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Monthly Market Update - May 2015

While Greece continued to get an outsized amount of attention in May, global stock markets were relatively flat (+0.1%) for the month. Positive returns in U.S. stocks were offset by negative returns in international stocks. However, on a year-to-date basis, international stocks are the clear leaders with large cap stocks up 8.6% versus U.S. large cap stocks up 3.2%. Bonds and alternatives (commodities and REITs) were flat or had slightly negative returns during the month.

Economy

  • First-quarter real GDP growth sputtered with the latest estimate coming in at -0.7%. The contraction in growth was expected due to the impact of the harsh winter, port strikes on the West Coast, and the reduction in oil drilling.
  • Inflation (CPI) in May was up 0.1%, bringing the year-over-year inflation rate down to -0.1%. Soft energy and food prices held back CPI.
  • May job gains were better than expected at 280,000 and previous months were revised higher. There was also a rise in the labor force participation rate up to 62.9%.

Stocks

  • The S&P 500 Index returned a solid 1.3% adding to previous monthly gains for a year-to-date return of 3.2%. The healthcare sector was the strongest sector (+4.5%), while the energy sector reversed much of last month’s gains and was down 4.8%.
  • Among developed markets, U.S. small cap stocks gained the most for the month, up 2.3%.
  • Developed international large cap stocks fell 0.5% in May; however, their 8.6% year-to-date return is impressive. Small cap stocks in the developed international markets generated even more year-to-date with a 12.1% return.
  • Emerging markets dropped by 4.0% as returns in Brazil, South Africa, and Malaysia were unfavorable.

Bonds

  • The 10-year U.S. Treasury yield increased to 2.12%, up from 2.05% the month prior.
  • Bond returns in the U.S. short- and intermediate-term segments were flat, while returns for inflation-protected and foreign bonds were down 0.8% each.

Alternatives

  • Both commodities and global REITs lost ground in May, returning -2.7% and -1.2%, respectively.

There’s More To The Story Than The Fed
By now, most investors know (and expect) that the U.S. Federal Reserve (“Fed”) is planning to hit the brakes on the near-zero interest rate policy sometime later this year or next year. The Fed controls the overnight Fed Funds rate for interbank borrowing which affects short-term interest rates and borrowing costs. However, the Fed does not control what happens with interest rates in other parts of the yield curve, such as the 10-year Treasury, or in other parts of the world. In May, we saw U.S. bond yields move up as a result of more optimistic market sentiment regarding global economic growth and inflation. More specifically, there were several themes at work:

  • Better economic data from European countries
  • Stabilizing oil prices due to lower production
  • Looser monetary policy in China

These, combined with lower levels of liquidity in the bond market, pushed yields upward (with the exception of the Fed Funds rate). The lower liquidity stems from the fact that banks and dealers are holding fewer bonds in inventory today than before the financial crisis.

So while the Fed is trying to stave off volatility by being open and providing guidance regarding a new era of higher short-term rates, these other themes in 2015 may cause uncertainty and volatility in the bond market. In addition, new issues may arise such as upcoming U.S. budget deadlines that will likely impact markets.

The good news is that most investors have a mix of stocks and bonds which have low correlations with each other and can counteract each other in the various market environments we experience. In addition, a return to normal interest rates is healthy and should mean a good environment for stocks.

Sources: Bureau of Economic Analysis (BEA), Federal Reserve, Institute for Supply Management, JP Morgan, Morningstar Direct, Standard and Poor's, Wells Fargo, Yahoo! Finance, BofA Merrill Lynch, wsj.com

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