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 and thus 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.
In this still challenging macroeconomic environment, we believe credit risk will remain elevated, justifying the higher credit spreads over time in both corporate and high-yield bonds.
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.)