Amid the confluence of current headwinds, you’d think the stock market rally would run out of gas.

Persistent fears over inflation, elevated interest rates, a cautious Federal Reserve, bloody overseas conflict, superpower tensions, and a divisive U.S. presidential election all pose challenges to this bull market. And yet, the rally is staying alive.

My contention is that surprisingly strong corporate earnings, a cooling but resilient economy, and justified enthusiasm over artificial intelligence (AI) are providing plenty of fuel to not only sustain the rally but keep it alive for the rest of 2024 (barring a black swan).

Interest rates are high and inflation is stubbornly “sticky,” but rates and prices have peaked. The Fed may have pulled back on its rate cutting plans, but a hike isn’t in the cards and we’re likely to get at least one cut by the end of the year.

Let’s take a deeper look.

Just when the market was gearing up for at least two Fed rate cuts in 2024, the Federal Open Market Committee (FOMC) meeting minutes released Wednesday, and a surprisingly robust S&P PMI report on Thursday, served up a reality check. Wall Street has reduced its expectations to a single rate cut, likely in September.

The FOMC minutes revealed ongoing concerns among policy-making officials about the unexpectedly high inflation rates observed in the first quarter.

The Fed will likely need to observe two or three more favorable inflation reports before signaling a rate reduction, which seems achievable by the end of the year. Recent data show softer labor market conditions and weakening retail sales, pointing to slower wage growth and less pressure on services inflation.

The combination of easing inflation and a moderating pace of economic growth will create a favorable environment for the Fed to begin a cycle of rate cuts. These cuts have been delayed, not obviated.

Accommodative monetary policy should also support a broader range of market leadership. We’re already seeing a revival in rate-sensitive sectors such as utilities and real estate.

The pace of economic expansion in the U.S. has slowed from brisk post-pandemic recovery highs. This deceleration is not necessarily a harbinger of an impending recession but rather an indication of the economy settling into a more sustainable growth trajectory.

Rhetorical sewage…

A constant source of frustration for me is the misperception among the American public that the economy is in horrible shape. You can blame political hyperbole and the news outlets that convey it.

To one presidential candidate, the United States is “a failing nation” with an economy that’s “descending into a cesspool of ruin.” Yes, Donald Trump made those remarks at a recent campaign rally. He also said “we’re living in hell right now.”

Reality tells a different story. The national unemployment rate in April came in at 3.9%, the lowest level since 1969; consumer price inflation has fallen from its COVID-induced peak of 9.1% in June 2022 to 3.4% in April; and the U.S. is racking up the strongest pace of gross domestic product (GDP) growth among all developed nations (2.6% is projected for 2024).

“Cesspool of Ruin” does not accurately describe the U.S. economy. (However, it would make a great name for a death metal band.)

Fact is, the economic backdrop is highly favorable. Key indicators such as consumer spending, business investment, and industrial production have moderated, reflecting a shift towards a steadier economic state.

Recent data shows a gradual decline in inflation rates, with core inflation measures falling closer to the Fed’s target range. This taming of inflation is largely attributable to easing supply chain issues, slackening demand, and tighter monetary policies implemented by the Fed over the past year.

From my perspective, the biggest tailwind for the rally has been corporate earnings. First-quarter profits have been unexpectedly resilient, with many companies reporting earnings that surpass analysts’ expectations.

Despite elevated interest rates, many firms have managed to maintain robust profitability through cost management, innovation, and market expansion (see chart).

Another critical factor bolstering the stock market is the AI boom, as reflected in the blockbuster operating results this week of chipmaker Nvidia (NSDQ: NVDA). AI isn’t just a fleeting trend but a transformative force with long-term implications for various industries.

Companies leveraging AI for competitive advantage are seeing improved margins and productivity, which, in turn, supports their stock performance.

However, “Magnificent Seven” mega-caps such as Nvidia aren’t just exemplars of the AI boom. They also have fingers in many pies, such as the Internet of Things (IoT), autonomous vehicles, fifth generation (5G) wireless, green energy, virtual/augmented reality, blockchains, robotics, nanotech…you name it. These areas are the growth drivers of today and the future.

The upshot: The interplay of decelerating growth, controlled inflation, impending Fed rate cuts, robust corporate earnings, and the rise of AI is creating a unique and favorable economic climate. This balance is enabling the economy to avoid the pitfalls of recession while offering opportunities for renewed growth and market vitality.

The main U.S. stock market indices closed higher on Friday as follows:

• DJIA: +0.01%
• S&P 500: +0.70%
• NASDAQ: +1.10%
• Russell 2000: +1.04%

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John Persinos is the editorial director of Investing Daily.

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