May 2022 Monthly Market Review

Performance was mixed across asset classes during May.  A late-month rally helped U.S. equities avoid meeting the technical definition of a bear market, but it still only yielded returns that ranged from slightly negative to slightly positive.  Currency moves proved to be a tailwind for non-U.S. equity markets.  However, in local currency terms, there was little difference between returns for U.S. equities, international developed market equities, and emerging markets (EM) equities.

One consistent theme across geographies was a wide divergence between growth and value, with value stocks outperforming growth stocks.  The growth/value divergence would have been even greater if it were not for the rally of a basket of high-beta stocks during the final few trading days of the month.  The yield curve twisted between the front-end and the belly (from the 2-year maturity to the 10-year maturity) with rising front-end yields, but a sharp drop in the belly.  The long-end of the curve saw higher rates so in aggregate the yield curve steepened in May.

Among real asset categories, energy commodities gained while other commodity categories and real estate declined.  After posting a drawdown in April, U.S. equity markets delivered mediocre returns with a 0.2% gain in the S&P 500 and a 0.1% decline for the Russell 3000 Index.  Both benchmarks teetered on the brink of a bear market—defined as a 20% decline from the previous peak—during the first three weeks of the month.  A shift in investor sentiment during the last week of the month  lifted the benchmarks to roughly flat positions.  Year-to-date (YTD) through month-end, the S&P 500 and Russell 3000 declined 12.8% and 13.9%, respectively.

Russell 3000 GICS sector returns exhibited wide divergence.  Energy (+15.2%) was once again an outsized gainer with defensive utilities (+4.4%) coming in a distant second.  Financials (+3.3%) also finished in positive territory, lifted by the strength in bank stocks.  At the other end of the spectrum, consumer discretionary (−4.8%) was the worst-preforming sector, dragged down by growth darlings Tesla (−12.9%) and Amazon (−3.3%).  Traditional retailers Wal-Mart (−15.6%) and Target (−28.9%) also came under pressure after reported earnings fell well short of expectations.  Other sectors such as real estate (−4.6%) and consumer staples (−4.4%), which typically protect in down markets, also came under pressure.  Real estate stocks were hurt by industrial REIT Prologis (−20.5%) while Procter & Gamble (−7.9%) and Costco (−12.3%) were main sources of weakness in consumer staples, reflecting investor concern about the health of the consumer.

Style-based benchmarks diverged in May, with the Russell 3000 Growth Index (−2.3%) falling well behind the Russell 3000 Value Index (+1.9%), widening the YTD gap to more than 1,700 bps.  Among market capitalizations and a reversal from April, small cap stocks finished just ahead of large caps, with the Russell 2000 Index (+0.2%) edging out the Russell 1000 Index (−0.2%).

A ferocious rally by high beta stocks in the last few trading days of the month created problems for many equity managers, particularly long/ short managers that had reduced gross and net exposure.  In the last week, the Invesco S&P High Beta ETF rallied nearly 10%, which was more than double the return of the S&P and 4x that of the iShares Min Vol ETF.  Consumer discretionary and tech stocks—areas of the market that had been pummeled in recent months—account for two-thirds of the High Beta ETF.  Technology was the most net sold sector by hedge funds this year; as a result, many long/short managers protected well in the first few weeks of the month.  However, reduced gross and net exposure limited hedge fund participation in the high beta rally, weighing on market-relative performance.

Developed non-U.S. and EM equities each posted 0.2% losses in local terms, but were slightly positive and ahead of domestic stocks in U.S. dollar (USD) terms.  May saw a reprieve from the dollar momentum, with the Dollar Spot Index down 1.2% for the month, but still up 6.0% for the year.  Inflation in the U.S. showed some signs of moderation and interest rate differentials could narrow as  other central banks took a more hawkish stance which halted the dollar’s rise in May.  Most notably, European Central Bank President Christine Lagarde signaled an end to negative interest rates in the euro area, prompting a 1.6% rise in the euro versus the dollar.  The Russian ruble (+12.4%) continued to recover from lows reached early in its war in Ukraine.

China (+1.2%) was among the best performing EM countries, but headlines were mixed below the surface. The country’s zero-COVID policy containment measures weighed on growth and investor sentiment.  As Shanghai rounded out its second month of strict lockdowns, signals of a slowdown in consumer and industrial activity emerged.  Reports indicated China’s retail sales were down 11% and industrial production fell 2.9% year-over-year in April.  More broadly, lockdowns caused supply chain and logistics disruptions, which weighed on growth.  Despite these headwinds, markets responded favorably after several of the country’s large IT and ecommerce names such as Alibaba, JD.com, and Baidu reported better than expected first quarter earnings toward month-end.  Markets were further boosted after Vice-Premier and Economic Advisor Liu He pledged to support the tech sector after a series of harsh, and often swift, regulatory crackdowns.  While details remain limited, officials signaled a willingness to support companies listed on domestic and foreign exchanges.

At its early May meeting, the Federal Open Market Committee (FOMC) hiked rates by 50 bps, which caused yields at the front-end of the curve to drift higher.  The start of the balance sheet normalization process—deemed Quantitative Tightening, or “QT”—will start in June.  Despite guidance for additional 50 bps rate hikes at the next several Fed meetings, markets seemed to have lowered its expectation for the path of policy rates during the period leading up to the release of the May meeting minutes.  This led to the aforementioned rally in the belly of the curve—the 2-year to 10-year maturity range—and caused a 10 bps steepening between the 2-year and 10-year Treasury yields and a 21 bps steepening between the 5-year and 30-year Treasury yields.  As a result of these yield shifts, Treasuries in the 5-year to 10-year maturity range rose 0.7% and outpaced the 0.6% return for Treasuries in the 1-year to 3-year part of the curve and the −1.9% return of longer-dated Treasuries.

Credit spreads narrowed for investment-grade corporates and U.S. agency mortgage-backed securities (MBS), which helped them gain 0.9% and 1.1%, respectively.  While spreads widened for high yield corporates, commercial MBS, and asset-backed securities, the additional carry on these instruments allowed them to deliver modest gains of 0.2–0.3%.  However, leveraged loans declined 2.5% driven by a sharp decline in CCC-rated loans.  Default activity ticked higher with Talen Energy’s Chapter 11 bankruptcy filing, but the negative performance in loans seemed more related to a rotation from loans and into bonds for the first time in six months.

Real asset categories produced mixed returns.  Energy equities rallied more than 15% on the upward momentum of energy commodities (+10.1%).  The 7.9% increase in Brent crude was driven by a combination of factors, including a preliminary agreement by the European Union to ban 90% of Russian crude imports by year end 2022.  Prices were also boosted by the start of the U.S. summer driving season and easing COVID lockdowns in major Chinese cities, both of which will add to already robust global demand.  U.S. natural gas prices increased 19.5% hitting $9/MMBtu, which is the highest level since 2008.  Key drivers included lower than average storage levels to start the summer cooling season, limited growth in natural gas production, and a significant increase in liquefied natural gas exports to Europe.

Gasoline prices continued to move upward in May.  U.S. refining capacity has declined in the last few years due to refinery retirements and storm-related damage, which, combined with lower inventory levels, has exacerbated the pain at the pump beyond what would have been expected from higher oil prices.

U.S. property stocks declined 6.3%, led by the industrial and apartment sectors. Industrial fell by 15% on concern that some of the bigger ecommerce players would slow their warehouse absorption rates.  During the month, Amazon indicated it had overbuilt warehouse capacity in 2020 and 2021 and was reducing its pipeline of new warehouses.  Amazon is likely to grow into its footprint in the coming quarters.  Meanwhile, there is still strong demand from other tenants and longer-term sectors’ tailwinds remain intact.  However, the change in demand expectations caused stocks to decline.  Apartment stocks fell 10% as higher rates appeared to weight valuations due to a narrowing spread between acquisition yields (cap rates) and debt costs.

Indices referenced are unmanaged and cannot be invested in directly.  Index returns do not reflect any investment management fees or transaction expenses. This report is intended for informational purposes only; it does not constitute an offer, nor does it invite anyone to make an offer to buy or sell securities.  Information herein has been obtained from third-party sources that are believed to be reliable; however, the accuracy of the data is not guaranteed and may not have been independently verified. The content of this report is current as of the date indicated and is subject to change without notice.  It does not take into account the specific investment objectives, financial situations, or needs of individual or institutional investors.   All commentary contained within is the opinion of Prime Buchholz and intended solely for our clients. Unless otherwise noted, FactSet was the source for data used in this report. Some statements in this report that are not historical facts are forward-looking statements based on current expectations of future events and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Past performance is not an indication of future results.