May Market Review and June Market Outlook

Last Month in the Markets – May 1^st – 31^st, 2023

What happened in May?  

Last month saw divergence among major North American equity indexes. The NASDAQ gained more than Canada’s TSX lost, plus 6% against minus 5%.  The S&P 500 and the Dow delivered performance with a gap of nearly 4%, plus .25% versus minus 3.5%, respectively.  The markets were weighted down by negative factors over the course of the month, such as a shift in investor expectations to a more hawkish path of the US interest rates and the risk of a negative economic shock from the U.S. debt ceiling situation. This was counterbalanced by positive momentum for a basket of technology stocks concentrated in the NASDAQ, based on the potential for Artificial Intelligence (A.I.) to give a boost to company profits.

May concluded with the passage of the debt ceiling bill in the U.S. House of Representatives showing a step forward in keeping the US government operating and allow the U.S. Treasury to meet its obligations. Several other influential events occurred:

• May 3^rd – U.S. Federal Reserve increased its federal funds rate by .25%. The meeting minutes of the Federal Open Market Committee indicated that the decision was not unanimous. Equities dipped temporarily on recession fears. https://www.federalreserve.gov/monetarypolicy/fomcpresconf20230503.htm

• May 5^th – Equities recovered quickly from the Fed’s rate increase when Canadian and U.S. jobs data was released. Employment rose by 41,000 and 253,000 in April respectively, and unemployment remained unchanged in both countries at 5.0% and 3.4%.  The strength of the jobs market showed that a recession was not immediately on the horizon.  https://www150.statcan.gc.ca/n1/daily-quotidien/230505/dq230505a-eng.htm?HPA=1&indid=3587-2&indgeo=0 https://www.bls.gov/news.release/empsit.nr0.htm

• May 10^th – April’s inflation report was released showing it had not responded to interest rate increases as much as needed but had not gotten too much worse either. As a result, markets held steady. 
  •  U.S. consumer inflation rose 0.4% in April and 4.9% on a year-over-year basis.  Shelter was the largest contributor to the monthly increase, followed by vehicle and gasoline prices. https://www.bls.gov/news.release/cpi.nr0.htm
  • May 16^th – Canadian inflation rose more in April at 0.7% for the month and 4.4% for the year.    https://www150.statcan.gc.ca/n1/daily-quotidien/230505/dq230505a-eng.htm?HPA=1&indid=3587-2&indgeo=0

• U.S. debt ceiling negotiations continued throughout the month and became increasingly concerning for markets during the second half, as the deadline to avert a crisis approached.  Over the last weekend of May, a deal was agreed by Biden and McCarthy.  Over the next three days the legislation, entitled The Fiscal Responsibility Act, was debated, and passed in the House. It then fast-tracked through the Senate, which passed it at the beginning of June.  https://www.cnbc.com/2023/06/01/debt-ceiling-bill-updates.html

As the US market seemed to show resilience in May, it is important to note that gains were primary concentrated in a few companies, while the broad-based market, including small caps underperformed. This dynamic is also seen in the year-to-date results, which show that without the high weightings of Apple, Microsoft, Google, Amazon, Nvidia, Tesla, and Meta in S&P 500 index, it would be tracking a negative return so far this year. While the prospects of AI look promising in the long term, the level of optimism priced into the valuations of these companies, especially against the divergence of continuing contractionary monetary policy and the rest of the market, is something to remain cautious about.

Internationally, a poor global manufacturing backdrop has given data showing that China’s post-lockdown recovery is slowing. In Europe, the tighter monetary policy narrative saw another interest rate increase of .25% in May by the European Central Bank. The Region performed poorly last month stemming from the uncertain global economic backdrop and the continued rate hikes. However, low valuations in Europe are providing a stronger base for asset price bottoms. CNBC CNBC

What’s ahead for June and beyond in 2023?

Now that the U.S. debt ceiling crisis has been avoided, markets will return to their usual priorities, inflation, interest rates, economic growth, and the linkages between them.  AI hype might continue but as valuations are currently stretched because of it, continued momentum will hinge on a high barrier of continued good company reporting.  

Inflation has stopped growing but it is remaining much higher than the 2% annual rate targeted by Canadian and American central banks. A big part of inflation stickiness has come from the heated labour market, which as shown recent signs of softening. The US May employment report showed an increase in the unemployment rate by .3%, bringing it to a 7^th month high of 3.7%. Although this trend is not defined enough to draw any long-term conclusions, it will help the case for a rate pause at the next Federal Reserve meeting. Employment Report

Ultimately, the recessionary pressure is starting to work its way into the economy and will progress, especially if interest rate increases continue. We will gain further insight to the North American central bank positioning in the middle of June, when the next two opportunities to adjust interest rates will arise, June 7^th in Canada and June 14^th in the U.S.

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