After a stellar start to the year for the stock market, investors are wary of potential choppiness in the second quarter as they gauge whether the Federal Reserve will deliver on expectations for a rate cut in June and turn their attention to upcoming earnings.

S&P 500 IndexSPXThe gain at the end of the first quarter was more than 10%, following a surge of nearly 13.1% in the first quarter of 2019 (link). Although chipmaker NvidiaNVDAand Facebook parent company Meta PlatformsMETAThe so-called "Magnificent Seven" stocks have provided most of the gains for the quarter, but economically sensitive stocks such as energy and industrials (link) have also rebounded over the past six weeks.

Whether this rally continues into June will likely depend on the Fed, which has yet to signal that inflation has dropped enough to warrant a rate cut(link). When January began, markets expected six to seven rate cuts during 2024, but now expect three as signs of the resilience of the U.S. economy bolster investor confidence in a so-called "soft landing."

"The market and the Fed's expectations are finally aligned," said Joe Kalish, chief global macro strategist at Ned Davis Research, "but that puts more pressure on every economic report that comes out because It doesn't take a lot to get everyone operating the same way. "If we don't see more progress on the inflation front, we expect greater volatility.

According to CME's FedWatch tool, futures markets currently imply a 61% chance of a quarter-point rate cut at the Fed's policy meeting ending on June 12, which would lower the benchmark rate to a range of 5% to 5.25%.

Jason Alonzo, a portfolio manager in Harbor Capital's multi-asset strategy team, said continued growth in the U.S. economy (link) could extend recent market gains as investors look for more attractive valuations. trend, expanding to cyclical industries and small-cap stocks. At the end of the first quarter, the Russell 2000RUTThe small-cap index gained 4.8%, while the S&P 500 industrials rose nearly 11% during the same period.

"Right now, the only thing markets are concerned about is whether the Fed is still in control even as the economy accelerates again," Alonso said. "If that idea is broken to some extent and the Fed has to signal that a rate hike is back on the table, that would be a shock to investors and cause real problems for all assets."

Economic data next week include ISM manufacturing data, ISM services data, and the closely watched non-farm payrolls report. Economists polled by Reuters expect the March non-farm payrolls report to show job growth of 198,000 jobs.

Sam Stovall, chief investment strategist at CFRA Research, noted that investors should not be surprised if market gains begin to slow as the Federal Reserve approaches a possible rate cut. He said that since 1989, the S&P 500 has gained an average of 15.5% between the last rate hike cycle and the first rate cut, but the average gain in the six months after the first rate cut was only 5.4%.

Still, strong momentum in the first quarter has historically carried over into the next quarter, said Keith Lerner, co-chief investment officer at Truist Advisory Services. He said that of the 11 times the S&P 500's first-quarter total returns were 10% or more, nine continued to rise in the second quarter, with the average gain being 6.2%.

"The market deserves its due, and at this time we believe the bull market rules apply." He said the biggest risk to a continued market rally was signs that the Federal Reserve was considering keeping interest rates at current levels until the end of the year, which would lead to a "dramatic" repricing of risk assets.

Emily Roland, co-chief investment strategist at John Hancock Investment Management, said the likelihood of a market slowdown also depends largely on corporate earnings, although the market is optimistic Interest rate policy was repriced, but unexpectedly strong corporate earnings helped push the S&P 500 to a series of record closing highs.

The S&P 500's earnings grew 10.1% in the final quarter of 2023, more than double the 4.7% forecast, according to LSEG I/B/E/S. High interest rates are likely to weigh on consumer and business spending, and analysts expect first-quarter earnings to rise 5.1%. Companies will begin to announce their results starting from the second week of April.

"If earnings continue to rise unexpectedly, it will be difficult for the Fed to justify cutting interest rates three times this year," Rowland said. "But if we see inflation level off, this reacceleration could turn into a more sustainable situation."