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Commentary provided by John Packs, Senior Investment Officer, AIG Retirement Services

Market Performance Snapshot (Week ending June 4, 2021 and Year-to-Date) 

  • Dow Jones Industrial Average®:  +0.7% | +13.6%
  • S&P 500® Index:  +0.6% | +12.6%
  • NASDAQ Composite® Index:  +0.5% | +7.2%
  • Russell 2000® Index: +0.8% | +15.8%
  • 10-year U.S. Treasury note yield: 1.55%
    - Down 3 basis points from 1.58% on May 28, 2021
    - Up 63 basis points from 0.92% on December 31, 2020
  • Best-performing S&P 500 sector this week: Energy, +6.7%
  • Weakest-performing S&P 500 sector this week: Health Care, -1.2%

    Past performance is not a guarantee of future results.

Markets calm as monthly jobs report shows solid, but not overwhelming, gains

Stocks rose to start June, as markets spent most of the holiday-shortened week awaiting the May jobs report from the Department of Labor (DOL). The 10-year Treasury yield fell slightly after the report’s release, but remained within its recent trading range.

  • DOL’s May payroll report revealed 559,000 jobs created during the month, an improvement on April’s disappointing number of 278,000, but still below expectations. Leisure and hospitality generated the greatest gains, accounting for 292,000 new jobs in May. The unemployment rate fell to 5.8% from 6.1% in April.
  • The headline employment figure reinforced other recent economic data showing improving conditions across the U.S. economy, however, the relatively modest pace of gains eased fears that the Fed might act more quickly to withdraw monetary support. Speaking about the report, Cleveland Federal Reserve Bank President Loretta Mester said, “I view it as progress continues to be made on the labor front, which is very good news. But I’d like to see further progress.”
  • The weekly report on new unemployment benefit claims dipped to 385,000, falling below 400,000 for the first time since the pandemic began.
  • Prior to the jobs report, Philadelphia Federal Reserve Bank President Patrick Harker shed more light on the central bank’s current thinking: “We’re planning to keep the federal funds rate low for long, but it may be time to at least think about thinking about tapering our $120 billion in monthly Treasury bond and mortgage-backed securities purchases.” Harker also reiterated that the Fed doesn’t want to surprise markets with a sudden move, saying, “Our goal here is to be boring.”
  • The Fed announced that it will start selling about $14 billion in corporate bonds and bond ETF shares purchased early in the pandemic to shore up credit markets. The effect of the corporate bond programs was more psychological than financial, as the mere existence of the programs helped to stabilize markets and the Fed ultimately made very few purchases. The Fed’s decision to start unwinding those purchases suggests that policymakers believe the corporate bond market is stable enough to keep functioning smoothly without the added security blanket.
  • Despite some ups and downs, equity markets have been relatively flat since mid-April. There has been some churn under the hood, with certain sectors, including energy, posting dramatic gains. Investors seem cautiously optimistic about the sustainability of the economic recovery, while also keeping a careful eye on inflation concerns.

Economic reports point toward higher prices and supply bottlenecks

New data on prices and supply chains bolstered concerns about inflation throughout the U.S. and Europe.

  • Oil prices rose to their highest level since October 2018, as investors and major producers anticipated global demand rising this year. OPEC announced that it will proceed with planned increases in oil production starting in July.
  • Since the beginning of the year, benchmark U.S. and international oil prices have risen about 40%. Other commodity prices, including copper and lumber, have also experienced sharp rises this year, reflecting both inflation-hedging and expectations of surging consumer demand.
  • Energy price inflation is driving prices higher across the world’s richest economies. The OECD, a quasi-governmental international economic think tank, reported that prices across 36 member nations rose 3.3% in April, the fastest rate of increase since 2008. Much of the gain was due to energy prices. Depressed prices in the same month last year also inflated this year’s figure – the so-called “base rate effect.”
  • The Federal Reserve’s Beige Book, a report on economic activity throughout the U.S., revealed continued expansion in recent months. Multiple industries report difficulty sourcing supplies and finding enough workers, with the report noting “a growing number of firms offered signing bonuses and increased starting wages to attract and retain workers.”
  • The Institute for Supply Management’s Purchasing Managers Indexes (PMIs) for manufacturing and services in the U.S. and Europe rose, indicating increasing activity in both sectors. The reports also noted extensive backlogs and rising prices for both inputs and finished products, as goods producers and service providers struggle to meet increasing demand amid global supply chain challenges.

Wage pressures and inflation expectations bear watching

In addition to reporting job gains, the May employment report also revealed that hourly wages rose 2% from the prior year. This was up from 0.4% annual growth in April. Wages in the leisure and hospitality field were up nearly 4% in May. Wage hikes often get passed along to customers as rising prices, contributing to inflation, so these figures deserve attention in the months ahead.

  • Market expectations for U.S. inflation have actually dipped slightly in recent weeks after rising sharply since the start of 2021. The difference between the 10-year Treasury bond yield and the yield on Treasury Inflation Protected Securities (TIPS), often referred to as the TIPS breakeven, serves as a gauge of investors’ inflation expectations. That difference rose from about 2% at the end of 2020 to 2.57% in mid-May, before dipping below 2.5% at the start of June.
  • The recent stabilization of inflation expectations suggests that markets are comfortable – for now – with the Fed’s assessment that rising inflation will be temporary. But the TIPS breakeven bears watching in upcoming months to gauge if investors maintain faith that Fed policy will avoid excessive inflation without stifling economic growth.
  • Wage growth is a key factor in inflation expectations. Even as the U.S. economy grew in the decade before the pandemic, longer-term trends, including the aging population, global trade, and technology and automation prevented wages from rising, which kept inflation in check. If evidence mounts that tight labor markets and rising demand are creating upward pressure on wages, markets will be watching for signs that inflation could be more enduring than the Fed expects.

Final thoughts for investors

Absent a resurgence of the virus, the U.S. economy will likely generate substantial growth this year, with wage growth and inflation above the pace experienced over the past decade. We won’t know until later this year, at the earliest, how sustained these trends might be. With the future uncertain, it’s important to stay focused on long-term goals and speak with a financial professional about structuring your portfolio for a variety of future paths.

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