Stocks continued to enjoy strong returns in May despite a bumpy start to the month. The S&P 500 finished with a 0.7% return. Smaller cap stocks and value-oriented stocks returned to leadership, with the S&P SmallCap 600 Value index leading the month among the major stock asset classes, gaining 3.81%. Energy (5.77%), Materials (5.22%) and Financials (4.79%) were the leading sectors in May, while Utilities and Consumer Discretionary were the two worst performing sectors, losing -2.38% and -3.81%, respectively. The NASDAQ had another tough month, losing -1.44% as the predominantly tech-based companies that make its constituency struggled to restart positive momentum. Bond returns were fairly muted as there was not a significant swing either direction with interest rates—the Bloomberg Barclays Aggregate Bond Index gained 0.33% in May.

As mentioned above, the markets did not have an easy time of it during the first half of the month. By the end of May 12^th, the S&P 500 had lost 2.78% as the inflation fears that have been on the horizon in recent months began to weigh heavily on investors’ minds. In a classic case of “fear of a thing” being more unsettling than the thing itself, as soon as we began to get strong inflation readings investors exhaled, interest rates stabilized, and stocks rose again. It is a great example of why it’s so difficult to correctly anticipate short term market movements. If you’re a day trader sitting at your desk on May 11^th, watching markets in selloff mode because everyone is afraid of higher inflation, and we come visit you from the future to let you know the CPI reading on May 12^th not only meets the consensus expectation of a 2.3% year over year gain, but exceeds it to 3%, which direction do you think the market goes from there? What we saw in May was the inverse of the trading adage that you should “buy the rumor, sell the news”— investors feared the rumor of higher inflation and basically shrugged it off once it arrived. This is not to say we can all move on from the inflation concern. On the contrary, the question of how long we’ll be in this inflationary period is what really matters. Will it be transitory, as the Fed, the Treasury department and many others seem to believe? Or will inflation beget more inflation and continue on its own momentum for the foreseeable future? We believe it is too early to tell.

On the one hand, it is completely plausible to suppose that inflation will be transitory. As with so many other economic measures, when you compare a metric today to its level a year ago, when a year ago the global economy was effectively shut down due to a pandemic, it would be surprising if there was not a historically large change. Once we move into the latter part of this year and early 2022, the year over year comparisons will be more useful as true apples-to-apples comparisons. The “inflation is transitory” camp also points to higher levels of household savings and pent-up demand from consumers being limited in how they spend their money in the past year as a factor that will cause inflation to rise temporarily as consumption becomes unconstrained once again. This, too, makes plenty of sense. On the other hand, when consumers expect prices to go up soon, that in and of itself can create more inflation as shoppers bring forward purchases for which they otherwise would have waited months or years. The transitory camp doesn’t tend to bring up this dynamic. Perhaps when someone like Fed Chair Jerome Powell says that inflation will be transitory, he’s making less of a predictive statement and more of an attempt at calming consumer behavior. An analogy is the gas shortage experienced by those in the Southeast U.S. in early May following the cyberattack on the Colonial Pipeline on May 7^th. Authorities assured consumers that the gas shortage would be mostly over with by that weekend not only because they believed that was how long it would take to bring things back online, but also because they wanted to mitigate the rush on gas stations from those who worried the problem would persist.

We expect that monetary and fiscal policy will continue to play an important role in market sentiment through the remainder of 2021. On the monetary side, the Fed stated in May that it would be evaluating the easing of its $120 billion per month bond buying program sooner than what the market had been forecasting if economic growth continues to accelerate rapidly. In recent years markets have experienced short term volatility whenever the Fed begins to tighten policy. On the fiscal side, investors will be focused not only on the prospects for the Biden’s multi-trillion-dollar spending plans to pass but also on how much longer Covid relief measures will last. In particular, the $300 enhanced weekly unemployment insurance is supposed to last until September, but many are arguing that the federal handout is disincentivizing millions of Americans to work. The April jobs report was one of the most disappointing releases in years, with only 266,000 nonfarm payroll jobs added compared with the forecasted 978,000. This, along with the Job Openings and Labor Turnover Summary (JOLTS) that showed more than 8.1 million job openings in March, lends credence to the notion that many people are content to remain unemployed and collect more in unemployment than they would receive in the form of the paycheck if they took a job. As of this writing, 24 states have announced that they would opt out of the federal unemployment support.

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