Monthly Market Update - May 2023


Highlights:

  • The S&P 500 Index continued its advance, but mid cap, small cap, and emerging markets declined. Market breadth continues to be narrow.
  • The Federal Reserve increased the Fed funds rate another .25% on May 3rd; many analysts believe this will be the last increase in this cycle.
  • Debate continues within the markets about the potential lag effects of the rate increases on the economy and when the turning point will be for corporate earnings.

Pricing in the equity market continues to debate whether the Federal Reserve will start easing rates later this year or stick to Chairman Powell’s refrain of “higher for longer.” In April and year-to-date, the markets’ consensus seemed to lean towards the easing by year-end scenario as the S&P 500® Index rose by 1.6% in the month, bringing the year-to-date Index return to 9.2%.

However, the breadth of the market gains continues to be narrow. Technology-related sectors are up over 20%, while health care, financials, energy, and utilities are negative on the year. Small and mid-cap indices also declined in April and are flat to up 1-2% year-to-date.

Inflation is the principal target of the Fed’s sharpest rate increases in history. The latest readings show a continued downward trajectory, but rates remain well above double the targeted 2% level. Overall economic growth has slowed but remains positive, with preliminary GDP growth in the first quarter at 1.1%. Meanwhile, some traditional signs of a cooling economy remain stubbornly elevated, especially employment, as jobless claims dipped below expectations. Preliminary data on personal consumption shows strong consumer behavior, while capacity (CAP) utilization, a measure of industrial output, came in higher than expected. The latest corporate earnings and guidance have been solid, and projections for overall S&P 500 earnings for 2023 have stabilized.

So far, the most dramatic impact of higher interest rates has been on regional banks. First Republic Bank’s failure and sale to JP Morgan on May 1st quickly replaced Silicon Valley Bank as the second-largest bank failure in U.S. history.

Debate continues about other lag effects that may be coming to the economy, given that the Fed Funds rate was still below one percent a year ago. One indication that banks are still catching up with the Fed’s rate increases came in Q1 earnings data, where many banks are still showing commercial and business-type loans on the books with average rates in the 5-6% range, while the prime rate of interest is now at 8%. In addition, banks are tightening their lending standards to protect their capital positions. The ultimate trickle down effect on the consumer, the economy, and corporate profits remains to be seen.

On the other hand, the overall theme of Q1 earnings reports was that they were better than expected. Some analysts believe Q1 could mark the bottom of corporate earnings this cycle. However, history suggests that corporate earnings are not out of the woods until ample time has passed after the Fed’s last increase, which the market is betting as the .25% increase that occurred on May 3rd.

In this month’s Q&A, Mike Sanders, Head of Madison Fixed Income, discusses the possibility of the Fed cutting rates this year, the current state of the bond markets, and how an active fixed income manager can navigate this volatility.

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The MSCI ACWI ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets countries (excluding the US) and 23 Emerging Markets countries. With 1,843 constituents, the index covers approximately 85% of the global equity opportunity set outside the US.

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India - MSCI India Index - is designed to measure the performance of the large and mid cap segments of the Indian market.

Fixed Income Definitions
Government Bond - Bloomberg US Government Index - measures the performance of the U.S. Treasury and U.S. Agency Indices, including Treasuries and U.S. agency debentures. It is a component of the U.S. Government/Credit Index and the U.S. Aggregate Index.

Municipal - Bloomberg U.S. Municipal Index - covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.

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Investment Grade Corporate - Bloomberg U.S. Credit Index - measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.

High Yield - Bloomberg U.S. Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded.

Definitions
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