As expected, the broad market took a breather during the month of May. The S&P was mildly productive, relative to the previous months, posting a gain of .61%. The bond market reversed course and posted a monthly gain of .33%, though still down over 2% year-to-date. The tech-heavy NASDAQ 100 (QQQ) slipped 1.2%, and the small cap Russell 2000 landed in the middle with a .3% gain. Large cap growth (RPG) slipped 1%, while large cap value (RPV) was again the standout, gaining 4.8% on the month.
MARKET DRIVERS
Inflation was again the talk of the market, but it appears that the market is digesting higher consumer price Index (CPI) numbers better than the higher inflation readings earlier in the year. The May CPI report showed another spike in inflation to levels not seen in over 20 years. Even with that data, reactions in the bond and stock markets were muted, pointing to the possibility that the market is okay with higher inflation, even if the Fed suggests that inflation is “transient”. Time will tell.
The other market driver was whether and when the Fed would be letting up on the gas and reducing its bond purchases, start to raise rates, or both. The Fed wants inflation to run a little “hot” but needs to be careful that inflation does not run away to the point where it becomes a hidden “tax” on the consumer.
From an economic activity standpoint, demand for goods and services is brisk, but supply constrains that have developed from COVID-related shutdowns, increasing manufacturing, and global shipping challenges are further driving up prices. Finally, the April Jobs report indicated that many businesses, particularly in the service sectors, are finding it difficult to adequately staff their operations, further straining the supply and demand imbalance. For now, demand is in control, which should bode well for the stock market.
PORTFOLIO ADJUSTEMENTS
May was a relatively busy trading month, having made our seasonal rebalance back to target all core equity positions, as well as a general rotation back to a more value-oriented posture. Early in May we reduced our sizable S&P 500 position and moved down the capitalization schedule by purchasing a mid-cap blend fund (IJH). The second week we further reduced our S&P exposure and purchased the S&P Pure Value ETF (RPV). The third week we exited the Quality factor fund (QUAL), capturing a 3% gain, and repositioned the proceeds to the Value factor fund (VLUE) we had sold in April. For those clients whose accounts we managed prior to 2017, the Guggenheim 3-7 year corporate bond trust had a sizable principal distribution (around 8%) as a result of two issues maturing. Those proceeds were re-invested in a preferred and income securities ETF (PFF), providing more equity correlated exposure to a portion of the fixed income sleeve. Overall, our allocation is once again overweight value after taking a brief pause in April. Value continues to be the more productive side of the style box since November 2020 and has continued to show greater productivity than growth.
LOOKING AHEAD
Typically, during the summer months, trading volume is lower than average. This has the potential to increase the day-to-day volatility in the securities markets, as each participant has a greater impact relative to a higher volume environment. However, we are of the opinion that given the pace and trajectory of the reduced COVID transmissions, social distance mandates being removed, more people getting out and about during the summer, many of whom will be mask free and flush with cash from reduced spending over the past 18 months, the market will likely grind higher. Pent up demand will likely drive prices higher and supply lower, perhaps enabling companies to increase their sales prices and thus revenue, which would naturally result in higher earnings. Should the Q2 earnings season confirm continued growth in revenue and earnings, the market has the potential to continue to move up and to the right.
We wish you a pleasant start of the summer and hope you have made some plans to spend time with your friends and loved ones and engage in activities that bring you joy and pleasure.
