I had a wonderful Fourth of July holiday with my family, highlighted by building sandcastles on the beach with my eight-year-old twin grandsons. But now, like millions of Americans, I’m back at work.

The U.S. economy seems to be settling into a more sedate groove as well. Recent reports suggest that the rapid economic recovery is slowing down and inflation is beginning to ease.

This deceleration of the economy, with the concomitant cooling of inflation, is boosting investor confidence. As summer gets into full swing, signs suggest the stock market will continue its outperformance in the second half of 2024.

Two critical sectors displaying signs of cooling are services and labor. The Institute of Supply Management (ISM) Services Index, released July 3, recorded a contraction in June with a 48.8 reading, signaling a decline in non-manufacturing activities.

Meanwhile, nonfarm payrolls showed an increase of 206,000 jobs in June, down from 218,000 in May, which had itself been revised downwards by 54,000. The unemployment rate nudged up from 4% to 4.1%, surpassing the Federal Reserve’s 4% estimate for the year.

The ISM’s prices paid indexes, which often forecast inflation trends for goods and services, were below expectations and near their lowest levels post-pandemic. Wage growth, another indicator of services inflation, dropped to 3.9% annually in June from 4.1% in May.

If inflation continues to ease and the economy avoids a significant downturn, market performance should remain strong. This scenario would likely prompt the Fed to start cutting interest rates while the economy maintains growth near trend levels.

The economy and labor market are adjusting from an unusually strong position, normalizing gradually.

The manufacturing sector has been weak, with the ISM manufacturing index showing contraction in 19 of the last 20 months. Initially, U.S. consumers increased spending on goods during and after the pandemic, but spending has now shifted to services such as travel, leisure, and hospitality.

The U.S. services sector, a significant contributor to gross domestic product (GDP), also has shown recent signs of softening. The ISM services data indicated contraction in two of the last three months, suggesting a potential slowdown as consumers deplete pandemic-era savings and face higher prices.

The consensus of analysts is for U.S. economic growth to cool to below-trend levels of 1.5% to 2%. The Atlanta Fed projects a second-quarter GDP growth rate of 1.5%, following a 1.4% annualized growth rate in Q1. These rates are below last year’s average quarterly growth of 3.2% and the Fed’s 2.1% growth forecast for 2024.

This slowdown could be attributed to the impact of higher interest rates on the services economy. However, sub-2% growth rates would likely be seen as a soft landing, a favorable outcome for markets.

Indicators such as job openings and quit rates have softened, with both metrics near yearly lows.

Labor supply has improved as workers return to the workforce, reflected in rising labor force participation rates. Immigration also has contributed to labor supply. Demand for labor has moderated, with fewer job openings across sectors, leading to higher unemployment rates and slower wage growth. This gradual softening is preferred by the Fed and markets because it indicates a slowing but stable labor market, which should help ease inflationary pressures.

The Fed is likely to begin its rate-cutting cycle this year if inflation and labor market trends continue to soften. The probability of a September rate cut has increased to 72%, suggesting up to two rate cuts this year.

Amid the favorable conditions I’ve just described, stocks kicked off the month of July with a winning week, as the following chart shows:

Your Investment Strategy for H2…

We just closed the books on the first half of 2024 and it was a good period for the financial markets. Conditions are auspicious for the second half as well.

Historically, markets perform well in an environment of cooling economic growth, moderating inflation, and potential Fed rate cuts. Lower rates and inflation typically boost economic activity and improve earnings growth projections.

From an equity perspective, mega-cap technology and growth sectors, capable of delivering strong earnings, should continue to perform well. Cyclical sectors tied to economic growth may lag until the Fed’s rate cuts stimulate consumption.

I continue to favor large-cap and mid-cap U.S. equities over the medium term, anticipating continued bull market phases, though not in a straight line. Market corrections are expected and can be healthy.

In fixed-income markets, longer-duration bonds within the investment-grade space may perform well as economic growth cools and yields soften. Although longer-dated Treasury yields may decline, significant downside is limited given elevated deficits and the Fed’s end goal for the fed funds rate.

The Week Ahead…

The following economic reports are scheduled for release in the coming days:

NFIB optimism index, Fed Chair Jerome Powell’s testimony in the U.S. Senate (Tuesday); wholesale inventories, Powell’s testimony in the U.S. House (Wednesday); initial jobless claims, consumer price index (Thursday); producer price index and consumer sentiment (Friday).

Powell’s remarks and the inflation data will loom large over markets. We face a possibly volatile week.

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This article previously appeared on Investing Daily.