May 2023 Market Commentary

The stock market ended slightly higher in May, driven by the technology sector, which was up just under 10% for the month. Bonds declined as the odds increased slightly that the Federal Reserve may hike rates one more time in June. The S&P 500 is up 9.7% year to date, supported by better-than-expected data on the economy, and technology, which is up 34%. The Bloomberg U.S. Aggregate Bond Index fell 1.1% for the month while yields moved higher. Yields on the 2-year Treasury have risen, up 34 basis points since the start of the month from 4.02% to 4.36%. The 10-year Treasury yield rose from 3.43% to 3.60%, peaking at 3.82% on May 24. Small- and midcap stocks fell 0.9% and 2.8%, respectively. International markets ended the month with losses, underperforming the U.S. market as the U.S. dollar rose.

Q1 real gross domestic product was revised upward to 1.3% annualized, beating analyst expectations. Major drivers were a better-than-expected rise in consumer spending and declines in business investment and in inventories as companies continue to be weighed down by the Fed’s interest-rate hikes. Despite a decrease in business investment, consumer spending continues to surge as the consumer has benefited from low unemployment and steady wage gains. Given the strength of the consumer and the core Consumer Price Index continuing to stay higher longer than hoped, another Fed rate hike is possible in June but is far from certain. The next Fed meeting is June 14.

The U.S. Economy Remains Resilient

While Wall Street continues to warn of trouble ahead, the current picture of the economy is one of resilience. Q1 real GDP was revised up to a 1.3% annual rate from 1.1% in the advance estimate, which is a significant slowdown from the second half of 2022 but positive nonetheless. The coincident economic index, a monthly measure of economic activity, rose 1.7% in April, below the average 2.6% annual growth historically but, again, still positive. The S&P Global U.S. Composite PMI, a forward-looking indicator, climbed to 54.5 in May (figures above 50 indicate expansion), its highest level since April 2022. The latest improvement was all due to services, as manufacturing activity slipped back into contraction territory. This data indicates the economy is not currently in recession.

Consumer spending has been a key support for the economy, driven by strength in the labor market, excess savings from the pandemic and the availability of credit. Labor is the main source of income for consumers. With nonfarm payrolls still growing, the unemployment rate at a multi-decade low and wages still rising at an elevated pace, aggregate weekly payrolls have also held up well. Consumers have accumulated a significant amount of excess savings in large part due to massive government stimulus and government shutdowns during the pandemic. The San Francisco Fed recently estimated that there is still about $500 billion in excess savings, and the number could be even higher. While credit conditions have tightened in the aftermath of the banking crisis that unfolded in March and are a headwind to growth in the coming quarters, consumer credit has not dried up sufficiently enough to put the brakes on the economy— for now. Data for Q1 continued to show year-over-year growth for most types of loans, including credit cards and home equity lines of credit.

Of course, the cost of credit has increased rapidly and may slow the economy in time. Delinquency and default rates are still low by historical standards but are likely to increase. Historically, these rates have been an accurate forward-looking indicator of financial stress on the horizon.

Growth Stocks Surge

The Russell 1000 Growth Stock Index, which measures the performance of U.S. large-cap growth stocks, surged an additional 4.5% in May and is up 20.8% year to date. The Index was led by Nvidia Corp. as the stock soared 26% in a single day after the company’s raised sales forecast smashed expectations. The main drivers of Nvidia’s improved forecast were accelerated computing and generative AI, which has fueled enthusiasm for the entire technology sector. Tech stocks have been on a wild ride since the Fed began raising interest rates in March 2022, tumbling for most of last year and then rebounding for most of 2023. Tech bulls have been emboldened by the possibility that the Fed is close to ending its rate hikes, pushing S&P 500 tech stocks to their best first quarter since 1998.

Outlook

Diversification is a core investment principle and a critically important tool for managing risk. While it is tempting to add money to investments that are performing well and trim laggards, our advice instead is to build for balance. If your portfolio is properly diversified, chances are you will have investments that are disappointing in the short run. If all your investments are up at the same time, chances are your portfolio is not diversified properly. Remember, the mood on Wall Street can change very quickly. We believe chasing past performance is a surefire way of reducing investment returns. Instead, our advice is to stay focused, stay disciplined and stay confident that a diversified portfolio of high-quality investments is a better strategy than constantly trading your portfolio in an effort to boost returns.