Equity markets showed surprising strength in the first half of 2024. The S&P 500 rose 16% through June 30 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 toward 2025.

1. The one-and-done rate cutting cycle

Most strategists (including us) think the Fed will lower interest rates in increments of 25 basis points 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.

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 2015-2016. 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 two-thirds of the index’s gain this year.

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-19 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.

To improve credit growth, policymakers could release up to $3 trillion renminbi (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 advisor.

IMPORTANT INFORMATION

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

All market and economic data as of July 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

Past performance is not indicative of future results. You may not invest directly in an index.

Index Definitions

The S&P 500 Index or Standard & Poor's 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.

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