A Month At A Glance
• Both equities and fixed income were positive (barely) in May—the first time since last summer
• US core bonds gained 0.6% in May, notching their first positive month this year
• A weaker dollar helped foreign equities outpace US stocks by a modest amount
• The Federal Reserve hiked the Fed funds rate by 50 basis points, marking the first hike of this size in more than two decades
After seven straight weeks of losses, US equities posted a strong gain in the final full week of May and eked out a positive month. It was the longest negative weekly streak since early 2001. The strong gain of 6.6% for the week ending May 27th propelled returns for the month into positive territory. The S&P 500 finished up 0.2% in May. Small-cap stocks matched the return of large-cap stocks. Value stocks outperformed their growth counterparts; the Russell 1000 Value index gained 1.9%, while the corresponding large-cap growth stock index fell 2.3%. Value stocks are more than seventeen percentage points ahead of growth stocks so far in 2022, making this the best start to a year for value relative to growth stocks (dating back to index inception in 1979).
Developed international and emerging-markets equities narrowly outperformed U.S. large cap stocks in May. The MSCI EAFE gained 0.7% in the month, bringing its year-to-date loss to 11.3%, which is ahead of the S&P 500’s negative return of -12.8%. Emerging-markets stocks were slightly positive, with a gain of 0.4% in May. Emerging-markets stocks have broadly the same year-to-date losses as developed markets. The year-long rally in the U.S. dollar paused in May, which helped returns for dollar-based investors in foreign markets. The dollar has surged more than 13% over the past year. This has been a headwind for investors in foreign assets with unhedged currency exposure. On the other hand, this is a great time to visit Europe.
Bonds rallied in May and posted their first monthly gain of 2022. The US core bond index returned 0.7%. The US Treasury yield curve continued to flatten during May but is far from inverted — a historical precursor to recessions, but with long and variable lead times. The 10-year rate fell from 2.99% at the beginning of the month to 2.85%. On the shorter end, the three-month Treasury rate rose above 1% for the first time since the onset of the pandemic. Floating-rate loans fell 2.6% in May—their worst month since March 2020. The negative returns for floating-rate loans were largely due to technical factors. Investors rotated into high yield bonds, which gained 0.25% in May, as they have seemingly become less concerned about rising inflation and rising interest rates.
On the topic of inflation, there is a growing consensus that the peak in US inflation is behind us. Headline inflation for April came in at 8.2%—down from 8.6% the month before. The month-over-month inflation reading also came down last month to 0.3% compared to 1.2% in March. Falling inflation expectations can be seen in the five-year/five-year forward inflation data (i.e., roughly speaking, what investors expect inflation to average in 2027 through 2031). The chart below shows inflation expectations have dropped sharply since late April. While there are signs that inflation is slowing, there is still uncertainty around where inflation will ultimately level off.
Falling inflation expectations can also be seen in the federal funds futures market. The Federal Reserve sets the fed funds rate. Over the past month, investors were putting nearly a 75% probability of the fed funds rate being 2.75%-3% or greater at the end of 2022. However, as the chart below shows, the bets have shifted and now place a 60% probability of a 2.5%-2.75% policy rate. Bonds have recently benefited from the narrative shift from surging inflation to a slowdown in growth. Slowing inflation and slowing growth could be a recipe for the Fed to pause rate hikes, or at least slow the pace at which they happen.
We did not make any asset allocation changes in the month. The drawdown in equity markets has us reviewing levels at which we would start to add to equities. The S&P 500 was bouncing right around the negative 20% level prior to a rally over past week. At that point, the expected return hurdle for us to add to US equities was not yet high enough.
Certain material in this work is proprietary to and copyrighted by Litman Gregory Analytics and is used by Argent Financial Group with permission. Reproduction or distribution of this material is prohibited, and all rights are reserved. Argent Financial Group is the parent company of Argent Trust, Heritage Trust and AmeriTrust.