THE FIRST HALF OF 2024 brought plenty of potential headwinds for investors. Progress against inflation slowed, leading to scaled-back expectations of Federal Reserve interest rate cuts, while geopolitical turbulence fueled uncertainty on multiple fronts. Yet resilient consumer spending, better-than-expected corporate profits and investors’ unchecked enthusiasm for a handful of technology companies more than overcame those challenges. All the major stock indexes rolled to record high after record high.¹

And now? What’s likely ahead for inflation and the economy?  How might the upcoming election affect financial markets? And what can investors consider doing to prepare for the months, years and decades ahead? Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank, shares his thoughts on these topics and more below. For a deeper dive into the Chief Investment Office’s Midyear Outlook,  read the “July Viewpoint: The buffalo is back.”

Q: In one of your audiocasts recently, you described the economy as being in a “bridge” or transition phase, still digesting pandemic stimulus. How has that impacted the markets — and how might investors consider positioning their portfolios now for the next phase?

HYZY: The economy is still trying to normalize. Part of that is the end game of getting inflation back to an acceptable level for households, corporations and the economy at large. Yet even while this bridge period lasts longer than expected, the corporate sector seems to have grown accustomed to dealing with uncertainty, producing profits that are still handsome and revising earnings estimates upward. In fact, by mid-June the S&P 500 was up more than 12% for the year, though we did see some volatility, particularly in April.

Moving forward, investors should consider emphasizing broad diversification to take advantage not only of likely advances in breakthrough technologies but also the potential broadening of the equity landscape and any opportunities that may arise in fixed income, real estate and commodities.

Q: Investors started the year with high hopes for three or more interest rate cuts in 2024. What happened — and do you believe we could still see at least one rate cut this year?

HYZY: The Federal Reserve was frustrated by the inflation data during the early months of this year, but starting in April, deceleration in inflation helped ease concerns. More recently, we’ve also seen economic data showing sluggish retail sales, lackluster housing data, a softening in the labor market and slowing industrial production. Our view is that economic data will continue to soften modestly as inflation cools in the months ahead, enabling the Fed to begin cutting by the end of the year.

Q: 2024 is an election year — historically, how have the markets reacted to election uncertainty?

HYZY: A summer rally is somewhat typical of election years, and then as we get into the fall months, we fully expect volatility to pick back up here and in other places around the world. But election-related volatility is generally short-lived and it shouldn’t change the outlook on what is driving the market’s positive advance this year.

Q: Despite periodic volatility, the S&P has proven quite resilient so far this year. Do you expect more of the same from equities in the second half?

HYZY: We expect that softening economic data, along with the gradual cooling of inflation, could ease the pressure on interest rates while the earnings recovery continues. And increased capital spending could lead to better-than-expected productivity gains. There are still potential headwinds, and the possibility of episodic volatility persists, but any bouts of weakness could continue to be viewed as buying opportunities for long-term investors.

Q: The CIO continues to favor equities over fixed income for 2024. How should investors be thinking about fixed income in this higher-for-longer interest rate environment?

HYZY: Although bond yields rose and values declined during the first half of the year, current rates are reinforcing the theme of a decent economy and a healthy corporate sector. Investors should focus on overall fixed income returns rather than short-term market movements and take advantage of today’s higher yields to provide needed investment income.

Q: Expectations around artificial intelligence, or AI, have driven large gains in the tech sector so far this year. Do you expect the effect to broaden to other sectors soon?

HYZY: Generalizations about the narrowness of the gains may be misplaced. As of the first week of May, there were about 186 companies outperforming the S&P 500 year to date. That’s sizable breadth, and during May, 10 of the 11 S&P sectors moved higher. Although the very large technology and communications services companies are still part of the group leading the market, energy, financials, industrials, parts of healthcare and consumer discretionary have also begun to rise. Small-cap stocks haven’t really joined yet, so if you're looking for an attractively valued asset class that’s not currently selling at a premium, small caps could be it.

Q: Recently you’ve talked about the concept of “asset-light” vs. “asset-heavy” businesses. What do you mean by that and how can understanding the difference be useful for investors?

HYZY: Asset-heavy businesses purchase and own substantial physical assets — factories, warehouses, fleets of vehicles — and are likely to be more affected by high interest rates and today’s steep cost of financing and refinancing debt.

Asset-light companies, in contrast, aren’t as dependent on the cost of capital. If you’re asset light, you tend to have more cash on hand and can innovate and grow more quickly. The S&P 500 currently is asset light relative to where it has been in the past, a trend we expect to continue as one of the hallmarks of a bull market.

Q: Is escalating global conflict one of the biggest risks we’re facing now? What other market risks do you see through year-end and into next?

HYZY: Geopolitical tension seems to escalate daily and continues to be number one on our list of current risks. There’s also the possibility of election-related volatility as November approaches, and there are some concerns about valuations in equity markets.

Q: Are there any surprising demographic trends with the potential to boost market performance in the coming years and decades?

HYZY: For millennials and Gen Z, there will be a rising need to invest during the next 10 to 20 years as their wealth grows and they save for retirement. That increasing demand could help market performance.

Q: What longer-term advice would you offer investors interested in managing their portfolios for today — and tomorrow?

HYZY: We don’t expect the market dynamic we have today to change significantly during the next decade. It’s defined by an enormous wealth transfer, a demand for assets that is so much greater than the supply, and the capital expenditures related to generative AI and other innovation themes.

We maintain a solid outlook for the remainder of 2024 and are bullish about the potential for growth in the next five to 10 years. But for investors, the most important thing is to start with a clear understanding of your goals — why you’re investing — and then to work with your advisor to establish and fine-tune a personal portfolio strategy that supports what you’re ultimately trying to achieve.