Solid economic data continued to prevail during May with employment, manufacturing, and inflation numbers all pointing to strength and expansion. Labor market strength remains, as jobless rates were lower in April than a year earlier in 306 of the 389 metropolitan areas, and the unemployment rate continues to fall for every major demographic. While the ISM Manufacturing index declined to 52.8 it remained in expansionary territory. Inflationary pressures continue to be non-threatening, despite the economic expansion, with consumer prices rising a relatively benign 2.1% over the past year. Nevertheless, market participants found much to worry about, with most concerns centering on foreign trade. Tariffs moved to the forefront of the economic discussion as Chinese trade negotiations stalled and the threat of new tariffs on Mexico were unleashed. While the economy is still strong it has lost part of its robustness, and investors see some vulnerability to continued expansion. This perception of vulnerability is clearly exacerbated by the potential negative impact of new tariffs and slowing trade. As a result, recessionary fears have increased and expectations for Federal Reserve policy have moved toward easing. The reaction of financial markets to these events have been fairly predictable, with equity markets selling off and most fixed income investments posting strong returns.
Equity markets reversed course in May as investors changed focus to the potential negative impact of trade relations, including new tariffs on Mexican imports. All major equity indices posted negative returns for the month, with the S&P 500 losing value four consecutive weeks for the first time since 2011. However, given previous strength, year-to-date returns remain in positive. The NASDAQ index, despite losing 7.78% for the month, continues to lead equity market returns at 12.86% year-to-date. Nearly all sectors suffered losses in May with Real Estate as the only exception. Real estate achieved a positive 1.16% monthly return and was joined by the traditionally defensive sectors of Utilities and Health Care (-0.77% and -2.36% respectively) as the best performing sectors.
Bonds became more attractive in May as investors sought safety from the volatility and potential downside of stocks. Most areas of the bond market participated in this shift in sentiment, posting positive returns for the month. Rationally deviating from this flight to safety were high yield bonds, whose returns usually track closer to stocks, posting a –1.27% return. However, all bond indices remain positive for the year. Bond investors have now started to price Fed policy easing into prices with a 50% chance at the Fed’s September meeting and more than an 80% chance of at least one cut by December. The yield curve became inverted with 3-month T-bills now yielding 2.34%, 22 bps more than a 10-year treasury note. This inversion typically signals recessionary expectation.