Highlights
- While inflation remains above the Fed’s target, indications point toward a moderation in rate hikes
- Mega-cap tech stocks fueled another strong gain by the NASDAQ, while the S&P was flat, and the Dow was down
- Smaller stocks continue to lag
- Rising interest rates, especially at the short end of the curve, weighed on bond prices
Economic Update
Inflation ticked higher in April with both the core and headline Consumer Price Index (CPI) rising by 0.4%, bringing year-over-year gains to 5.5% and 4.9%, respectively. As a reminder, the Fed’s target inflation rate is 2%. The principal driver of inflation remains shelter, which is divided into two primary categories, “Rent of primary residence,” and “Owners’ equivalent rent of residences.” Combined, these two components account for roughly one-third of the index, and both increased by over 8% on a year-over-year basis as housing remains tight, which is keeping prices high.
The Federal Reserve’s Open Market Committee met in early-May and voted to raise interest rates by 0.25% to the current range of 5.00% – 5.25%. The benchmark rate is now at the highest level since June of 2006. Compared to previous hiking cycles the current one is the steepest rate of increase going back over the past 40 years. The Fed has shifted their language since the first of the year. Instead of communicating that “ongoing increases will be appropriate,” they now seem to be pivoting to a more “data-dependent” approach. Market participants had increasingly been predicting that the Fed might hike by another quarter-point at their June meeting. However, comments from Federal Reserve officials tempered those expectations, with odds favoring a pause at the June meeting.
Stocks and Bonds
Stock market performance continues to be dominated by strength in a concentrated number of mega-cap (i.e., very large) companies. The NASDAQ, S&P 500, and Dow Jones Industrial Average are the three most commonly referenced large-cap benchmarks for the United States stock market. Yet, all three had widely divergent performance during the month of May ranging from +5.9% for the NASDAQ to -3.2% for the Dow. The S&P managed a slight gain of 0.4%. Year-to-date the NASDAQ is up 24.1% while the Dow is barely positive at 0.2%. The S&P has returned a respectable 9.6% through the first five months of 2023.
For the small- and mid-cap benchmarks, May was a repeat of the theme that has become common over the past several months with the Russell 2000 and the S&P 400 Midcap lagging. Both indexes were down for the month, which pulled their year-to-date returns into slightly negative territory.
Foreign and emerging markets were also down during the month, -4.1% and -1.7%, respectively. However, both remain up for the year.
May was a reversal of the pattern seen in the month of April with eight of the eleven sectors of the S&P 500 finishing in negative territory. Technology, Communications Services, and Consumer Discretionary were the only three sectors with a positive return for May and they are also the only three sectors that remain in positive territory on a year-to-date basis. Energy showed the largest decline for the month and is also in last place year-to-date. Weakness in the price of oil has weighed on energy producers with West Texas Crude Oil down 10% in the month of May and off by over 11% so far in 2023.
Bonds also sold off during the month of May as interest rates moved higher. The move in rates was especially pronounced at the short end of the curve where the yield on the 1-month Treasury rose from 4.36% at the end of April to 5.17% at the end of May (+81 basis points), a move driven by concerns that Congress and the White House would fail to reach a compromise on the debt ceiling, which could have led to a potential “default.”
Mega-cap Tech Dominance
As mentioned above, the market’s performance so far this year has been dominated by a small handful of exceptionally large technology stocks, leading to very narrow market breadth. The chart below shows the percentage of S&P 500 companies that have outperformed the index over the past several years. So far in 2023, only 28% of stocks are outperforming the S&P 500. Over the long-term that number averages closer to 48% making 2023 the narrowest market we have seen in the past two decades. The only other year that comes close is 2020, which was obviously an outlier for other reasons.
The combined weighting for the two largest stocks in the S&P 500, Apple and Microsoft, currently sits above 14%, which is a record high. The total market value of the two companies is over $5.3 TRILLION, which is more than the combined market value of the smallest 288 stocks in the S&P 500 and more than one-and-a-half times the value of the entire S&P Mid-cap and S&P Small-cap combined.
Finally, the seven largest technology-oriented stocks in the S&P 500 (AAPL, MSFT, GOOG, AMZN, META, NVDA, and TSLA) are up an average of 76.9% year-to-date. The remaining 493 stocks that make up the index have risen by an average of 2.45%.
The bottom line here is that the market has been carried by an exceedingly small number of names so far this year. Diversification outside of the largest of the mega-cap stocks has been a detractor to performance. However, history reminds us that just because something has done well there is no guarantee that outperformance will continue indefinitely. (Past performance is not indicative of future results.) Instead of chasing yesterday’s winners, having exposure to other areas of the market will position portfolios to participate once the performance broadens out, which inevitably will happen, even if the timing is unknown.
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