- As widely expected, the Fed raised its federal-funds rate for a tenth consecutive time with a quarter point hike that put the benchmark interest rate in a range of 5%-5.25%. The Fed signaled they might be ready to pause raising rates now in what was a fairly dovish post-meeting statement.
- Markets were mixed during the week, with stocks and bonds little changed for the week. The S&P 500 and Russell 2000 fell -0.8% and -0.5%, respectively, although the Nasdaq was able to eke out a barely positive +0.1% weekly gain.
- The Treasury yield curve steepened as front-end yields fell while longer term yields were up. The steepening yield curve reflects the more dovish Fed with the 2-year Treasury yield down -9 basis points (bps) for the week, while the 10-year Treasury yield gained +1 basis point.
Bank turmoil returns, US stocks and bonds slip
Stocks started the week, and the month of May, with four straight losing sessions before snapping the streak on Friday. Weakness in regional banks had led to a broad move lower to start the week as investors began the week with the news that another bank had failed. Before the start of trading on Monday morning U.S. regulators announced that JPMorgan Chase would acquire First Republic Bank, which wasn’t able to escape the turmoil that overcame regional banks in March. Anticipation for the Federal Open Market Committee (FOMC) rate decision also weighed on stocks. Despite First Republic’s failure, the FOMC ultimately stuck with the expected quarter point increase in the Fed’s benchmark interest rate on Wednesday afternoon. It was the tenth consecutive rate hike and puts the federal-funds rate in a range of 5%-5.25%, up from near zero just a little over a year ago. That’s the most aggressive series of increases since the 1980s, and the highest level for interest rates since the Great Recession of 2008. The Fed signaled they might be ready to pause raising rates now. The post-meeting minutes were altered to remove a line saying that “some” additional hikes “may” be needed and instead, said its actions would be dictated by “the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Overall, the new statement was dovish in tone, although in his post-meeting press conference Fed Chairman Jerome Powell reiterated that the Fed is determined to tame high inflation. Still, the KBW Regional Banking index sank nearly -3% on Thursday, hitting its lowest level since November 2020. However, Friday brought a relief rally with an unexpectedly strong April jobs report, as well as a solid earnings report by Apple. Nonfarm payrolls had the best monthly gain in job growth since January helping to fuel Friday’s relief rally. Regional bank shares rallied +4.7% on Friday but were still down -8% in the brutal week. Friday’s rally also wasn’t enough to overcome the weekly losses for the broader market indices. The S&P 500 and Russell 2000 fell -0.8% and -0.5%, respectively, although the Nasdaq was able to eke out a barely positive +0.1% weekly gain.
The European Central Bank (ECB) also met this week and hiked rates by a quarter point to 3.25%, a slower pace than its recent half-point hikes. Additionally, the ECB announced it will speed up its balance sheet runoff beginning in July. Non-US stocks managed to eke out gains even with the ECB tightening. The MSCI EAFE Index, which represents developed market stocks, was just barely positive with a +0.04% gain, while the MSCI Emerging Markets Index rebounded +0.5% for the week.
Bonds also struggled during the week as the Treasury yield curve steepened with front-end yields dropping while longer term yields were up. A steepening yield curve reflects the more dovish Fed with the 2-year Treasury yield down -9 basis points (bps) for the week to end at 3.91%, while the 10-year Treasury yield gained +1 basis point to finish at 3.44%. For the week the Bloomberg US Aggregate Bond Index slipped -0.1%. However, non-US bonds were up, with the Bloomberg Global Aggregate ex US Bond Index gaining +0.3%.
Chart of the Week
The April Employment Report showed strong headline numbers, but the details were mixed. Nonfarm Payrolls expanded by 253,000, much better than the expected 180,000 by Wall Street economists. And the Unemployment Rate unexpectedly ticked lower to 3.4% from 3.5% in March, tying the lowest level since the early 1950s, versus the forecast for it to tick up to 3.6%. However, digging beyond the headline numbers showed big downward revisions in previous months as February and March were revised down by a combined 149,000. With those negative revisions, the three-month average rate of growth is now 222,000 jobs, which is the lowest reading level since January 2021. Moreover, the birth/death adjustment added a massive 378,000 jobs to the April tally, the second largest increase from the model on record (only last October had a higher statistical adjustment). The birth/death model has added 1.84 million jobs since last March, or +43% of all new payrolls during the period. For the month, construction, manufacturing, and finance payrolls all rebounded from a small decline in March. The prior month construction jobs declined for the first time since January 2022 and manufacturing jobs increased by 11,000 in April, 16,000 more than expected after March was revised down 7,000. Finance-related payrolls gained 23,000 payrolls, the strongest month in a year. Month-over-month Average Hourly Earnings came in higher than expectations at +0.5%, up from +0.3% the prior month where they were expected to remain. Hourly wages also ticked up on a year-over-year basis, to +4.4% from 4.2% where they were expected to stay. Labor-Force Participation was unchanged, as expected, remaining at 62.6%.
Jobs Juggernaut Is Slowing After Negative Revisions
Nonfarm payrolls, monthly change (3-month moving average)
Note: Seasonally adjusted.
Source: Labor Department.
- The Institute for Supply Management’s (ISM) Manufacturing Index rose to 47.1% in April from a three-year low of 46.3% in March, beating expectations for an improvement to 46.8%. Still, that represents the sixth consecutive month that U.S. manufacturing activity has contracted (levels below 50% signal economic contraction). The last time the index was below that threshold for more than six months was between March 2008 and June 2009 — during the Great Recession. Most of the individual components improved, but they also remain largely in contractionary territory. New orders, production, and employment all increased, but employment was the only one to move out of contraction territory. The prices paid index rose back into the expansionary territory after turning negative in March, which is an unwelcome trend for future inflation.
- The ISM Non-Manufacturing Index for April improved to 51.9% from 51.2% in March, in line with expectations. The line between expansion and contraction is 50.0%, so the April reading reflects continued expansion in the services sector at a slightly faster pace than the prior month. New Orders rose +3.9 points to 56.1% from 62.6%. The Production gauge fell -3.4 points to 52%. The Employment Barometer slipped -0.5 points to 50.8%. The Prices Index, a measure of inflation, was unchanged at 59.6%.
- The seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index (PMI) rose to 50.2 in April, up from 49.2 in March, a bit below the earlier released ‘flash’ estimate of 50.4. It’s the fourth straight monthly rise for the index and the first reading to signal expansion (levels above 50 indicate economic expansion) in six months. The improvement was driven by strength in production which increased at the fastest pace since May 2022. For those watching inflation, the report saw input costs rise at the sharpest pace in three months, while selling prices also increased at an accelerated rate.
- The S&P Global US Services PMI improved to 53.6 in April from 52.6 in March and was broadly in line with the flash estimate of 53.7 which is also where expectations were. The rate of expansion was the sharpest for almost a year. The rate of job creation was the fastest since last August and firms were also more upbeat regarding the year ahead outlook.
- March Factory Orders rose +0.9%, an improvement from February’s downwardly revised -1.1% contraction (originally -0.7%) and -2.1% decline in January, but below expectations for a +1.2% gain. Like last month though, the gains were carried by strong airline orders. Factory Orders Excluding Transportation slid -0.7% in March. Durable-Goods Orders rose +3.2% in March, in line with expectations and the unrevised initial estimate last month (durable goods are released ahead of the full report). Core Capital Goods Orders (nondefense capital goods excluding aircraft), a proxy for business spending, fell a revised -0.6% in March, below expectations and the prior reading which were both -0.4%. Orders for Nondurable Goods fell -1.4% in the month.
- The March Job Openings Labor Turnover Survey (JOLTS) report again showed a sharper-than-expected decline in job openings. At 9.6 million, job openings are deteriorating at a rapid clip, having fallen by about -2.5 million over the last year and are at the lowest level since April 2021. The Hiring Rate held steady at 4% and has been little changed in recent months as firms still look to fill open positions, but year-over-year hiring rates have slowed and are now very close to pre-COVID levels. In another sign that the labor market is cooling, the Quits Rate edged lower to 2.5%, the lowest point since February 2021, and has nearly reversed all their pandemic gains.
- Growth in Consumer Credit accelerated in March, rising to $26.5 billion in March, the fastest pace in four months, and far above expectations for an increase of $16.8 billion and February’s $15.3 billion gain. Growth for revolving credit, which includes credit cards, jumped $17.6 billion — the largest monthly increase in over a year. Nonrevolving credit, which includes auto and school loans, was up $8.9 billion. The data does not include mortgage loans, which is the largest category of household debt.
- April U.S. Light Vehicle Sales rose for an eighth straight month to a seasonally adjusted 15.9 million, beating expectations of 15.1 million, and March’s 14.8 million.
- The Commerce Department reported Construction Spending was up +0.3% in March to a seasonally adjusted annual rate of $1.83 trillion, beating expectations for a +0.1% rise and above February’s negatively revised -0.3% drop (originally reported as -0.1%). Year-over-year (YoY), total construction spending was up +3.8%. The March increase was driven by non-residential construction, which was up +0.7% for the month—the ninth gain in the past 10 months—and up +18.8% YoY. Residential construction fell -0.2% in March—the 10th straight monthly decline—and was down -9.8% YoY. Public construction was up +0.2 after a +1.1% gain in February and was led by substantial growth in educational- and commercial-related expenditures.
- The weekly MBA Mortgage Application Index fell -1.2% for the week ended April 28, following a +3.7% rise the previous week. The index has now oscillated between positive and negative readings for six straight weeks. The Purchase Index fell -2.0% compared to a +4.6% rise the prior week and the Refinance Index rose +0.8% following a +1.7% gain the prior week. The increase came as the average 30-Year Mortgage Rate slipped -5 basis points to 6.50% and put the 30-year fixed rate up 1.14 percentage points versus a year ago.
- Weekly Initial Jobless Claims rose by +13,000 to 242,000 for the week ended April 29, almost wiping out the last two week’s gains, above expectations for 240,000. The prior week was revised down to 229,000 from the originally reported 230,000. The number of people already collecting unemployment claims (i.e. Continuing Claims) fell by -38,000 to 1,805,000 in the week ended April 22.
The Week Ahead
After last week’s deluge of data, the economic calendar is fairly light this week. The headliners are consumer and wholesale inflation with the CPI and PPI reports on Wednesday and Thursday. Friday also brings inflation data with import prices and the inflation expectations components from the University of Michigan Consumer Sentiment report. On Tuesday, top Democrats and Republicans will meet for talks over raising the debt ceiling borrowing limit. The first quarter earnings season is winding down, but some of the firms still left to report this week include Tyson Foods, PayPal, Electronic Arts, Airbnb, Occidental Petroleum, and Walt Disney.
Did You Know?
TRADING PLACES – In the first four months of 2022, the three worst-performing sectors in the S&P 500 were Communication Services, Consumer Discretionary, and Technology, all of which were down -18% or more. Through the first four months of 2023, these three sectors were the year’s best performers, with each one rallying at least +14% (Source: Bespoke Investment Group).
TECH INEQUALITY – Mega cap tech is trouncing small cap tech. The S&P 500 Technology sector was up +25.5% year to date through 5/5/2023 compared to a gain of just +3.1% for the Russell 2,000 Technology sector. The median market capitalization of the S&P 500 Tech sector company is about $9.3 billion, while the median Russell 2000 Tech company only has a market cap of about $325 million, or $9 billion smaller than the median S&P 500 tech company. That sector size discrepancy is about two times bigger than the next largest sector discrepancy (Health Care). Over the last five years, the S&P 500 Technology sector is up +138% compared to a gain of just +30.7% for its Russell 2,000 counterpart (Source: Bespoke Investment Group, Bloomberg).
SUFFICIENTLY SUPPLIED – Supply chain constraints continue to ease. The New York Fed’s Global Supply Chain Pressure Index (GSCPI) measures the state of global supply chain issues. In April, the index fell to -1.32 standard deviations below its historical average to the lowest reading since November 2008, showing that the disrupted state of global supply chains has been mostly resolved (source: NY Fed, Bespoke Investment Group).
This Week in History
BRUSSELS SPROUTS THE ECB – On May 2, 1998, the European Central Bank (ECB) was founded in Brussels with the goal of defining and executing the European Union’s monetary policy. Much like the Federal Reserve in the U.S., the ECB’s primary objective is to ensure that the inflation rate is kept below, but close to, 2% over the medium term, and additionally to oversee the financial stability of the Eurozone. The ECB’s establishment paved the way for the introduction of the Euro currency, on January 1, 2002, which replaced the national currencies of 19 of the 27 EU member states (source: Hedgeye Risk Management, The Retrospect).
Asset Class Performance
The Importance of Diversification. Diversification mitigates the risk of relying on any single investment and offers a host of long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.
Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.