U.S. Equities Higher in May
It was another positive month for U.S. stocks as the large company S&P 500 index flirted with its all-time highs. It was up 1.8% on a total return basis on better economic data. It’s climbed 3.6% year to date (YTD).
Small and midcap equities also gained ground with midcaps leading the way up 2.3% over the month and 7.5% YTD. The S&P REIT index that proxies the returns from commercial property gained 2.2% and has posted 5.9% YTD gains.
U.S. Treasury and investment grade bond returns were flattish over the month. The ten year Treasury closed to yield 1.85%.
Global equities performed poorly in U.S. dollar terms as the greenback strengthened. Emerging market equities gave up most of their YTD outperformance losing 3.7% in May while the more developed EAFE countries posted a loss of 0.9%.
Broad commodity indices were range bound in May but remain up almost 9% so far this year. Oil ended the month close to $50 a barrel. Recall it began the year at $37 and dipped to $26 in February.
Brexit and the Federal Reserve
Do you remember the Neil Sedaka song Breaking Up Is Hard To Do? Here are a few lines that would seem to mirror the European Union’s plea as Great Britain decides whether to stay or leave the common market.
I beg of you don’t say goodbye
Can’t we give our love another try?
Come on, baby, let’s start anew
Cause breaking up is hard to do
The vote is June 23, just three days after the Fed meets to decide on U.S. interest rate policy. While the betting markets put the chance of Brexit at 30%, recent polling suggest it is much closer. Questions of sovereignty and Britain’s place in the world are at the heart of the matter. The economic and financial consequences of Britain leaving the EU would certainly be disruptive in the short term and add to uncertainty.
Analyst George Friedman thinks this is part of a trend as nation-states reassert themselves and rebel against supranational organizations like the EU, IMF, and multilateral trade treaties that are seen as not being in the national interest.
Many thought the Fed might hike interest rates in June. That idea is probably mute now given the weak May employment data released last Friday. While the unemployment rate fell to 4.7% (mainly because 458,000 people dropped out of the labor force) only 38,000 new jobs were created compared to the 200,000 or so monthly average over the past year.
Despite the report, the labor market is tightening. Average hourly earnings were reported up 2.5% from a year earlier and real wages have finally surpassed their 2009 peak. The recent Verizon settlement will give workers a cumulative 17% increase over four years, which works out to 4.3% a year. Not bad for workers in an intensely competitive industry. Labor’s share of corporate revenue is increasing at the expense of profit margins. That partly explains the lack of earnings and modest gains in stocks over the past 12 months.
It is always difficult to differentiate between “noise” and “signal” when looking at monthly data that is subject to revisions. U.S. economic indicators had been generally good recently so we think the employment report is probably noise. The widely followed Atlanta Fed’s “GDPNow” model forecasts a solid 2.5% growth in the second quarter.
We remain broadly diversified in light of modest global growth, low inflation (it is percolating in the U.S.) and middling valuations across most asset classes.
Jeff Pantages, CFA®
Chief Investment Officer