April’s soggier markets fertilized a rebound in May, with the S&P 500^® Index setting a new all-time high and the Dow Jones Industrial Average hitting 40,000 for the first time. Both were fueled by strong earnings. The first-quarter earnings season is nearly finished, and almost 80% of companies that reported have reported better-than-expected earnings. The S&P 500 Index’s information technology (IT) sector resumed its leadership role, rising just over 10% during the month, helped by chipmaker Nvidia’s earnings once again significantly exceeding expectations while providing encouraging guidance for its future earnings.

Meanwhile, economic growth remains durable, supported by investments and low unemployment. However, the latest revision to first quarter gross domestic product (GDP) downgraded the growth rate from 1.6% to 1.3%, suggesting the economy is cooling.

Inflation data was mixed over the month, with the April Consumer Price Index (CPI) rising 3.4% over the past year, broadly in line with expectations, while the Core CPI (which excludes the more volatile food and energy components) rose just 3.6%. As this was the lowest increase since April 2021, it provided some relief while still remaining high enough to further delay interest rate cuts from the U.S. Federal Reserve (Fed). Fed Chairman Jerome Powell remarked on May 14, just a day before the CPI figures were released, that because 2024’s inflation reports had been higher than expected the Fed would likely need to keep interest rates “at the current rate for longer than had been thought.” April’s Personal Consumption Expenditures (PCE) Price Index inflation—the Fed’s preferred measure—rose 2.7% relative to April 2023. While the figure was in line with expectations and a welcomed improvement over March’s more distressing report, it remains above the Fed’s long-term average target of 2%.

Treasury yields fell in May, largely due to more stable inflation data improving the outlook for eventual interest rate cuts. However, concerns about the volume of Treasury bond issuance has reemerged as a concern, weighing on the markets in May. The Bloomberg U.S. Aggregate Bond Index rebounded, rising 1.70% in May, improving its year-to-date loss to -1.64%.

Outlook: While economic signals have recently been more mixed, we continue to expect the economy will achieve a soft landing and inflation will fall sufficiently to allow the Fed to loosen monetary policy, although the risk of softer than expected growth has increased. As we have often stated, inflation’s decline will not be linear or swift, and we maintain our view that the Fed will be conservative, preferring to hold rates as high and as long as it can to ensure inflation doesn’t reignite.

Recent earnings provided a boost to equity markets, and we expect earnings will remain broadly supportive through the rest of the year. Furthermore, when interest rates eventually fall, the riskier segments of the market—such as small-cap stocks, companies with relatively lower quality and more value-oriented stocks—should see renewed interest, broadening the strength within equity indices. While the recent strength in the utilities sector is one example of this broadening, we encourage investors to be patient as turning points in the economy often result in more volatility in the economic data, and thus more volatility in financial markets.

Over much of the past year, growth stocks and higher-quality companies with strong earnings, good cash flow and strong balance sheets have excelled, and we expect it will take time for sustained outperformance to pivot to riskier segments of the market. Investors will likely need to see a few rate cuts and begin debating when enduring growth will return, which is a considerably higher burden of proof than believing a soft landing is likely.

Nevertheless, we continue to see value in bonds as we expect the Fed will lower interest rates later this year, pushing bond yields lower across the yield curve. While we and the market maintain some concern about supply putting upward pressure on longer-dated Treasury bonds, we believe these concerns are likely to ebb and flow, potentially creating attractive entry points. Meanwhile, current yields on longer-dated bonds still offer a compelling opportunity to lock in significant yields for the length of the bond.