Thanks for tuning in to our Monthly Market Moment for May.
Financial markets continue to be choppy, as a confluence of a slowing economy, changing monetary policy, and banking sector fears drive volatility. Nevertheless, we’ve seen a healthy bounce from year-end levels due in large part to a decline in long term interest rates as the Federal Reserve likely nears an end to its current hiking cycle. Rising interest rates were the primary driver of lower levels in 2022, so the recent reversal in yields is likely to help to remove one key headwind going forward.
However, this development has come in hand with jitters in the banking sector, which has driven flight to quality in the market. As we wrote previously, we have been closely watching the bank developments and are encouraged by the quick and concerted action of the government and large national banks to stave off a broader contagion. While some smaller and midsized institutions continue to struggle, the largest banks with the strongest balance sheets are proving to be an important source of stability. This is helping to prevent a systemic crisis from developing as a necessary flushing out of risks in the regional banking sector plays out. We remain very confident in the resilience of the banking sector more broadly.
A separate reason for the decline in long-term interest rates is a slowing economy. GDP growth in the 1st quarter came in at 1.1%, less than half the rate of the 4th quarter, and a weakening of manufacturing data and commodity prices such as oil, offer further evidence that a slowdown is underway. Retail sales are also weakening as consumers cut back on big expenses. While the Fed’s tightening was quick to impact commodity and interest rate driven sectors such as Real Estate, the Services side of the economy, where most jobs exist, has been quite resilient. With Services accounting for three-quarters of GDP, this dynamic has continued to drive labor demand even as the Fed sought to constrain it. This is particularly important as wages are a feeder into broader inflation dynamics.
However, after months of being surprised by strong labor data, the jobs market has finally seen some signs of a slowdown as well. The April jobs report showed 253,000 jobs added, half the value of the January report, with wage growth of 4.4%, nearly a two-year low. This follows a Jobs opening report which showed the number of unfilled jobs in the economy shrinking to the lowest level since 2021. Critically however, these data show an economy that is actually still quite healthy and expanding, but just at a more reasonable pace. This is exactly what the economy needs to stabilize and what the Fed is working to achieve.
As we approach mid-year, a key question for the markets will be whether this slowdown is adequate to get inflation under control without triggering a large recession. While the Fed is finally seeing some success here, this is coming at the expense of earnings, which are now down on a year-over-year basis. This suggests the Fed’s window to engineer a ‘soft landing’ is closing but may not yet be shut.
The underlying health of the labor market is reason for optimism on this front, as well as suggesting that if we get a recession it could very well be a light one. Recessions typically see a surge in unemployment, and we just aren’t seeing that. The unemployment rate has actually ticked back down to a near record low. Earnings are also coming in better than expected, with the majority of companies in the S&P 500 beating estimates in the 1st quarter and with a beat rate of 6.9%, well above the long-term average. So while earnings are indeed pressured, the gradual lowering of guidance and bearish sentiment generally in the market is helping to create some supportive conditions for stocks going forward, particularly in the light recession scenario.
Lastly, this highlights an important lesson in investing, which is that the economy and the market are not the same thing. Markets are always looking ahead, so to the extent the economic slowdown doesn’t surprise the market, stocks are likely fairly priced. This bear market is already notable in that it has been 7 months since the recent low. Looking at the last dozen times a bear market went this long without setting a new low, the market was higher every time but once, 6 months later, and with an average gain of 9% to boot. While the past in no means dictates the future and we remain in a period of high uncertainty, these are data that are supportive of staying the course.
We will continue to monitor these changing economic conditions and remain vigilant for opportunities to add value in portfolios. We welcome your questions and comments and wish you and your families well. Thank you for watching.