Markets stabilized in May after one of the worst months since the start of the pandemic. While it wasn’t a great month, after the terrible start to the year, any improvement was welcome. U.S. markets were mixed, with the Dow and S&P 500 up slightly, while the Nasdaq was down but not nearly as much as in prior months. International markets and fixed income also showed small gains.
Looking Back
Interest rates. Once again, interest rates drove the markets, but this time, the news was good. As expected, the Fed hiked the federal funds rate by 50 bps at its May meeting. But the markets started to pull back from expectations of future hikes, signaling that inflation was starting to peak. Long-term rates ended the month at about the same level after peaking in the middle of the month, and that stabilization helped support markets.
The economy. We also saw signs that the economy, though softer, was stabilizing in May. All of the key metrics—job growth, consumer spending, and business investment—remained healthy. And while there were some signs of softening, especially in consumer confidence and housing, they did not appear to have affected the fundamentals.
Risks abroad. Finally, just as the inflation and economic worries pulled back, other worries started to moderate as well. The Ukraine war receded from the headlines as it turned from an immediate concern into a chronic one. Chinese Covid-19 shutdowns, and the risks to the supply chain, have not materialized and look like they will not. Across the board, the fears that drove the pullback at the start of the month have started to fade.
So looking back at May, we saw stabilization in the economy and markets, and, most importantly, in expectations. After seeing the markets react to rising worries at the start of the year, those worries started to moderate in May.
Looking Ahead
Economic health. June will likely see continued improvement moving forward, and the economic news remains positive. The good news from May should continue throughout this month, just as we saw with the most recent jobs report. This will also drive continued positive earnings growth, which outperformed expectations in the first quarter.
Inflation and rates. The primary headwinds to the economy and the markets (i.e., inflation and rising interest rates) seem to be pulling back a bit. Inflation is showing signs of starting to roll over, and the Fed is indicating that the market has gotten ahead of itself on its expected rate increases. June is unlikely to see a reversal of those headwinds—inflation remains high, and the Fed is still committed to raising rates. But as the worries start to moderate, the effects are projected to be less going forward.
Valuations. With the economy solid and worries starting to moderate, we should see valuations remain stable, too. The start of the year saw valuations drop to levels typical before the pandemic but then hit the bottom of that range in May. With valuations seemingly stabilized, we may see recovery both in valuations and appreciation as expected earnings growth is factored in. Higher interest rates meant lower stock prices at the start of the year, but as painful as this was, the stabilization in May has set the stage for growth to resume in June.
That’s not to say we will not see more turbulence this month—inflation and interest rates could rise further, Covid-19 could surge again, and the Ukraine war could expand. And when and if those bad things happen, we will see more market volatility. So as always, the headlines will drive short-term market performance.
A Stable Foundation
Despite the headlines, fundamentals drive the economy and the markets, and both began to stabilize in May. This process will likely continue in June. We are moving in the right direction, and the fundamentals remain sound.
And that is the bottom line here. We started May with the fear that many bad things could happen, but what we actually saw was that these issues were not as bad as initially feared. As we move into June, while we may have several fears, those fears are a much better reflection of reality than they were in May. This is real progress.
May was the month when markets started to stabilize around the new conditions of inflation and rates. As such, we saw more stability and potential for growth. Overall, we are entering June in a better place than we were a month ago. And while we have seen substantial volatility and may see more, this provides a good foundation going forward.
© Commonwealth Financial Network
Read more commentaries by Commonwealth Financial Network
