Highlights:
- Despite ongoing tariff tensions, markets rebounded in May, with the S&P 500 rising 6.3%, as investors grew desensitized to trade headlines and legal rulings on tariff authority.
- A proposed spending bill, facing Senate resistance due to its projected $3.8 trillion deficit increase by 2034, showed some alarm in the bond market, with longer-term Treasury yields rising.
- Overall economic activity remained steady, though signs of weakness emerged in consumer spending and capital investment, with AI-related infrastructure being a key exception.
- While corporate earnings were generally positive, investor sentiment was tempered by inflation risks, delayed Fed rate cuts, and elevated bond yields.
After taking repeated tariff-related blows, the stock market rallied in mid-May on news that the U.S. and China had reached an agreement and held steady with subsequent news, even if negative. Investors, it seemed, were becoming like the townsfolk in "The Boy Who Cried Wolf," increasingly insensitive to the regular pronouncements of outsized tariffs. The belief arose that tariffs would eventually reach a level that the economy could manage and absorb. Hence, the muted reaction to the May 28 court ruling that the Trump tariffs exceeded executive authority and the subsequent appeals court stay of the same. The S&P 500 Index rose 6.3% for the month, taking the year-to-date return to a positive 1.1%. While the Index return suggested market ebullience, the underpinnings were more complex, as returns were concentrated in the familiar Mag 7 mega-caps and their sectors. Health Care returns were nearly the inverse of the Index, losing close to -6%.
One cloud hanging over the stock and bond markets was the fate of the "big beautiful" spending bill, which passed the House but at month’s end was facing serious concerns in the Senate. The House version contained cuts to social programs that appeared to have but a minor impact on balancing the loss of revenue from tax cuts. The nonpartisan Congressional Budget Office projected that the bill would increase the federal deficit by $3.8 trillion through 2034, a result that disturbed conservative deficit hawks in the Senate and is showing some alarm in the bond market, with longer-term Treasury yields rising.
While the fate of the budget bill remained in suspense, the economy continued to plug along while showing signs of tariff stress. Already sluggish consumer spending dipped in April as durable goods spending dropped while savings increased, even as confidence measures ticked up in May. Tariff uncertainty also seemed to be sparking hesitancy in capital spending, with the notable exception of the build out of AI driven data centers. A drop in gasoline prices helped consumers absorb initial tariff-driven price increases.
The prospect of Federal Reserve rate cuts was pushed further out by tariff uncertainty, the potential inflationary impact of higher consumer product prices, and a wait-and-see consensus on how all of this would affect the employment picture. At least through May, the unemployment rate of 4.2% was relatively benign, but anecdotal information suggested a hiring slowdown, perhaps exacerbated by the accelerating adoption of AI efficiencies.
Investors seeking visibility through the fog of uncertainty could be buoyed by the month's generally positive corporate earnings reports. But the broad hesitancy to provide confident guidance sustained concerns. Worry over an economic slowdown, an uptick in inflation, and a lack of action on federal deficits drove long-term rates higher, with the ten-year Treasury yield hovering around 4.5%. If bond yields continue their move higher, it could place pressure on equity markets. With the S&P 500 registering an above-average valuation, a hesitant consumer, and a frozen Federal Reserve, we find ourselves increasingly focused on company fundamentals and valuations.