Haworth says a primary concern now is at what point the market’s strength, still concentrated on technology-oriented stocks, reaches a broader spectrum of the stock market. “Cyclical stocks that typically respond well to a stronger economy have yet to see the market rotate their way,” notes Haworth. “There’s still a lot of room for the market's strength to broaden out to more sectors.” For example, he points out that the utilities and real estate sectors are highly interest-rate sensitive, and are likely to benefit once rates begin to decline.
U.S. economy boosts stocks
While interest rate trends can have a bearing on the stock market, performance is also closely tied to the strength of the U.S. economy. “As the Fed raises interest rates, we typically expect slower economic growth,” says Eric Freedman, chief investment officer, U.S. Bank Wealth Management. Surprisingly, however, Gross Domestic Product (GDP) grew more quickly in 2023 (2.5%) than it did in 2022 (1.9%).3 The economy’s continued growth in the face of higher interest rates was due in large part to strong consumer spending, fueled by above-average wage growth.
Haworth notes that modest corporate earnings growth occurred in 2023’s final two quarters. “If we assume interest rates are near a peak for the current cycle, economic trends and specific company considerations are likely to have a greater bearing on stock performance going forward.” Haworth says investors are likely to put more emphasis on factors such as how fast companies can grow and whether they are experiencing sufficient earnings growth.
Yet interest rates are still a consideration for equity investors. Stock prices tended to track with bond yield trends over the course of 2023. When interest rates rose, stock prices retreated, and when rates fell, stocks reacted favorably. Haworth still anticipates a continuation of the kind of market volatility that’s existed since mid-2023. “The market is waiting for more news in terms of the timing and extent of Fed rate cuts in 2024.”
The path forward
The market remains heavily focused on the Fed's next decisions about interest rates. The Fed held the line on rates after its last rate hike in July 2023. After its March 2024 meeting, Fed chair Jerome Powell indicated that Fed rate cuts were likely in 2024,4 but the timing of such cuts remains a question mark. “The Fed is very focused on achieving its long-term inflation target of 2% (still below the current rate of 3.2%),” says Freedman.
While interest rates may fluctuate up-and-down in the near term, with some ramifications for stocks, it isn’t the only factor equity investors should consider. “One of the variables we’re watching is whether the declining inflation rate results in stock valuations appearing more reasonable,” says Haworth. He notes that if inflation declines from current levels, it would generally benefit stock valuations.
Nevertheless, stocks may still be subject to near-term volatility. “To bid stock prices higher, investors need to believe that earnings will grow faster than is indicated by current expectations and generate more attractive growth potential than the current elevated yields on fixed income instruments,” says Haworth.
Putting your portfolio into perspective
As you assess your own circumstances, be prepared for potential stock price fluctuations in the near term. Nevertheless, assuming that current inflation trends endure, and the economy can hold its ground, stocks should continue to represent a key component of any diversified portfolio for long-term investors.
Talk with your wealth professional about your comfort level with your portfolio’s current mix of investments and discuss whether any changes are appropriate in response to an evolving capital market environment consistent with your goals, risk appetite and time horizon.
Note: The Standard & Poor’s 500 Index (S&P 500) consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The S&P 500 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. The Russell 2000 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results.