NEW YORK, March 29 (Reuters) - After a stellar start to

the year for stocks, investors are on guard for potential bumps

in the second quarter as they gauge whether the Federal Reserve

delivers on an expected interest rate cut by June and turn their

focus on the health of upcoming earnings.

The S&P 500 ended the first quarter with a gain of

more than 10%, its largest first quarter advance since the

nearly 13.1% jump in the first quarter of 2019. While so-called

Magnificent Seven stocks such as chipmaker Nvidia ( NVDA ) and

Facebook parent Meta Platforms ( META ) provided the bulk of the

gains for the quarter, economically-sensitive sectors such as

energy and industrials have rallied over the past six weeks.

Whether the rally continues through June will likely depend

on the Fed, which has not yet signaled that inflation has come

down enough to justify a rate cut. Markets began January with 6

to 7 cuts priced in over the course of 2024, but are now

anticipating 3 cuts after signs of resiliency in the US economy

increased investor confidence in a so-called soft landing.

"The market and the Fed are finally aligned on expectations,

but that puts even more pressure on every economic report that

comes out because it doesn't take a lot to make everyone run the

same way," said Joe Kalish, Chief Global Macro Strategist at Ned

Davis Research. "We are expecting more volatility if we don't

see more progress on the inflation front."

Futures markets are now implying a 61% chance of a 25 basis

point cut rate at the Fed's policy meeting that concludes June

12, bringing benchmark rates to a range of 5 to 5.25%, according

to CME's FedWatch Tool.

Continued growth in the US economy will likely continue the

recent broadening of the market rally into cyclical sectors and

small-cap stocks as investors search for more attractive

valuations, said Jason Alonzo, a portfolio manager on Harbor

Capital's multi-asset strategies team. The Russell 2000

index of small-cap stocks ended the first quarter with a 4.8%

gain, while the S&P 500 industrials sector rose nearly 11% over

the same time.

"Right now the only thing the market cares about is whether

the Fed remains in control even if the economy re-accelerates,"

Alonzo said. "If that idea was upset somewhat and the Fed had to

imply that rate hikes were back on the table, that would be a

shock to investors and cause a real issue for all assets."

Economic readings next week, including ISM manufacturing

data, ISM services, and the closely-watched non-farm payrolls

report, which economists polled by Reuters expect to show a

growth of 198,000 jobs in March.

Investors should not be surprised if the market rally starts

to slow as the Fed nears a potential rate cut, noted Sam

Stovall, chief investment strategist at CFRA Research. Since

1989, the S&P 500 has gained an average of 15.5% between the

last rate hike of a cycle and the first rate cut, but gained an

average of just 5.4% in the six months following the first rate

cut, he said.

Still, strong momentum in the first quarter has historically

carried over to the following quarter, said Keith Lerner,

Co-Chief Investment Officer at Truist Advisory Services. Of the

11 times that the S&P 500 has posted a total return of 10% or

more in the first quarter, the market continued to advance in

the second quarter 9 times, with an average gain of 6.2%, he

said.

"The market deserves the benefit of the doubt and at this

point we think bull market rules apply," Lerner said. The

biggest risk to a continued rally would be a sign that the Fed

is considering keeping rates at current levels through the end

of the year, which would lead to "dramatic" repricing of risk

assets, he said.

The likelihood of a market slowdown will also depend largely

on corporate earnings, which came in surprisingly robust and

helped push the S&P 500 to a series of record closing highs

despite the market repricing interest rate policy, said Emily

Roland, Co-Chief Investment Strategist at John Hancock

Investment Management.

S&P 500 earnings grew at a 10.1% pace in the last quarter of

2023, more than double the 4.7% expected advance, according to

LSEG I/B/E/S. High interest rates will likely weigh on consumer

and corporate spending, with analysts expecting a 5.1% earnings

growth over the first quarter. Companies begin reporting results

in earnest the second week of April.

"If earnings continue to surprise to the upside, the Fed

will have a hard time justifying 3 cuts this year," Roland said.

"But if we see a leveling out of inflation this economic

re-acceleration could turn into something more sustainable."