May 2023 | Equity Commentary
Published on June 13th, 2023
The debt ceiling debate featured prominently in financial headlines throughout May, but it appeared equity markets seemed far less concerned about default than media commentators. Volatility remained relatively subdued for the month, with the S&P 500 rising for three consecutive weeks to finish up +0.4%.1 However, we believe the rally lacked breadth—the top five contributors to the S&P 500 (Nvidia, Alphabet, Amazon, Microsoft, and Apple) added 2.4% to the index return for the month, while the remaining 495 companies subtracted -2.0%.2 A similar pattern has played out throughout 2023, with the capitalization-weighted S&P 500 up double-digits for the year but an equal-weighted version of the index roughly flat.3 In bond markets, yields on short-duration Treasury bills rose sharply with debt ceiling uncertainty,4 but longer-duration Treasury bonds showed less pressure. The 10-year US Treasury bond yield rose only slightly in May from 3.59% to 3.64%.5
Just a few days before the “X date” of June 5, President Joe Biden and House Speaker Kevin McCarthy reached a deal to suspend the debt ceiling in exchange for spending cuts totaling $1.5 trillion over ten years (according to the Congressional Budget Office). The bill passed with comfortable margins of 314 to 117 in the House and 63 to 36 in the Senate. Among the spending cuts were $20 billion in reduced funding for the IRS and the setting of an official end date to the Biden administration’s pause on student loan repayments. But a close look at the deal shows no meaningful change to the US government’s debt growth trajectory over the next several years, in our opinion. By some estimates, the deal would only reduce federal spending from its current baseline by about 0.2% of GDP over the next two years.6
The May US jobs report underscored ongoing strength in the services sector, particularly in transportation, health and education, and leisure and hospitality. Nonfarm payrolls rose by 339,000, well above consensus estimates and up from 225,000 in April. Household survey data showed that the number of unemployed people increased by 440,000 to 6.1 million, which factored into the unemployment rate rising by 0.3% in May to 3.7%.We believe strong momentum in the labor market continues to frustrate the Federal Reserve, but one bright spot in May’s jobs report was slowing wage pressures. The average hourly earnings in May increased 0.3% from April, slightly decelerating from the 0.4% increase the previous month. Year-over-year wage growth in May rose by 4.3%, a slight improvement from April’s 4.4% YoY rate.7 The Fed has indicated that 3.5% year-over-year wage growth could be acceptable and compatible with its inflation target, which puts current wage growth within a percent of that goal.8
The Fed raised the benchmark fed funds rate by a quarter percentage point at the May 2-3 meeting. The idea that the Federal Reserve may pause interest rate increases at its June 13-14 meeting received some clarity in May. Comments made by Fed leadership in the month appeared to confirm the pause, while also leaving the door open to possibly resume hikes later in the summer. Fed governor Philip Jefferson – who has been nominated to serve as Fed vice chair – said that “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle.” He added that “skipping a rate hike at a coming meeting would allow the committee to see more data before making decisions about the extent of additional policy firming.”9
Given that inflation remains sticky, with core CPI rising 5.5% year-over-year in April,10 the Federal Reserve’s motivation to ‘pause’ hinges on two factors, in our opinion. The first is acknowledging that rate hikes work on a lag, so the full effect on the economy may not be known for months or quarters. The second factor is the regional bank crisis, which may yet result in credit tightening that can serve as a headwind on economic activity and new investment. The April Senior Loan Officer Opinion Survey indicated banks are tightening lending standards, but it’s also worth noting that banks have been tightening for several months now, even preceding the bank stress. March’s failures did not notably accelerate that tightening, according to the April survey.11
Overseas, an economic resurgence in China post-zero-Covid has yet to materialize as investors initially hoped. China’s official purchasing managers index (PMI) for manufacturing activity fell to 48.8 in May, which indicates contraction. Services activity expanded, but we would note that May’s reading marked a deceleration from April’s and also the weakest reading in four months.12 We believe China also faces many structural problems that may be contributing to underwhelming growth, like a faltering property boom, a very high youth unemployment rate, and strained relationships with Western countries.
Sources
1. Bloomberg: SPX Index TRA
2. Credit Suisse: U.S. Return Composition – June 2023 pdf
3. https://www.wsj.com/articles/this-rally-is-all-about-a-few-star-stocksand-some-investors-are-worried-b64382e2
4. https://www.marketwatch.com/story/least-loved-treasury-bills-resemble-junk-bond-yields-on-debt-ceiling-anxiety-says-creditsights-3316abf1
5. https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2023
6. https://www.wsj.com/articles/a-debt-deal-that-doesnt-deal-with-debt-eef3e608
7. https://www.bls.gov/news.release/pdf/empsit.pdf
8. https://apnews.com/article/inflation-business-pandemics-jerome-powell-federal-reserve-system-01ca0f8ac5439f764827fb89d18a51e7
9. https://www.bloomberg.com/news/articles/2023-05-31/fed-s-jefferson-signals-pause-on-way-but-more-hikes-could-follow#xj4y7vzkg
10. https://www.bls.gov/news.release/cpi.nr0.htm
11. https://www.federalreserve.gov/data/sloos/sloos-202304.htm
12. https://www.cnn.com/2023/05/30/economy/china-pmi-economy-intl-hnk/index.html
As of May 31, 2023
