Curb your enthusiasm—for stocks

Key Takeaways

• Stocks now appear pricey, whereas bonds may be more attractive
• Expect market volatility to increase as we get closer to Election Day

As good a year as it’s been for stocks, Niladri “Neel” Mukherjee, chief investment officer for TIAA Wealth Management, thinks investors should temper their expectations for the second half of 2024.

As Mukherjee writes in TIAA’s 2024 Midyear OutlookOpens pdf, the stock market now looks “pricey” in the wake of 14% gains for the S&P 500 equity index through mid-June: “Our expectations for equity returns are modest for the rest of the year, at least until corporate earnings can further grow into elevated valuations.”

Citing price-to-earnings ratio (P/E)—a common valuation metric—Mukherjee notes that the S&P 500 is now 14% more expensive than its 10-year average P/E. Moreover, a disproportionate amount of the S&P 500’s gains have come from just five stocks—Microsoft, Alphabet (parent company of Google), Meta (parent of Facebook), Amazon and Nvidia. The so-called Magnificent 5 have returned 34% year-to-date, whereas the other 495 stocks in the index have returned a mere 6%.

Some of the blame for inflated valuations lies in the market’s misreading of the Federal Reserve at the start of the year. Mukherjee himself anticipatedOpens pdf that the Fed would be cautious about cutting interest rates. The market, however, was far more optimistic—pricing in a whopping seven rate cuts for 2024.

Those expectations—reflecting a belief that companies and consumers would soon have access to cheaper credit, boosting economic activity—added helium to stock prices. Expectations surrounding rate cuts are now priced into the stock market, according to Mukherjee. “At current valuation levels, return expectations should be tempered. With further multiple expansion unlikely, the heavy lifting will have to be done via earnings growth.”

Politics and geopolitics

Other risks for financial markets include elections and geopolitics. An escalation of trade tensions in the run up to and following the November U.S. presidential election seems possible, Mukherjee writes. And the U.S. election isn’t the only one to watch. Worldwide, there are nearly 40 elections with potential to unsettle financial markets.

“An unexpected snap-election in France at the end of June to appoint a new parliament and new general elections in the [United Kingdom] in July are the next political tests for markets,” he writes. “Given the strong performance of populist parties at the European parliamentary elections, especially in France and Germany, … political risks might have a growing impact on market performance in the second half of the year.”

The case for bonds

There is one asset class—bonds—whose outlook, according to Mukherjee, is increasingly positive. Inflation has been stuck in the 3% to 3.5% range, above the Fed’s 2% target. Bond yields have risen as bond traders’ expectations for Fed rate cuts have faded. (Note: Bond yields move in the opposite direction of bond prices.) As a result, yields on 10-year bonds are now about three quarters of a percentage point higher—in both the taxable bond market and the tax-exempt municipal bond market— than this time last year. 

Not only are current yields attractive—especially for bonds with high credit ratings and intermediate or longer maturities, as noted by Mukherjee—but there’s potential for bonds to appreciate in value once the Fed does start cutting rates.

“We expect the economy and inflation to moderate this year as slowing growth, a weakening labor market and lower inflation will set the stage for the Fed to start gradually unwinding restrictive monetary policy,” he writes. “The current level of yields has increased the attractiveness of fixed income securities and provided a cushion from weakness in riskier assets going forward.”

Click hereOpens pdf to read TIAA Wealth Management’s full 2024 Midyear Outlook. For more insights on the market and economy, and to discuss the implications for your investment portfolio and financial plan, please schedule a meetingOpens in a new window  with a TIAA advisor.