated lead-up to what appears likely to be a closely contested Presidential election may ultimately draw more investor attention.

Keeping a proper perspective

Freedman says it’s important to maintain an appropriate perspective about the markets. He encourages investors to view markets with a long-term lens. “Timing the markets and trying to be precise on when to be in and when to be out is challenging,” says Freedman. “Markets will do things at the exact opposite time you expect them to.”

Freedman says investors can follow a more productive path. “Our best advice is having a plan, a programmatic approach to investing. That takes the emotion out of it.” Freedman says such an approach helps investors avoid buying too much when the market is up and selling too quickly if stocks decline.

In the near term, investors should prepare for the market’s recent volatility to persist. “Expect continued choppiness in the markets, and not necessarily a straight upward path for stocks in the coming months,” says Haworth. Yet he says investors may be better served by positioning their portfolios for the long-run. “We’re encouraging investors who may have taken a more cautious approach before to adjust back to their long-term strategic target portfolio today.” Haworth says for those who still have a sense of caution about the stock market, “consider putting a portion of your portfolio to work in equities in a systematic way, such as dollar-cost averaging available cash over a series of months.”

Check in with a wealth planning professional to make sure you’re comfortable with your current investments and that your portfolio is structured in a manner consistent with your time horizon, risk appetite and long-term financial goals.

The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. Diversification and asset allocation do not guarantee returns or protect against losses. The Russell MidCap Index provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500, is designed to measure the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment. The Russell 2000 Index refers to a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index.

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