The market is going to worsen early in 2024 before recovering, according to Evercore ISI. The firm sees the S & P 500 falling in the first half of next year to 3,970 as a “recession materializes and politics [amplify] volatility.” After that, it expects the broad market index to bounce back up to 4,750 by year-end as inflation hits the Federal Reserve’s 2% target. The final year-end forecast represents just 3.2% upside from Friday’s close. The Fed has engaged in 11 rates hikes since March 2022, bringing its policy rates to a range between 5.25% and 5.5%, the highest level in 22 years. These moves have helped to tamp down inflation, though not quite to the central bank’s target. The latest consumer price index report showed prices rose 3.2% year over year in October. That’s less than economists expected but still higher than the Fed’s 2% target. Still, the Fed’s rapid rate hike cycle will have consequences in the first half of 2024, according to macro research analyst Julian Emanuel. Forward indicators have been signaling a recession for more than a year, he added. An inverted yield curve also portends the start of a recessionary period in the first quarter of 2024, he added. An “expected recession beginning in 1H24 coupled with the pricing of Fed cuts, if not the actual cuts themselves, which, counterintuitively, confirm the emergent weakness, will pressure the S & P 500 lower to 3,970,” Emanuel wrote in a Sunday note. The subsequent rally will start before the 2024 U.S. presidential election in November, according to Emanuel. “‘Defense Wins Championships’ is a consistent theme between [the] last hike and first cut in the recession playbook,” said Emanuel. “Politics sets a precedent that stocks are volatile, but a recession, mild (1954) or otherwise (2020), still ends in an up year for equities as inflation falls to/below the Fed’s 2% target.” With this in mind, Evercore ISI prefers defensive sectors, such as communication services, consumer staples and health care. In particular, communication services will benefit from greater news flow and views in the election year, the firm said, and has high potential for productivity gains from artificial intelligence advancements. Year to date, the communication services sector has surged nearly 47%. Meanwhile, consumer staples and health care have struggled in 2023 and are down 4.7% and 3%, respectively. By comparison, the S & P 500 is up 20.1% year to date. .SPX YTD mountain SPX in 2023 Meanwhile, the firm thinks consumer discretionary, industrials and materials will underperform. The consumer discretionary sector rallied 36% in 2023. Industrials have added 11.5%, while materials have inched up just 5.4% year to date. Emanuel also thinks the generative AI theme will drive gains in 2024, calling it the “bright future of productivity.” Generative AI benefits could drive gains in just a handful of stocks, he added, which could further push up the concentration of the top five stocks in the S & P 500.