U.S. indices ended mixed this week, results varied widely, with the NASDAQ posting a 2.5% total return, the S&P 500 adding 0.3%, and the Dow slipping 1.0%. Sector performance was also mixed, as only technology, communication services and consumer discretionaries ended the week higher. Defensives and flight-to-safety sectors were some of the worst performers. Treasuries sold off again with the curve flattening, as the 2-year yield ended higher around 30 basis points this week. Strong results from selected information technology stocks lifted the NASDAQ to its fifth consecutive week of outperformance relative to the S&P 500 and the Dow. Over that five-week period, the NASDAQ gained 7.5%, the S&P 500 added 1.7%, and the Dow was down 2.1%. The technology-heavy Nasdaq Composite outperformed and ended the week up 23.97% for the year-to-date period—a stark contrast to the 0.16% decline of the narrowly focused Dow Jones Industrial Average over the period. Similarly, the Russell 1000 Growth Index ended up 20.75% over the period, while the Russell 1000 Value Index—heavily weighted in the struggling financials sector—was down 1.64%. Markets were scheduled to be closed on Monday, May 29, in observance of Memorial Day.
The yield of the 10-year U.S. Treasury bond rose for the second week in a row, climbing to the highest level in two and a half months. The 10-year bond closed around 3.80% on Friday—up from 3.46% a couple weeks earlier, but below the peak of 4.07% beginning of March. The dollar index ended the week higher.
Artificial intelligence has been a focus topic for the market in recent months. Given the heightened interest, more S&P 500 companies than normal have commented on “AI” during their earnings conference calls according to FACTSET. At the sector level, the Information Technology (38), Industrials (17), and Communication Services (15) sectors have the highest number of S&P 500 companies citing “AI” on Q1 earnings calls, while the Communication Services (75%) and Information Technology (66%) sectors have the highest percentages of companies citing “AI” on Q1 earnings calls.
According to published data, The Treasury General Account, which is the U.S. Treasury’s cash-operating account, continues to decline. Treasury Secretary Janet Yellen warned that it’s highly likely the government could run out of money as soon as June 1, reaching its “X date,” or the date at which the country reached the debt ceiling, and the United States can’t meet its financial obligations. We believe that there will be a deal to raise the debt ceiling and investors should ignore the noise and remain committed to their financial plan. The Wall Street Journal reported that the two sides were nearing a two-year spending deal that also extended the debt ceiling over the same period. Republican House Speaker Kevin McCarthy also told reporters that his White House counterparts were being “very professional, very knowledgeable.” According to analysts a range of negative and disastrous outcomes will evolve is U.S. defaults on its June 1 or June 6 Treasury bill maturities. Volatility would spike in equities and rates markets, with a period of sharp volatility in U.S. T-bill markets immediately. If the technical default continues, this will have a rolling effect. Another possible outcome of a default is that rating agencies would temporarily downgrade the U.S. sovereign rating until at least the default is resolved. The long-term impact to a U.S. government ratings downgrade may be higher rates on U.S. Treasuries going forward. Higher rates mean higher debt service costs, which ends government spending on several programs. Increased shareholder redemptions from nervous investors are certain.
Inflation gauge remains stubbornly high while consumers continue to spend. April’s Personal Consumption Expenditure Index rose more than expected by 0.8% month over month after rising by 0.1% in March. Consumer spending is up by 3.1% year over year over the past three months. This means that economic growth continues, boosted by resilient consumers. Consumers continue to spend their pandemic savings, keeping economic growth positive. However, we expect that the labor market will moderate in 2023 and that excess savings will decline, leading consumers to spend less throughout the year. Durable goods orders rose more than expected in April, also showing that the consumer remains resilient. Durable goods orders increased by 1.1% MoM, after rising by 3.3% in March. The increase was driven by transportation, as aircraft orders increased by 2.3% due to a surge in defense aircraft orders, while nondefense aircraft orders fell. Analysts expect consumers and businesses spending to slow down especially on durable good. Contrary spending is shifting from goods to services. The Q1 GDP (second reading) in United States increased more than expected by 1.3% quarter over quarter and by 1.6% year over year. The continued strength of consumer spending keeps growth positive, although some components of the GDP point to softer growth late in the year.
Shares in Europe fell on signs that the economic outlook may be worsening and continued uncertainty over U.S. debt ceiling talks. In euro terms, the European STOXX Europe 600 Index slid 1.59%. Major stock indexes also weakened. Germany’s DAX declined 1.79%, France’s CAC 40 Index dropped 2.31%, and Italy’s FTSE MIB tumbled 2.93%. The UK’s FTSE 100 Index lost 1.67%.
European government bond yields broadly increased on concern that central bank policymakers would extend their policy tightening due to persistent inflationary pressures. The yield on the benchmark 10-year German government bond settled above 2.5%. Spain’s and Italy’s sovereign bond yields also rose. A survey of purchasing managers compiled by S&P Global showed that business output in the eurozone grew for the fifth month running in May, although the pace slackened somewhat as weakness in manufacturing offset another strong month of services activity. European Central Bank (ECB) policymakers echoed ECB President Christine Lagarde’s view that interest rates would need to rise further and stay high to curb inflation in the medium term.
Elevated volatility is expected to continue in the Equity and Bond markets until there’s a meaningful decrease in inflation. We remain defensive in our positioning, and we’d look for opportunities to upgrade portfolios during market weakness. Within equities, we continue to favor U.S. Large Cap exposure, since China’s evolving COVID policies continue to weigh on manufacturing and growth. We prefer Developed International equities over US, as the energy recession wasn’t as severe as anticipated. There are always investment opportunities in the United States, large-cap equities provide an attractive blend of quality, yield and growth at a reasonable value, although at higher valuations. For fixed income, we remain defensive in our credit positioning and higher in credit quality.