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Investment Strategy

Three big surprises that could drive markets in the second half

Equity markets showed surprising strength in the first half of 2024. The S&P 500 rose 16% through June 30th and notched 33 all time highs, driven by both better expectations for corporate earnings and higher valuations.

The rally is all the more impressive because it’s happened while market participants adjusted to a higher-for-longer interest rate backdrop. Market pricing suggests that the Federal Reserve will likely cut rates only once or twice in 2024; as many as seven cuts were priced in when the year began. Optimism about sustained economic growth and the potential of artificial intelligence (AI) has helped markets make strong gains.

We also expect the rally to continue: In our Mid-Year Outlook, we laid out the case for why we think global equities will continue to make new highs.

However, we believe it is a certainty that more surprises will pop up over the next six months. Here are three scenarios that are not part of our base case, but which could transpire in the second half of the year—with important ramifications for markets. We see them as underappreciated possibilities that are worth keeping in mind as we head towards 2025.

1. The one-and-done rate cutting cycle. Most strategists (including us) think the Fed will lower interest rates in increments of 25 bps once or twice this year, with further cuts coming once per quarter in 2025.

But that base case presumes the growth and inflation backdrop remains “just right”—not too hot or too cold. By the end of the year, investors could be forced to consider a scenario where the Federal Reserve has lowered interest rates, but must delay further easing because the economy and inflation are firming up.

Many cyclical sectors (such as transportation and housing) are currently operating at recessionary levels, and easier monetary policy could provide a spark that heats up their performance. That would translate to a stronger economy. Meanwhile, shelter inflation has remained stubborn, and it could begin to accelerate again as the supply of new multi-family housing units starts to dry up. Starts of new multi-family buildings have already collapsed by over 30% from their 2022 peak. And goods prices, which have provided a steady source of disinflation to the overall index, may have already bottomed. This could contribute to higher prices for consumers.

Goods prices may have already bottomed

PCE Goods inflation, % 3-month moving average

This chart shows the performance of the S&P 500 index and the “Magnificent 7” stocks relative to their levels at the beginning of 2024.
Source: Bureau of Economic Analysis, Haver Analytics. Data as of May 31, 2024.

With the stock market at all-time highs and cyclical sectors poised to rebound on any hint of lower interest rates, the Federal Reserve may only get to lower policy rates once or twice before taking another long pause. A similar situation occurred in the late 1990s.

More recently, the inverse dynamic played out in 2015-16. At that time, the Federal Reserve was desperate to raise interest rates, but the growth and inflation backdrop was too weak to justify a durable hiking cycle. The Fed hiked rates once in December 2015, and then didn’t move rates again until December 2016. We could be in for one or two cuts, and then a long pause until 2026.

2. AI investment slows down. The AI earnings and investment boom has been the most important trend in markets so far this year. The six largest companies in the S&P 500 (Nvidia, Microsoft, Apple, Alphabet, Amazon, and Meta) all have tremendous AI narratives, and collectively, they have contributed nearly 2/3rds of the index’s gain this year.

AI narratives have largely driven market performance this year

Year-to-date price performance , %

This chart shows the monthly year-over-year inflation data for PCE goods inflation from 2019 to mid-2024.
Source: Bloomberg Finance L.P. Data as of June 23, 2024. 

These large gains reflect elevated expectations. By 2027, Nvidia’s data center revenue is expected to equal to a staggering 10% of all projected S&P 500 capex. That would be the same share as IBM at the peak of the mainframe boom in 1969, or Cisco, Lucent, and Intel at the peak of the dot-com boom in 2000.1

We are bullish on AI as a long term investment theme, but in the second half of 2024, one of the biggest risks to equity markets is that AI-related capital expenditures and earnings growth could slow down. If the market’s AI narrative were to falter, it could dampen S&P 500 performance.

3. Chinese policymakers finally do whatever it takes. China’s economy has lagged over the last three years. Policymakers have responded with piecemeal that have put a floor under growth, but have not stimulated the economy. Consequently, the Chinese stock market is still down 50% from its early 2021 peak, housing sales volumes have fallen 33%, and consumers have been persistently pessimistic since the COVID pandemic. In the second half of the year, Chinese policymakers could deliver a big surprise by finally doing whatever it takes to jumpstart the economy and financial markets.

Overall credit growth has remained subdued

Net new credit as a % of GDP, 6-month trailing average

This chart shows the net new credit in China as a percentage of China’s GDP in a 6-month trailing average from 2006 to 2024.
Sources: People's Bank of China, Haver Analytics. Data as of April 30, 2024.​

To improve credit growth, policymakers could release up to 3 trillion CNY in funds to help clear unsold housing inventory, and the People’s Bank of China could continue to ease monetary policy. Further, government officials could take steps to assure foreign investors that they will allow profits to flow through to investors. This would likely increase valuations and foreign direct investment.

Given very low starting levels for valuation and positioning, an incremental shift towards more aggressive stimulus and treatment of foreign capital could spark a material rally in Chinese assets that would help the broad emerging market equity index and industrial commodities like copper.

As 2025 approaches, these and other potential surprises could have significant impacts on equity markets and the global economy. Whether the Federal Reserve’s rate-cutting strategy is curtailed, AI-driven investments slow down, or Chinese policymakers take bold moves to revitalize their economy, these scenarios underscore the importance of staying diversified and adaptable. Investors should remain cognizant of these possibilities and be prepared for a dynamic and evolving market landscape.

We can help

If you want to learn more about these scenarios and how to position your portfolio to prepare for these or other eventualities, contact your J.P. Morgan team.

1Empirical Research Partners. June 2024.

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We consider three ways markets could take investors by surprise in the second half of the year—and what each development might look like.
Published Jul 15, 2024

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