The stock market will be shaped by conflicting forces in the economy and profits

• Investors are grappling with mixed signals from a weakening economy and expectations for continued corporate profit growth.
• The unexpected rise in unemployment has sparked fears of a recession, but they may be unfounded.
• The overall direction of the stock market depends on how stable corporate profit growth is.

Markets are receiving mixed signals, which will likely drive stock performance through the end of 2024.

On the one hand, investors are watching the economy cool, and the recent rise in the unemployment rate has sparked fresh fears that the U.S. is on the brink of recession. Counteracting that strength is Wall Street’s continued expectation that earnings growth will remain steady, leading to further gains in stocks.

“While market attention in the first half of the year was largely focused on the path of inflation, attention is quickly turning to growth risks in the second half of the year, given elevated earnings expectations in the second half of 2024 (+9%) and in 2025 (+14%),” JPMorgan analysts wrote in a note on Thursday.

They argue that market dynamics now revolve around a “two-sided debate,” with risks to economic growth and high stock valuations at the forefront.

Last week’s unexpected rise in the unemployment rate, the triggering of the Sahm rule recession indicator and the Federal Reserve maintaining tight monetary policy for potentially too long have heightened investor concerns that a recession is just around the corner.

That would likely involve a drastic drop in stock prices, something we saw hinted at earlier this week when the Nasdaq 100 extended a month-long decline to more than 10% and some mega-cap tech stocks saw double-digit percentage declines in a single day.

“In our view, the current market downturn was primarily driven by concerns about weakening economic growth and an overestimation of the likelihood of a recession,” JPMorgan strategists wrote.

This week the bank raised the probability of a recession by the end of the year from 25% to 35%, while Goldman Sachs increased the probability of a recession from 15% to 25%.

Analysts note that the stock market remains at risk of further declines as valuations remain high and the Federal Reserve shows little urgency in cutting interest rates.

“While the recent market rally has removed some of the froth, equity positioning and valuations remain at risk, especially if growth continues to slow and the Fed fails to demonstrate urgency,” JPMorgan said.

While the U.S. economy appears to be slowing, corporate profits continue to rise, which should help put a floor on stock prices and even fuel them to continue rising.

Of the 88% of S&P 500 companies that have reported second-quarter earnings so far, 79% beat estimates by a median of 6%.

Year-over-year, profits rose by almost 12%, far exceeding expectations of 9% set just a few weeks ago.

What’s more, future earnings expectations reached an all-time high last month, according to Yardeni Research.

Yardeni’s research

There is a stark contrast between fears of an imminent recession and a potential stock market slowdown, even as corporate profits surge.

The popularity of the word “recession” in Google searches has reached its highest level since June 2022, when rising inflation and aggressive interest rate hikes sparked investor concerns about an economic slowdown.

At the same time, the frequency of mentions of the economic slowdown during corporate press conferences fell to its lowest level since the third quarter of 2022, according to Bloomberg data.

“The S&P 500 is up 10.5% (YTD). We expect some sideways movement in the coming months and are mindful of looming risks in the Middle East, but we remain positive on U.S. economic growth and U.S. equities,” Ed Yardeni of Yardeni Research said in a note to clients earlier this week.

JPMorgan analysts note that the final unknown for investors to consider is the renewed uncertainty surrounding the election after Kamala Harris rose as the likely Democratic nominee.

“Her late entry into the presidential race adds an additional obstacle for investors in pricing in election risk later in the year, as the gap between the candidates has narrowed and the final policy agendas of both countries remain uncertain,” the analysts wrote.