Stocks spring back but caution persists
E*TRADE Capital Management
The US stock market may still be in its longest, if not its deepest, downturn in more than six years, but it showed its resilience in May by battling back from its year-to-date lows and turning a sizable monthly loss into a slight gain.
While there were no major bearish surprises last month, negative themes that were already weighing on the market continued to exert pressure: The Fed raised interest rates again (as expected), inflation remained high, the Russian invasion of Ukraine dragged on, and earnings season, amid some bright spots, continued to disappoint.
Not surprisingly, many consumer and investor sentiment gauges fell to fresh lows last month, and chatter increased about the possibility of a recession. Morgan Stanley Wealth Management recently noted its proprietary recession indicator showed a 27% chance of a recession in the next 12 months, up from 5% in March.1 Nonetheless, after dipping briefly into a bear market on May 20, the S&P 500 climbed nearly 6% to break even for the month.
The perennial challenge for investors in such conditions is to remain focused on the long-term horizon. That’s no small task, but history provides an abundance of lessons about the market’s ability to recover from setbacks and economic adversity, and reward investors who stay the course.
The Nasdaq Composite’s 1.9% loss highlights the continued pressure on tech and growth stocks. But the market pared its losses dramatically toward the end of the month, and the S&P 500, Dow Jones Industrial Average, and Russell 2000 all closed May in positive territory:
Crude oil prices pushed toward their highest levels of the year last month (up more than 9% to nearly $115/barrel), which helped the S&P energy sector rack up another market-leading gain. Real estate and consumer stocks lost the most ground:
On the global stage, both developed markets and emerging markets rebounded from significant losses early in the month. The MSCI EAFE Index of developed markets gained 0.7% in May, while the MSCI Emerging Markets Index rose 0.4%, with an especially strong showing from Latin American equities:
Short-term interest rates climbed more than most long-term rates in May, leading to a slight flattening (mostly in the middle) of the US Treasury yield curve.
Although the benchmark 10-year T-note yield pushed to 3.17% in the first half of the month—its highest level since November 2018—it closed May at 2.84%, down from 2.89% on April 30. Also, the 5-year yield ended the month below the 10-year yield for the first time since March:
Here are some themes to keep in mind as we head toward mid-year:
- Watch the Fed. So far, the Federal Reserve’s monetary policy tightening has been measured, the economy has started to cool, and consumers are slowly starting to change their behavior. The ongoing challenge will be for the Fed to continue to lower inflation without slowing down the economy too much.
- But don’t get distracted by recession talk. The stock market is reflecting expectations of an economic slowdown, but whether that turns out to be a recession remains to be seen. Regardless, recessions are a normal (if unwelcome) part of the economic cycle. Like bear markets, they shouldn’t be a reason to abandon a long-term investing approach.
- Focus on fundamentals. Stocks with strong cash flows, the ability to pass on rising prices to consumers without hurting demand, and reasonable valuations may be well-positioned to perform in an uncertain environment.
While investors should remain clear-eyed about the challenges still facing the economy and the markets, equities have proven their ability to not just survive, but recover from repeated bear markets, recessions, and shocks. Maintaining a diversified, balanced portfolio—rather than changing course or taking unnecessary risks—is a time-tested way to confront volatility and uncertainty.
Thanks for reading, and we’ll talk to you again next month.
Head of Portfolio Construction for Morgan Stanley Portfolio Solutions
Mike Loewengart is Head of Portfolio Construction for Morgan Stanley Portfolio Solutions and a Managing Director in the Morgan Stanley Wealth Management Global Investment Office. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) designation. He is a graduate of Middlebury College with a degree in economics.
Executive Director, Morgan Stanley WM Global Investment Office
Andrew Cohen is an Executive Director in the Morgan Stanley Wealth Management Global Investment Office and an investment strategist for ETCM LLC. Prior to joining E*TRADE, he was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a Chartered Financial Analyst (CFA®) charterholder and a member of the CFA Institute and CFA Society New York. He is a graduate of Virginia Tech with a Bachelor of Science (B.S.) in finance.