Mid-May Update

May has been a volatile month for our portfolio, but less so for the S&P. We continue to beat our benchmark by over 100bps despite uncomfortably large daily swings. The VIX shows reversion to the mean, which not only reflects the low volatility in the market, but that demand for options is lower because traders are less concerned about downward market deviations. Below is the implied volatility for the S&P 500 over the last six months.

Moving forward this month, inflation, interest rates, and trade talks will determine the success of the market.

  • Inflation:¬†Last week, we saw inflationary fears ease as the CPI and PPI both came in below consensus estimates. We’ll get a better look at the Fed’s view on inflation when they release their FOMC minutes on the 23rd. The markets currently expect with 100% certainty that the Fed will raise rates during their June 13th meeting. This will weigh on utilities and help lenders. As inflation does actually rise, I expect energy stocks and industrials to outperform. I’m not worried about inflation at this point, but expect investors to be overly focused on it and the specific language used by the Fed.
  • Interest rates: Some commentators believe the market will be primarily driven by interest rates moving forward, especially compared to corporate earnings. Over the past few months, we have seen stocks receive little gain from earnings beats while earnings misses lead to big stock drops. However, fundamentals like earnings will always underlie stock movements. Furthermore, these pundits rarely bother to look at the numbers. I do.Yes, interest rates will continue to affect stocks, but at the current yield of 3.09% for the US 10-year Treasury, few investors will rotate from equities to bonds. This number will increase once rates go up, especially as we cross the 3.6% mark. That won’t happen for months, possibly well into 2019. However, there will be a noticeable bump after the Fed meeting in June.
  • Trade talks:¬†This is the factor most likely to dramatically swing the market. The US is overexposed as it renegotiates on trade deals with China, the EU, Japan, and our fellow North American countries. New tariffs on steel and aluminum imports are scheduled to take effect on June 1st. House Speaker Paul Ryan set a loose deadline of May 17th for a NAFTA deal to be presented to Congress; no such deal is yet on the table. Japan has threatened retaliatory tariffs against the US. Finally, Trump tweeted this week that he foresees trade talks with China failing. At least from here, it seems things can only get better.

The week ahead will be volatile, but we’re well positioned to make gains based on our stocks’ strong fundamentals. With positive news on trade, the market will have an above average week. Otherwise, expect sideways movement as investors digest the multiple forces impacting the markets.

Below is an update on our monthly returns versus the S&P.


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