US stocks had an unexpectedly strong rally in the first half of the year, but the momentum may not last, according to the Wells Fargo Investment Institute (WFII).
The S&P 500 index rose nearly 13 percent to reach a level of 5,375 in mid-June, easily surpassing the previous record and WFII’s 2024 target of 4,600 to 4,800.
Although interest rates remain high, companies have still managed to achieve impressive earnings growth, with corporate profits rising by almost 6 percent in the first quarter, roughly double the estimated 3 percent.
But looking ahead, WFII thinks the S&P 500 has limited growth potential through the second half of 2024.
When it comes to investing, WFII recommends large-cap stocks over small-cap stocks. Large-cap stocks are shares of companies with a market capitalization of $10 billion and are often considered safer investments.
The S&P 500 index rose nearly 13 percent to reach 5,375 in mid-June, easily surpassing the previous record and WFII’s 2024 target of 4,600 to 4,800.
Larger companies with strong balance sheets are also expected to do better in a slowing economy.
WFII is bullish on certain sectors, including energy, healthcare, industrials and materials.
Wells Fargo favored energy stocks when U.S. crude was at $71 a barrel.
Oil prices have now risen to around $78 but remain below year-to-date peaks.
Healthcare stocks are also expected to see stable demand and profits, while industrials and materials stocks should benefit from government stimulus, green energy transitions, data center growth and recovery of supply chains .
WFII’s senior global market strategist Sameer Samana expressed skepticism about future earnings in the next six months.
“If I had to tell you which direction the next 7 to 10 percent are coming, I’d say it’s lower. I can’t make the math work in a positive way, at least until something more meaningful changes,” Samana said.
The stock rally of the past year and a half is partly due to people fearing missing out on the AI-driven rise
While Samana doesn’t foresee a market crash, he noted that current U.S. stock valuations are high, with the S&P 500’s earnings margin at 21 times, suggesting that positive earnings growth this year is already priced into the market.
“Because of those full valuations and because we’ve discounted a good portion of that earnings growth, it probably means some kind of subdued returns for much of the rest of this year,” Samana said.
“I don’t think paying higher and higher multiples is a game that anyone can win. It’s certainly not a game we want to play,” the strategist added.
The stock rally of the past year and a half is partly due to people fearing missing out on the AI-driven rise, with the S&P 500 surging more than 24 percent last year despite minimal earnings growth due to inflation.
“Much of it can be attributed to difficulties in finding labour, persistently high input costs and disrupted supply chains. It seems like companies are finally starting to get a handle on a lot of that: a more normal work environment,” says Samana.
“Unfortunately, sales are starting to slow as the economy is starting to slow, and you can see that most in the consumer-facing parts of the S&P,” Samana said.
But as economic growth slows, generating revenue while maintaining profit margins will become more challenging.
WFII does not expect a recession, but is cautious about the financial pressure on lower-income consumers, who are more affected by inflation and interest rates.
Geopolitical issues, including conflicts in Ukraine and the Middle East, can also contribute to market volatility.
While the S&P 500 continues to rise, WFII remains cautious and cautious about the outlook for the next six months.