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Monthly Market Commentary - May 2023

Jon Adams, Chief Investment Officer

The month of May began with a bang, with the announcement of JPMorgan’s takeover of First Republic Bank, the latest in a series of regional bank troubles. From there, the wild ride for markets continued, with rapidly changing Fed expectations combined with contentious debt ceiling negotiations.

For the month, the S&P 500 Index finished up modestly (+0.43%), while US bonds (measured by Barclays Aggregate Bond Index) were down about -1.1%. The US Dollar rallied about 2.5% vs. a broad basket of currencies, driven by real interest rate differential vs. other currencies as well as macro risks.

Below, we focus on three key themes that influenced markets during the month.

Let’s Make a Deal

Winston Churchill once famously observed that “Americans will always do the right thing, only after they have tried everything else.” While this was meant as a backhanded compliment, it has some similarities to the recent debt ceiling negotiations. Investors came into May fearing the unfathomable, a US default, and considering how to position portfolios under such a dire scenario. Thankfully for investors, cooler heads appear to have prevailed and Speaker McCarthy and President Biden were able to broker a deal between their respective parties just before the June 5 “X date,” when the Treasury Department would have no longer been able to pay all of its obligations in full and on time.

The bill set the course for federal spending for the next two years and suspended the debt ceiling until January 1, 2025, which importantly falls after the next presidential election. Also included in the bill are more stringent work requirements for certain adults receiving food stamps, a reduction in IRS funding, a claw back of some Covid-19 relief funds and a restarting of student loan repayments. The nonpartisan Congressional Budget Office estimated that the bill would cut the deficit by $1.5T over 10 years.

As of this writing, the bill was passed by the House, but still needs to pass the Senate and be signed into law by President Biden, though these steps appear highly likely.

Hike, Pause or Cut?

The US Federal Reserve raised its target rate to between 5% to 5.25% on May 3. This marked the 10th consecutive rate increase since the Fed began its aggressive hiking cycle in March of 2022. The key question following the May meeting was whether it marked the beginning of a pause from the Fed, or if the bias toward hiking further would be maintained.

Market expectations for the Fed took a roller coaster of a ride during the month. Immediately following the Fed meeting, the market implied no more rate hikes and about 0.8% of rate cuts before the end of 2023. By the end of May, the market implied probabilities of one more 25 basis points rate hike this summer, followed by 1-2 rate cuts before the end of the year.

Additional inflation data are due just before the Fed meeting on June 14 and will play a large role in the Fed’s decision, along with employment data due on June 2. While inflation has slowed considerably in recent months, it remains well above the Fed’s target while the employment market has yet to show clear signs of the sharp slowdown many economists have been projecting. Until this dynamic changes, we feel that the Fed’s bias will be to keep rates more restrictive than what the market expects.

Hold Your Breadth

While US stocks have fared well in the first few months of the year, the gains have been overwhelmingly driven by a handful of mega-cap technology stocks, leading investors to question the durability of the moves. Nvidia garnered most of the attention during the month, posting a blowout earnings report combined with an exceptionally strong revenue forecast, becoming just the ninth company globally to achieve a market capitalization of $1 trillion. The exceptional performance of this handful of names has been driven by enthusiasm behind Artificial Intelligence as well as conflicting economic forces that we referenced earlier, leading investors to seek perceived relative safely in these sizeable firms.

With the rapid cycle of rate hikes, markets are no longer being fueled by easy money. Monetary policy divergence, financial stress and geopolitical tensions could usher in a new period of opportunity for stock pickers and asset allocators. In light of these factors, we expect markets to be more “alpha” driven than “beta” driven in the medium term and feel that active management should prove its mettle.

Should you have any questions or concerns reach out to your Advisor or any member of your Calamos Wealth Management team to further discuss your personal situation.

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