By Carolina Mandl, Svea Herbst-Bayliss and David Randall

NEW YORK The recent rally that has lifted U.S. stocks and bonds is more of a year-end rebound than a turning point, according to big money managers, who see fiscal and monetary policies, next year's presidential election and recession fears as likely to start weighing on markets.

Since late October, the S&P 500 has rallied roughly 10% and the Nasdaq has surged 13%, as investors increased bets that the Federal Reserve's tightening cycle is over after signs of cooling inflation and job growth and a better-than-expected third-quarter earnings season.

Ten-year Treasury yields hit a 16-year high of 5.021% in late October, but have fallen back to 4.414%. Lower yields have driven a technology-fueled equities rally.

Some big investors and advisers believe, however, that reasons to cheer are short-lived and growing concerns over the economy will start weighting on asset prices early next year.

"We've started seeing some signs that things are a little weaker than what people may believe," Ryan Israel, chief investment officer of Bill Ackman's Pershing Square Capital Management, told clients last week, adding the main focus now is where the economy is heading.

Markets may have “gone too far in extrapolating” rate cuts in early 2024 from recent data suggesting that consumer inflation is falling and the U.S. labor market is weakening, said Mohamed El-Erian, an adviser to financial services firm Allianz SE.

While inflation has become less front-and-center after U.S. consumer prices were unchanged in October, on investors' minds is the fallout from the Fed's 525 basis points in total interest rate hikes since March 2022 coupled with the central bank's efforts to reduce its balance sheet, under its so-called quantitative tightening.

Overall, growth in the global economy is expected to slow in 2024, hit by elevated interest rates, higher energy prices and cooler growth in the world's two largest economies, the U.S. and China. Most economists, however, believe the world will avoid a recession.

"I don't think that the market is going to dodge a very aggressive Fed tightening cycle and then continued quantitative tightening environment without a little bit of damage coming sometime next year," said Peter van Dooijeweert, head of defensive and tactical alpha at Man Group's Solutions unit, which creates portfolios for clients. His focus now is more on earnings, credit markets and broader economic data for signs of a potential slowdown.

The U.S. presidential race next year is also a concern because it could be a source of more market instability. "As we get into 2024, with a general election that's going to be extremely contested, I think we're going to see more risks there," said Max Gokhman, head of MosaiQ investment strategy at Franklin Templeton.

MAGNIFICENT SEVEN

One of the biggest sources of uncertainty for investors is the performance of the so-called Magnificent Seven group of very large companies, which have driven stock indexes this year.

Bill Gross, the co-founder of bond giant Pimco who now manages his own money and that of his foundation, told Reuters in an email that the drop in yields has largely benefited technology stocks, which are also riding investor enthusiasm for artificial intelligence. But he sees little room for the 10-year Treasury yield to move lower at 4.45%. "Do not look for yields to be a contributing factor in the future," he said.

For a new boost in market performance, tech stocks will depend more on showing how AI can lift results, investors said. Last month, Microsoft quarterly results beat Wall Street sales estimates, with its cloud computing and PC businesses growing as customers anticipated using its AI offerings.

"The market might be too optimistic about how much of the AI boom is really going to contribute to the bottom line of earnings of the Magnificent Seven," said van Dooijeweert.

A Reuters poll on Tuesday showed that strategists estimate the S&P 500 will end next year only about 3% higher than its current level, as they fear an economic slowdown or recession.

"I think it would be important to hold your convictions quite loosely as you go past New Year's Eve," said Gokhman, of Franklin Templeton.

(Reporting by Carolina Mandl, David Randall and Svea Herbst-Bayliss; Editing by Megan Davies and Leslie Adler)