Key Takeaways
- We expect economic growth to moderate and the inflation rate to descend toward the 2% range, a combination that would deliver a soft landing in the US.
- Equity returns have been very concentrated in a few stocks, a situation that has historically led to a broadening of opportunities. Among the opportunities are quality, value and low-volatility strategies.
- Bond yields remain at attractive levels as the Fed considers rate cuts. High-yield bonds seem to offer strong potential in our view, even if credit spreads were to widen over the next year.
- Muni bonds are starting to see favorable tailwinds. We think it makes sense to overweight credit and duration while employing a barbell maturity structure.
Growth Likely to Moderate; Inflation Has Resumed Cooling
The S&P 500 again surged to new highs in the second quarter of 2024, with interest rates being the primary driver. As rates rose early in the quarter, stocks struggled; when rates later fell, they supported stock prices. As we enter the year’s second half, inflation has been cooling again; we think year-over-year rates will fall in the third quarter before rising due to base effects.
Economic growth has slowed from last year’s heady pace, and we expect that trend to continue in the second half of 2024 as tight monetary policy impacts activity. Within gross domestic product, personal consumption is the key metric to focus on, since consumer demand is decelerating, and the consumer is a huge share of the economy.
Big picture, we expect growth to moderate in the rest of 2024 and in 2025 (Display) toward slightly below long-run expectations; later this year, headline inflation should descend toward a 2% handle. That combination would be quite a feat and produce a soft landing. Of course, the upcoming presidential election and other incoming data points will give markets plenty to chew on.
Equity Market Returns Could Be Ready to Broaden Out
S&P 500 price/earnings (P/E) multiples have risen along with the market rally—right now, they’re high by historical standards. So, the heavy lifting in 2024 and 2025 will likely need to come from the “E” in P/E rather than the “P.” Earnings expectations have risen recently (Display); the proof will be in the pudding.
At the index level, performance has been a story of the Magnificent Seven versus the rest, with performance concentrated in only a few names. History tells us that after these types of periods, returns have tended to broaden out to a larger number of stocks, and falling rates have magnified this effect.
Where should investors look for opportunities among the magnificent others? We think quality companies should be a continuing destination, especially as economic conditions continue to moderate. In our view, value stocks offer compelling companies with upside potential, enabling investors to, as we call it, “find growth in value.”
In our view, dividend payers may be a versatile equity building block, with income-generating capabilities as well as potential gains. With volatility likely to be a frequent visitor, low-volatility equity strategies might be a suitable counter. And small-cap stocks seem to offer an attractive price point, though active stock selection should be front and center.
High Yield Bonds as an Equity Surrogate
Bond yields ended the second quarter where they started—they were still providing attractive carry and income across the bond market.
We’ve often discussed the capacity of high-yield bonds to be an equity surrogate, and they’ve fared well over the past year. An 8% yield sets up strong potential (Display): credit spreads are low, but underlying interest rates are still high, which could boost returns when rates eventually decline.
As for the foundation, we see a familiar story—fundamentals are supportive and relatively flat, based on leverage, margins, default rates and interest coverage. Even if credit spreads were to widen over the next year or so, we still think the math works in favor of high yield’s return prospects.
Municipal Bonds: Uneven Start, but Tailwinds in Sight
The muni market got off to a somewhat bumpy start in the first half of 2024, but we’re starting to see tailwinds converging. From supportive “summer technical” factors to elevated yields and intriguing credit opportunities, conditions seem to point to a strong second half.
The belly of the muni yield curve—bonds with five- to 15-year maturities—underperformed in the first half. With yields in that segment lower than those in shorter- and longer-term bonds, we think a barbell maturity structure of those two segments can bolster yields and provide a downside cushion. Municipal credit has outperformed, buoyed by strong demand (Display), and we see more potential there.
High-grade municipals moved back to fair-value territory, so in our view it makes sense to keep the flexibility to rotate into Treasuries if summer technical factors cause valuations to compress. In addition to overweighting credit and adopting a barbell maturity structure, we also think muni investors should consider overweighting duration.
To sum things up, the rest of 2024 will present a lot of incoming information for investors to digest. Data points will roll in to help fill in the macro picture, and politics will take up even more of the front page as November’s presidential election moves closer into view. Pay attention to both, stay active and look for ways to separate the signal from noise.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.
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