Understanding capital markets

Understanding capital markets—including stock and bond markets—and the factors that affect their performance allows you build an investment portfolio that helps you meet your financial goals. Here, we’ll look at the capital markets definition and investment trends that are affecting these markets.

What are capital markets?

Capital markets are the collective term for, primarily, stock and bond markets. They’re a way to bring together individuals or institutions with money (also known as capital) they wish to invest, and entities looking for money to help realize their growth plans.

For example, government entities, such as municipalities, regularly issue debt securities (bonds) to meet costs for major capital projects. In the case of the federal government, bonds help finance day-to-day expenditures. Investors, in effect, lend money to the government entity by purchasing a bond. The borrower is required to pay interest on a timely basis and repay principal when the bond matures.

Businesses issue stock (or equities) to raise funds for expansion or other investments in the business that will create value for their shareholders.

Capital market performance in 2024

Equity market investors continue to benefit from a generally strong 2024 market environment, this time with positive results spread among a wider swath of equities compared with 2023’s narrow leadership.

Fixed-income (bond) markets have struggled with interest rates generally trending higher in 2024. However, as interest rates fall in anticipation of Fed rate cuts, total returns for bonds are rising.

“The macroeconomic backdrop to this point in 2024 is one of continued growth, driven primarily by solid consumer spending,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. He notes that inflation as measured by the Consumer Price Index, at 2.5% for the 12-months ending in August, is down considerably from peaks reached two years ago.¹

While inflation is down, the unemployment rate moved above 4% and job growth slowed. Employment numbers are closely watched as early signs of an economic slowdown.

Stock market performance in 2024

U.S. stock market, as measured by the S&P 500, gained more than 19% year-to-date through September 16, 2024. This comes on the heels of a more than 26% gain in 2023.²

However, 2024’s equity market is distinguished from 2023’s in that more sectors of the market are participating in the rally. Last year’s gains were primarily generated by a narrow group of technology-oriented stocks. In 2024’s third quarter, leading market performance is coming from the real estate, utilities, consumer staples and financial sectors.²

Bond market performance in 2024

While the 10-year U.S. Treasury yield jumped to as high as 4.70% by late April 2024, it retreated below 4% in August and stayed at that level. As a result, bonds gained in value (bond prices rise when interest rates decline). Year-to-date through September 16, 2024, the Bloomberg Aggregate Bond Index gained 5.25% on a total return basis.³

Current capital market drivers

The economy proved resilient even as the Federal Reserve (Fed) maintained higher interest rates. It set the federal funds rate that apply to overnight loans between financial institutions to a top level of 5.5% in July 2023 to help temper inflation.

In today’s environment, Haworth says investors should pay particular attention to three primary factors:

• Fed rate cuts. In late 2023, the Fed put the possibility of rate cuts on the table but delayed cutting rates due to persistent inflation concerns. With a modest, 0.25% rate cut expected at its mid-September meeting, markets anticipate that the Fed will apply a series of rate cuts in the months ahead.⁴ “We’re not seeing signs of inflation resurging, and the Fed is putting increasing focus now on its mandate related to keeping the labor market strong,” says Haworth. “The Fed will make interest rate decisions based on what it sees in the data over time.”
• The state of the economy. Despite headwinds created by Fed monetary policy, the U.S. economy continued to grow, driven primarily by healthy consumer spending. “How strong and resilient will consumers continue to be in 2024 and beyond? That’s an open question,” says Haworth. “The key issue today is whether the labor market has changed enough to alter consumer spending.” A recent favorable sign was a very strong retail sales report in August indicating consumer spending was on solid footing.⁵

• The direction of corporate earnings. Earnings, or a company's profits, are typically one of the biggest drivers of capital market performance. “S&P 500 earnings have grown for three straight quarters,” says Haworth, “in contrast to an earnings contraction that was underway in the first half of 2023.” Haworth notes the earnings outlook for the rest of 2024 remains positive, and markets are even more optimistic about earnings prospects for 2025. He adds, however, that “it’s a stock-by-stock story, and not every company is on the same earnings growth track.” Earnings growth is critical as it helps lay the groundwork for rising stock prices. If anticipated earnings growth fails to materialize, Haworth says equity investors could face a more challenging environment.

While these factors are likely to have the greatest impact on equity and fixed income markets, investors need to be aware that other events can temporarily affect the markets and potentially contribute to investor uncertainty.

Read more about our capital market perspective in our quarterly investment outlook.

Capital markets explained

Here are answers to some fundamental questions that may help you better understand capital markets and how they work.

What are the types of capital markets?

Capital markets are most commonly defined as stock and bond markets.

• Stocks (equities) are issued by a corporation, giving investors an ownership stake in the firm. Individuals and institutions can purchase stock in the company, have voting rights as a shareholder and receive dividends that the company pays out from its earnings (profits). Stock values can rise and fall, and investors can re-sell shares through an exchange on the secondary market, which is where bonds or shares of stock are bought and sold after their initial public offering (IPO, sometimes called “going public”).
• A variety of entities issue bonds, such as governments, school districts and corporations. By buying a bond, the investor becomes a lender to the issuing entity and receives interest and principal payments. Bondholders always take priority over stockholders when it comes to repayment if the entity that issued the security faces financial difficulties, such as bankruptcy.

How do capital markets work?

The key to capital markets is the issuance of securities. Entities that want to raise money will issue debt (bonds) or equity (stocks) securities that are exchanged with investors. A corporation, for example, may issue new shares of stock at a set price. However, once that share is on the open market, its price will constantly change, reflecting demand in the market.

Proceeds from investors’ purchase of stocks or bonds go directly to the issuer to meet its current financial purposes. It’s important to note that original issues of stocks and bonds are not always accessible to individual investors, such as in an IPO. Most individuals purchase stocks on the secondary market, where those who previously purchased stocks or bonds can re-sell the securities they hold.

How do capital markets differ from financial markets?

There are similarities between the two, but capital markets typically refer to the issuance of new securities to raise capital, while financial markets can refer to all forms of securities trading.

Financial markets encompass a wide variety of exchanges involving traditional securities like stocks and bonds, as well as other types of assets and contracts.

Capital markets: Talk to your financial professional to learn more

As you assess your own financial goals, understanding the current and anticipated performance of capital markets may help you more effectively position your assets to achieve your objectives. As always, it can be helpful to discuss your circumstances with your financial professional to help determine your best steps in today’s capital markets.

Our investment strategies are designed to weather all types of market cycles. Learn about our investment management approach.