The panic in the markets is over but the scene for…

Ha Therias Cortalis

The market turmoil of late July and early August is a thing of the past, with hard-hit assets and currencies recovering. Financial markets have stabilized after a turbulent few weeks, and Capital Economics expects the recovery in stocks to continue. According to its assessment, the market impact of weak US labor market data in early August has been severe. It says that while the risk of a US recession has risen slightly, there is little sign of a more serious crisis. As such, it sticks to its bullish outlook for stock markets and risk assets in general.

Along with her view that a “soft landing” for the US economy remains the main scenario, she notes that the outlook is supportive for markets and estimates that the S&P 500 International Markets Index will reach 6,000 by the end of 2024 and 7,000 units by the end of 2025.

More specifically, as Capital Economics points out, the turmoil that rocked markets in the heart of the summer has largely passed. The S&P 500 is almost back to its early-July peak, while the VIX (and most other similar indices) have fallen to relatively low levels. But while the panic has subsided, The landscape has changed dramatically since the sale, according to the house. In this context, two developments stand out.

Firstly, While the S&P 500 has recovered most of its losses, there have been big changes under the surface.

In particular, technology companies that led most of the stock market’s rally in the first half of the year are still well below their highs since early July, despite rebounding from the market’s lows on Aug. 5. The rest of the stock market, which posted marginal gains in the second quarter, has recovered some of its losses.

In this context, the financial results that NVIDIA will announce today after the close of Wall Street will be crucial to the climate surrounding artificial intelligence and the outlook for the technology sector more broadly.

secondly, US bond yields (and the dollar) have not recovered and remain much lower than they were at the beginning of the summer.

From a Capital Economics perspective, the main driver has been a reassessment of the monetary policy outlook, with risks around inflation (now less of a concern) and growth (now somewhat more of a concern) shifting. Although market participants are expecting slightly less easing for the rest of 2024 than they did immediately after the data came out, the cumulative amount of rate cuts they are discounting through the end of 2025 is now roughly where it was on August 5, due to the peak panic over the US payrolls data.

One result of these two changes is that equity risk premiums are still somewhat higher than they were before the recent selloff began. Corporate credit spreads are also slightly higher than they were before the selloff. In other words, even as the S&P 500 and major stock indexes in most other major economies have returned to pre-selloff or higher levels, sentiment is arguably somewhat less bullish.

Another key aspect Capital Economics suggests that the reason for the peak of turmoil in July and August was that stock prices and bond yields fell sharply at the same time – a combination that is usually associated with growing fears of an impending recession. This was a relatively unusual pattern during the 2021-24 monetary tightening cycle: the only other period in which it was prominent was the “mini banking crisis” of March 2023. Like that episode, this crisis proved to be relatively short-lived.

Clearly, if the US economy slips into recession, the stock market is likely to fall again, and bond yields will fall even further.

So what does all this mean for the sequel? As the house points out, the speed of the stock rebound since early August, in both the technical and non-tech components of the market, suggests that both optimism about the possibility of a soft landing and underlying enthusiasm for AI remain strong.

“Recent U.S. economic data has supported our view that a soft landing remains the most likely scenario,” he says. As such, it maintains its forecast for the S&P 500 to reach 6,000 by year-end (compared to about 5,600 today) and 7,000 by the end of 2025.