Estimate Time4 min

Midyear stock market outlook

Key takeaways

  • While the market as a whole has made gains this year, a small number of mega-cap stocks have been the main drivers of those gains.
  • That looks inconsistent with the idea that we're in a new bull market, since early bulls tend to be characterized by broad-based gains and rising small caps (which we haven't seen).
  • That said, earnings have continued to prove surprisingly resilient.
  • With each decent earnings season we see, it becomes less likely that the market takes another leg down (and more likely that we're already in the start of a bull market).

My, how the time flies. It's now almost June and it has been about a year since the market started going nowhere. So, let's take stock of where we are in this unusual market cycle, and what we might expect for the rest of the year and beyond.

A market in limbo

The stock market has been essentially directionless since June of last year. That's a long time to be in limbo, and it makes me wonder whether the strength in the S&P 500® in recent weeks could indicate that the next (or current) bull market is finally declaring itself.

Chart shows S&P 500 returns and Russell 2000 returns since August 2021, and shows that both indexes have generally stayed within a trading range since June 2022.
Past performance is no guarantee of future results. Returns indexed to zero as of the market’s high in January 2022. See below for additional disclosures on the S&P 500 and Russell 2000. Source: FactSet, FMRCo.

If that strength had been broad based, with many stocks making gains, it would be easy to call this a new bull market. But the opposite has been true. Because the S&P is weighted by market capitalization, the largest companies have an outsized influence on its movements. And indeed, so far this year, the gains have been driven by just a handful of mega-cap stocks, while the rest of the market has languished.

Chart shows the indexed performance of the 10 largest companies in the S&P 500 index against that of the 490 smallest companies in the index. Chart shows that in recent months the largest 10 companies have been increasing in stock price, while the smallest 490 have generally been moving sideways.
Past performance is no guarantee of future results. Indexed value based on performance of largest 10 and smallest 490 constituents of the S&P 500, based on market capitalization. Source: FMRCo., Bloomberg.

As I've written about before, it's particularly notable that small- and micro-caps have been lagging this year. Early-cycle bull markets tend to be driven by segments and styles that are more economically sensitive and more volatile. Small- and micro-cap indexes are usually in or close to the lead in an early bull market, so their weakness this year hasn't looked consistent with a new bull market.

Could it be that a new bull market—albeit one that doesn't look like past new bull markets—is nonetheless quietly underway? Or is that big market-clearing rout that so many investors seem to be waiting for just around the corner? Let's look at both sides of the argument.

The bearish view and the bullish view

The bearish outlook is that the much-anticipated recession is going to finally arrive, and that we are on the brink of an earnings washout that will trigger another down leg—in what will prove to be a prolonged bear market.

The bullish outlook is that interest rates have peaked, the Fed is done, the economy is holding up, and earnings will rebound later this year.

So far, earnings have proved surprisingly resilient. Earnings estimates seem to weigh in favor of the bulls, with consensus estimates expecting that earnings growth is bottoming now, and will return to a 10% growth rate in 2024. And corporate revenues have continued to march to new all-time highs (in non-inflation-adjusted terms, at least) through this market cycle.

Historically, stocks prices tend to recover about 2 to 3 quarters before earnings do. If the bullish view is right, it would make sense for the bull market to start declaring itself now.

Sign up for Fidelity Viewpoints weekly email for our latest insights.

The Fed and the economy

What about some of the other factors at play?

First and foremost is Fed policy. Until recently, the consensus among investors was that the Fed had raised rates for the final time this cycle during its May meeting, with the market expecting that the Fed would actually soon begin cutting rates. That outlook was suddenly called into question with last week’s inflation reading—which showed the core Personal Consumption Expenditures index (a measure of inflation that excludes food and energy prices), rose more than expected in April, and at a faster year-over-year pace than it had in the previous month. Now, the market is pricing in a higher chance of one additional rate hike in July. 

My guess is that the Fed may indeed be close to done (or done) raising rates for the cycle, but that it will be a while before it cuts rates, unless the economy falls off a cliff and takes inflation with it. So far, that has not happened.

Ultimately, whether the Fed is done raising rates for the cycle will come down to the usual suspects: inflation and employment. Inflation has generally been heading in the right direction—notwithstanding the most recent report—although it's clearly not yet back at the Fed's targeted level. And the employment picture continues to hang in there, with unemployment merely 3.4% as of the most-recent reading.

Meanwhile, the economy seems to be showing neither positive nor negative momentum. The Fed's Weekly Economic Index is a diffusion index, which means it takes a basket of economic indicators and measures how many of them are rising, versus how many of them are falling. Lately, the index has been hovering right around zero.

Chart shows the level of the Weekly Economic Index, showing that it has been between 0% and 2% in recent months.
Past performance is no guarantee of future results. The Weekly Economic Index (WEI) is an index of 10 daily and weekly indicators of real economic activity, scaled to align with the 4-quarter GDP growth rate. The index is not an official forecast of the Federal Reserve. Weekly data. Source: FMRCo., Bloomberg.

What about the debt ceiling?

One potential near-term speed bump may be the fiscal cliff. While news headlines suggest that a deal may be close at hand, nothing is certain until a deal is passed by both chambers of Congress and signed into law. The exact timing of the X-date (the date when the Treasury could essentially run out of cash) is hard to pin down with precision, but estimates are that it could fall as soon as June 5. At that point, the Treasury would need to start picking and choosing which bills to pay.

I believe that, sooner or later, the debt ceiling will get raised. And when it does, it will likely be welcome news for the market. But how quickly this happens, and how much volatility is created until that happens, is anyone's guess.

Watching for signs of a bull

Coming back to the near-to-intermediate-term outlook for the market—what might the next signs be if we are indeed in a new bull market?

One signal I'm watching for is the relationship between earnings and valuations (such as price-earnings ratios, or P/Es). Stock prices typically recover before earnings do. This means that the early phases of bull markets have historically been driven by rising P/Es—because prices are rising even as earnings are still falling.

Looking at the chart below, a classic bullish playbook would be to see the rate of change in P/Es, in blue, cross up to the positive side, even as earnings growth, in orange, continues to weaken (but not by too much).

Chart shows the percentage changes in year-over-year earnings growth and year-over-year P/E changes in the S&P 500. Chart shows that year-over-year earnings growth has been positive but declining, while year-over-year changes in P/Es have been negative but increasing.
Based on data for S&P 500 constituent companies. Forward P/E is stock price divided by consensus earnings estimates for the following 12 months. Weekly data. Source: FMRCo., Bloomberg.

As I said, the overall resilience in earnings has been surprising, given that the Fed has raised rates by 5 percentage points in little more than a year. One theory that might explain it is that the economy has become less sensitive to rate increases. After all, homeowners and corporations had ample opportunity to refinance their debt during the ultra-low interest rate days of 2020 and 2021.

And to be sure, a big hit to earnings could still be coming. But with every decent earnings season that comes and goes, time seems to be running out for the doomsday scenario.

Now, if only small caps would play along.

Image: Jurrien Timmer
Jurrien Timmer
Director of Global Macro

Jurrien Timmer is the director of Global Macro at Fidelity Investments. Fidelity Investments is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing and other financial products and services to more than 20 million individuals, institutions and financial intermediaries.

In this role, Mr. Timmer is part of Fidelity's Global Asset Allocation (GAA) group, where he specializes in asset allocation and global macro strategy. Additionally, he is responsible for analyzing market trends and synthesizing investment perspectives across Asset Management to generate market strategy insights for the media, as well as for Fidelity's clients. Mr. Timmer has been at Fidelity for 28 years and has more than 30 years of experience in the industry.

Prior to assuming his current position in 2005, Mr. Timmer held various other roles within Fidelity, including director of market research and technical research analyst. He also co-managed Fidelity Global Strategies Fund from 2007 to 2014.

Before joining Fidelity in 1995, Mr. Timmer was a vice president in the Fixed Income group at ABN AMRO. He has been in the financial industry since 1985.

Mr. Timmer earned his bachelor of science degree in finance from Babson College.

Start a conversation

Already working 1-on-1 with us?
Schedule an appointmentLog In Required

More to explore

Views expressed are as of the date indicated and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author, as applicable, and not necessarily those of Fidelity Investments.

Investing involves risk, including risk of loss.

Past performance and dividend rates are historical and do not guarantee future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance. The Russell 2000® Index measures the performance of the small-cap segment of the US equity universe. It includes approximately 2,000 of the smallest securities of the Russell 3000 ® Index based on a combination of their market cap and current index membership.

Indexes are unmanaged. It is not possible to invest directly in an index.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917