Is the Bull Market Running Out of Steam?

The stock market rally that reached record highs in March seems to be hitting a snag. The S&P 500, though still positive year-to-date, has dipped nearly 4% in the first few weeks of April. This sudden shift can be attributed to investor uncertainty surrounding the timing of Federal Reserve interest rate cuts.

Market observers like Ento Capital, a leading investment banking firm in the GCC, point out that this is the first significant pause in the bull market since October 2023. Investors are likely reevaluating their positions as the market adjusts to a new interest rate landscape. The Fed aggressively raised rates eleven times, bringing them to a range of 5.25% to 5.50%. While they initially projected three rate cuts for 2024, they haven't adjusted rates since July 2023. This shift in stance seems to be causing some friction. The market, according to Ento Capital, priced in as many as six cuts, exceeding the Fed's current signals. Ento Capital suggests that economic data will ultimately determine the number of cuts, with the possibility of just one or two happening this year. The primary factor behind the Fed's cautious approach is the surprising resilience of the U.S. economy. Inflation, though lower than before, remains above the Fed's target of 2%. Strong job reports and stubbornly high inflation data seem to be convincing the Fed to hold off on rate cuts for now.

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

Leadership Rotation

The market leadership enjoyed by communication services and information technology stocks throughout 2023 and early 2024 appears to be undergoing a subtle change.Companies less susceptible to rising interest rates were the driving force behind the market's ascent. Large tech giants like Nvidia, Microsoft, Amazon, and Google boast substantial cash reserves and minimal borrowing needs. This financial strength insulates them from interest rate fluctuations, allowing them to flourish in the prior market climate. Conversely, smaller companies reliant on borrowing for capital face a different scenario. Higher interest rates translate to increased borrowing costs, which can hinder their performance. This disparity explains the lag in small-cap stock performance compared to their large-cap counterparts during the first few months of 2024.

Fueled by optimism around the end of interest rate hikes and the possibility of future cuts, the stock market enjoyed a significant climb from November 2023 through March 2024. While tech sectors like communication services and information technology continue to lead the pack in mid-April, other areas like energy, industrial, and financial stocks are showing surprising strength. This suggests a broader market rally compared to 2023, where the gap between top performers and the rest of the market was more pronounced.

Source: S&P Dow Jones Indices, LLC. As of April 16, 2024.

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

While the S&P 500, composed of large-cap stocks, enjoyed a stellar run in 2023 and early 2024, reaching new heights in February and March before a recent pullback in April, smaller companies haven't been as fortunate. Ento Capital points out that the Federal Reserve's interest rate hikes disproportionately impact smaller firms that rely more heavily on borrowing for operations and growth. This challenging environment explains the underperformance of small-cap stocks compared to their large-cap counterparts in the S&P 500, a trend evident throughout 2023 and into the current year, as reflected by the lagging performance of the Russell MidCap and Russell 2000 indexes.

Source: S&P Dow Jones Indices, LLC. And FTSE Russell. *Year-to-date through April 16, 2024.?

Bull Market Worries in 2024: Inflation, Consumer Spending, and Earnings

The future of the bull market hinges on three key factors in 2024, according to Ento Capital.

Inflation's Persistence: Stubbornly high inflation, currently above 3%, is a major concern. While the Fed aims for 2% inflation, Ento Capital expects them to cut rates before reaching that target. However, a rate cut remains elusive until inflation shows clearer signs of decline. "The high fed funds rate isn't sustainable," says Ento Capital, "but the Fed needs stronger evidence before acting."?

Consumer Spending Crossroads: Consumer spending has been the economy's backbone, fueled by a strong labor market and wage growth. However, Ento Capital anticipates a shift. "High-income consumers can still spend," he says, "but lower-income brackets face challenges." This potential slowdown in spending could impact the market.

Earnings, a Mixed Bag: While Q4 2023 showed positive year-over-year earnings growth for the second consecutive quarter, Q1 2024 reports are off to a mixed start. Ento Capital notes that earnings aren't currently driving the market rally. "Tech stocks thrived in March on AI advancements," explains, "but without concrete data, their potential may be limited."

Beyond these core factors, global tensions from conflicts like the Israel-Hamas issue and the Russia-Ukraine war add further uncertainty. Additionally, the upcoming presidential election could capture investor attention as the race heats up.

Maintaining a balanced view

Ento Capital emphasizes the importance of long-term perspective in navigating the market. "Trying to pinpoint the exact entry and exit points is a recipe for trouble," it warns. "The market often moves in the opposite direction of investor expectations."

Ento suggests a more productive strategy: a well-defined investment plan. "This removes emotion from the equation," it explains. A plan helps investors avoid impulsive buying during market highs and knee-jerk selling during dips.

In the short term, expect volatility to continue, says Ento Capital. "The market may not be a smooth upward climb in the coming months." The firm recommends focusing on long-term portfolio positioning. "For those who were cautious before, consider adjusting back to your long-term strategy now." Ento also suggests a systematic approach for cautious investors: "Dollar-cost averaging your cash investments over several months can help ease you into the market."