May 2022 | Equity Commentary
Published on June 6th, 2022
The U.S. stock market continued its choppy streak in May, with volatility working both ways (up and down). Early in the month, stocks seemed to welcome news that Federal Reserve Chairman Jerome Powell was “not actively considering” raising rates in three quarter percentage point increments. But that rally was short-lived. China lockdowns, combined with weaker-than-expected earnings from major retailers, sent stocks sharply downward. At one point in late May, the S&P 500 nearly crossed into bear market territory, but just as the index approached a 20% decline from its peak level stocks swung wildly again—this time higher. By the end of the month stocks had completed a round trip, leaving the index flat for May. The U.S. Treasury bond market had a far less eventful month, with the 10-year and 30-year U.S. Treasury bond yields both trading in a tight range below and above 3%, respectively.
One of the most discussed topics on Wall Street last month was whether inflation may be peaking. The deceleration of headline inflation from March to April seemed to confirm this possibility—month-over-month, inflation fell from 1.2% in March to 0.3% in April. The same went for the year-over-year change in CPI, which fell to 8.3% in April from 8.5% in March1. It is likely too soon to call peak inflation with just these data points, however. Gas prices continued to rise throughout May, and the European Union’s just-announced Russian oil ban, coupled with China’s economic reopening, could further disrupt commodity markets and global supply chains, respectively.
The inflation question matters to markets because it is likely to be a key determinant of the path of the Federal Funds rate for this year and next. The Federal Reserve has been explicit in prioritizing inflation over growth and employment, so the ongoing inflation question continues to drive uncertainty about where rates will end up. In our view, there is a fairly straight line between Federal Reserve policy uncertainty and ongoing equity market volatility.
Economic data in May was mixed. A look at economic fundamentals in key U.S. districts, compiled in a survey known as the Fed beige book, showed the U.S. economy growing at a more modest pace in the spring than previously expected. Many companies reported worker shortages, struggles with higher input costs, and consumers who were starting to push back against higher prices. Even still, 77% of S&P 500 companies beat earnings expectations in Q1, delivering a blended earnings growth rate of +9.2%, according to Factset.2 Nine of the eleven S&P 500 sectors reported earnings growth in Q1, with the Energy sector contributing the lion’s share to the overall figure. Without the Energy sector, however, S&P 500 earnings-per-share growth would have registered at much more modest +3.2% for Q1.2
In the U.S. labor market, workers continue to have the upper hand. The Labor Department reported that employers added 390,000 new jobs in May, with wages increasing 5.2% year-over-year. May’s figures fall just short of extending the 12-month streak of the U.S. economy adding 400,000 jobs per month, which still marks the strongest period of job gains dating back to 1939.3 Initial jobless claims also fell to 200,000 in the final week of May, indicating that employers are holding on to workers in hopes of avoiding further shortages. The unemployment rate remained steady at 3.6%, which is nearly in-line with its pre-pandemic level.
Manufacturing and services in the U.S. continue to demonstrate resilience even as headwinds persist. The May Manufacturing PMI was 56.1%,4 which marked an increase of 0.7% from April and firmly suggests the economy remains in expansion mode. Manufacturing activity has been expanding for 24 straight months now in the U.S., and businesses surveyed continue to point to strong demand looking ahead. For every cautious comment made in the survey, there were five positive growth comments.
The U.S. services sector also posted strong activity in May, with the Services PMI registering at 55.9%.5 Services have also expanded for 24 months straight, but a cautious reading of this services print would note that activity decelerated 1.2% from April. In particular, the Business Activity Index declined by 4.6% from April to March, and the Supplier Deliveries Index—which measures how long deliveries are taking—remains elevated.5 A close read of the May jobs report offers a hint that the services sector could feel some tailwinds heading into summer—while retailers cut nearly 61,000 jobs in May, leisure and hospitality employers added 84,000.5 The suggestion here is that consumers are increasingly shifting spending from goods to services.
Finally, the big news late in the month was the European Union’s announcement of a phased Russian oil ban. The EU will start by blocking all Russian crude and refined fuels that arrive on ships, leaving a carve-out for pipeline oil to appease Hungary. Germany and Poland have pledged to stop buying oil that arrives via pipeline by the end of the year, however, which will effectively sanction 90% of Russian oil imports. The EU also took the bold step of blocking insurance companies from covering cargo ships carrying Russian oil, which is meaningful given that European insurers cover most of the world’s oil trade.
Days later, an agreement was reached by OPEC+ to raise output by 648,000 barrels a day in July and August,6 which marks a 50% increase in production from previously announced plans. Oil markets did not seem placated by the news, however, as the benchmark for U.S. crude prices (WTI) rose by 1% on the day of the announcement and continued charting higher the following day. There are also murmurings that OPEC is considering exempting Russia from its oil-production targets, which would open the door for increased production from Saudi Arabia, the United Arab Emirates, and other key oil producers. Whether there will be any follow-through on this plan is unclear.
From an investment portfolio standpoint, not much has changed over the last month. We continue to favor defensive, high cash flow, ‘recession-resistant’ businesses while also holding excess cash to pad against further volatility.
As of May 31st, 2022