We started the month of May with corporate earnings that had exceeded all expectations and an all-time high on the S&P 500. However, there were lingering concerns as to whether the recovery would be able to keep pace with Q1 throughout the rest of the year, as well as mounting fears that the Fed may begin to taper its monetary support.
Taxes and inflation concerns were also in the spotlight. The Biden administration is likely to want to raise capital for its own fiscal largesse with tax hikes, and with demand outstripping supply as the economy picks up steam, inflation fears are looking as though they will be one of the major themes of 2021.
To add to this, there were seasonal concerns such as the old Wall Street adage that you “sell in May and go away,” alluding to the traditionally softer months for US equities between May and October. This last point may have been particularly prominent in the minds of certain investors given the magnitude of the move US stocks have made in the first quarter.
The May 12 Sell-off
What has actually transpired over the course of the month appears to be a market collectively attempting to digest the outsized gains it has already made this year with a blistering post-COVID recovery, impressive vaccination roll-out, and a great deal of pent up demand as consumers flush with newly-minted stimulus money attempt to flex their muscles.
Stocks sold off from their highs in the first half of the month, a weak bounce led to a re-test of the low set by the market on May 12, and it has been tentatively clawing back those losses since then. That May 12 low in stocks was also a high-water mark for the month in bond yields. US 10-year yields were rejected from the 1.70 level, then attempted to re-test it a week later, and have rolled over since then. 1.55 is the level to keep an eye on now, with that earlier support of 1.58 having failed to hold throughout April and May.
There have been a number of economic indicators that have fuelled the above concerns over the course of the month. May 7 saw the biggest mismatch between market expectations and a non-farm payroll reading in recent memory. The number of newly employed Americans during April (excluding farming) came in at 266,000, down from the March reading of 770,000 and nowhere near the market’s expectation of a 990,000 reading.
The report sparked vociferous debate over whether the Biden administration’s $300 per week federal jobless benefit scheme was encouraging people to stay out of the workforce and contributing to wage inflation. This one data point and the debate surrounding it would set the tone for the entire month.
The May 12 CPI reading, in which both the broad and core measures came in 0.6% over the market’s expectations, stoked fears that inflation had finally arrived in a form that would register on the Fed’s radar, leading to speculation of a Fed response akin to taking the punch bowl away.
Over the course of the month, various regional Fed presidents would reiterate Jerome Powell’s statements from earlier in the month that the Federal Reserve would maintain a dovish stance and that any inflation would be transient.
Weaker than expected retail sales figures in both broad and core readings, as well as preliminary consumer surveys from the University of Michigan that reveal a dip in sentiment has also added to the sense of uncertainty that’s pervading the market.
The Bottom Line
It should be noted that the market can often find reasons to justify its collective emotional valence using whatever data points appear to be at hand. Both retail sales and consumer sentiment readings were barely a blip in the scheme of things, and are likely to be more affected by the inflated levels they’re coming down from, rather than being evidence of anything more concerning.
The CPI move higher was slightly more than a blip, but well within the Fed’s tolerances, particularly since it has been so vocal this year about letting inflation run hot, even if it were to get over 2%. The fact is that none of this is news to anyone in the know.
We expected inflation prints to tick higher as the base effects of last year’s COVID crash worked their way out of the year-over-year data. We also expected significant bottlenecks in supply owing to how comprehensively the US shut its economy down during the pandemic. For a trader, much of this hand-wringing appears to have more to do with worries over how high we’ve run so soon and fears as to how long it can continue.
This, of course, is the ultimate question, and one that nobody can really answer with any confidence. The macro picture certainly appears ripe for higher asset prices, as is the fact that summer stock market rallies appear to be more pronounced during a new President’s first year in office. We saw the same thing in 2017 with Trump’s election (along with a pronounced bull market in crypto as well, which we’ve also experienced this year).
Of the major US indices, the S&P 500 is the one closest to its record highs at the moment, followed closely by the Dow. How the price action looks as these markets edge closer to their highs will tell us a lot more about what to expect in the next few months.
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