The debt ceiling debate weighed on markets over the month of May, but a last-minute agreement by Congress and the President helped lift the equities market—with technology-related stocks leading the way for the second consecutive month.
The final debt deal, which staved off a potential government shutdown, hinged on a commitment to keep nondefense spending roughly flat in 2024 and only 1% higher in 2025.
Technology stocks continued to rally in May, extending the gains from late April when Microsoft, Google, Meta, and Apple all reported results above consensus expectations. A standout performer in May was Nvidia, a leader in the semiconductor industry that has benefited from rising demand for Artificial Intelligence (AI) development.
Economic data released over the month was generally positive. The Bureau of Economic Analysis (BEA) revised 1st quarter gross domestic product (GDP) up by 0.2% to 1.3%, while retail sales showed signs of encouraging growth, according to the latest report from the Department of Commerce.
Inflation data reported over the month remained persistently high, with Personal Consumption Expenditures rising 0.4% in April, according to the BEA. This matched the monthly gain of the Consumer Price Index (CPI), where the cost of shelter (primarily housing) was the largest contributor to rising consumer expenditures. In fact, single family home prices in the U.S. reached a new high in March, eclipsing the previous level set in June 2022, according to the Federal Housing Finance Agency (FHHFA).
On a more positive note, for Americans struggling with high food costs, the index for food at home fell 0.2% in April. However, those who prefer dining out experienced rising prices, with the index for food away from home up 0.4%.
Outlook: We remain moderately constructive in our outlook given modest economic growth, a resilient consumer, an insatiable job market, and the resolution of the debt ceiling.
However, the economic uncertainty and volatile investment environment that characterized the 2nd quarter is likely to prevail through the rest of the year. The challenges of transitioning to a post-pandemic world, continued inflationary pressures, a restrictive monetary policy, and ongoing geo-political tensions, are long-term factors that are likely to pose headwinds for the stock and bond markets in the quarters ahead.
Longer term into next year we are more cautious, as the lagged impact of higher rates affects the economy along with signs of a slowdown, including declining new manufacturing orders, softness in inflation-adjusted wages, increasing layoffs, and declining savings. Also, several leading economic indicators are at levels that in past preceded weak growth and recessions.
Corporate earnings, the Federal Reserve’s (Fed) pending moves on interest rates, and the economy itself will ultimately drive both fixed income and equity markets in the months and quarters ahead.
Earnings surprised to the upside in the 1st quarter, helping to power positive equity returns. However, equity market trading has been quite narrow, with a handful of mega-cap names powering gains in the S&P 500 year to date. An equaled-weighted version of the S&P 500 is about flat on the year, trailing the market-cap weighted version by more than 11% in early June.
Within the equity market, we continue to believe quality factors such as reliable earnings and strong balance sheets will be the primary determinants of performance. Mega-cap technology stocks, which have rebounded after lagging the market last year, are likely to remain a safe haven despite high valuations, as investors migrate back to less cyclical, high quality, and low capital intensity stocks.
While small cap and value stocks are still historically cheaper relative to the large cap stocks, these sectors typically perform better when the economy transitions from contraction back to expansion.
Equity markets also have been supported by an expected near-term end to the Fed’s aggressive interest rate hiking cycle. The Fed is likely to pause hiking in June to assess the lagged impact of higher rates and tighter credit standards, although another rate hike remains possible. The key will be incoming data, especially the next consumer price inflation report, due for release during the Fed’s next meeting in mid-June. Futures markets at the start of June were pricing in one more hike through June and July.
A final resolution of the U.S. government debt ceiling negotiations has helped bring to an end a period of significant uncertainty along with a relief rally in the equity markets. Treasury rates likely will remain volatile, with uncertainly over inflation and the Fed, along with the increased supply of bonds as the U.S. Treasury rebuilds cash in the wake of the debt ceiling debate resolution. While the Fed is likely to keep rates high for an extended time, we expect longer-term rates to move lower over time as markets increasingly price in slower growth and easing inflation into 2024.
We continue to be modestly positive in the near-term but are cautious into 2024 with increasing risks of a recession and lower earnings, as the lagged impact of tighter financial conditions hits. We recommend waiting for meaningful improvement across a range of critical factors before becoming more aggressive, including more attractive overall valuations, lower inflation, and an economy poised for expansion. We would use any significant market correction to take on greater risk.
U.S. stocks inch higher
The S&P 500® Index rose 0.25% in May, from 4,169.48 at the April close to 4,179.83 at the end of May. The total return of the S&P 500 Index (including dividends) was 0.43% for the month and 9.65% year to date. (The S&P 500 is a market-cap-weighted index that represents the average performance of a group of 500 U.S. large capitalization stocks.)
The NASDAQ Index surged in May, up 5.80%, from 12,226.58 at the end of April to 12,935.29 at the May close. For the year, the NASDAQ was up 23.59% through May, as technology stocks accelerated their rebound off large losses in 2022. (The NASDAQ – National Association of Securities Dealers Automated Quotations – is an electronic stock exchange with more than 3,300 company listings.)
Retail sales rise
Retail sales were up 0.4% from the previous month in April, and up 1.6% from 12 months earlier, according to the Department of Commerce retail report issued May 16. Rising sales were led higher on the month by miscellaneous store retailers, non-store retailers, general merchandise stores, and health & personal care stores.
The gains were more impressive on a year-on-year basis, with food and drinking establishments leading, up 9.4% from April of last year as consumers continued the trend of spending more time in restaurants and bars. Spending in non-store retail (primarily online) and health & personal care stores were not far behind, up 8.0% and 7.9% year-on-year, respectively. General merchandise stores were up 4.3% on the year, and miscellaneous store retailers were up 2.4%.
Falling sales in the sporting goods, hobby, musical instruments & bookstores category weighed on the index in April, falling 3.3% month on month, while gasoline stores continued to lead retail sales lower on a year-over-year basis, down 14.6% from April last year, as oil and gasoline prices continued their declines.
Employers continue to add jobs
The U.S. economy added 339,000 new jobs in May, the largest monthly increase since January and the 29th straight month of job growth, according to the Department of Labor. Despite the strong increase in jobs, the unemployment rate moved up 0.3% to 3.7% in May, as more individuals entered the work force.
Professional and business services added the most employees (64,000), followed by health care (52,000), and leisure and hospitality (48,000), where most of the gain came in food services and drinking places (33,000).
Job openings also rose in April, topping 10 million again after declining for the prior three months, as reported by the Bureau of Labor Statistics on May 31. While this may be good news for job seekers, it could be a cause of concern for the Fed, which would prefer to see more demand for jobs than supply of jobs, for fear of creating upward pressure on wages. In fact, average hourly earnings for all employees rose 0.3% in May and are up 4.3% over the last 12 months.
Most sectors decline in May
Despite the S&P 500 Index generating a positive return over the month, eight of the index’s 11 sectors generated a negative return in May. Energy was the worst performing sector for the month – and year to date. With demand for energy waning, the sector was down 7.06% in May and 11.40% through the first five months of 2023.
However, the Information Technology sector extended its recent surge in May, rising 9.46% and ringing its year-to-date return to 33.95%. Communications Services, up 6.21% for the month and 32.81% year to date, and Consumer Discretionary, up 3.21% for the month and 18.73% year to date, were the only other positive performers in May.
The chart below shows the past month and year-to-date performance results of the 11 sectors: