Facts are stubborn things; and whatever may be our wishes…they cannot alter the state of facts and evidence.
– John Adams, The 2nd President of the United States
S&P Dow Jones began its coverage of May’s stock market performance “U.S. equities staged a remarkable recovery in May, thanks to optimism surrounding easing tariff tensions, with the S&P 500 up 6%, posting its best May since 1990.” While the article described the month’s market action as “broad based” it also felt more than a little like “ground hog day” as “the Mag 7” stocks returned 12.4% and with Information Technology stocks providing more than half of the indices total return. For the rest of the market, it was “the land of the 5’s” as US mid and small cap and foreign developed and emerging markets all provided returns starting with that number. Year to date the performance gap between US and foreign equity markets continues as the S&P is up just over 1%, US mid and small cap stocks and information technology stocks continue to be in negative territory and foreign developed markets are +16.5%.
Receiving little notice was perhaps the most interesting and, arguably, the most significant trading session of the month, that of Wednesday, May 21st. While opening down on the day the market had rallied sufficiently throughout the morning to be within a hair’s breadth of breakeven on the day. At 1 pm the market suddenly began to decline falling 1.5% in 30 minutes. The reason was the news of a very poorly received 20-year US Treasury bond auction with insufficient demand to absorb the supply at the proscribed interest rate forcing the Federal Reserve to step in and purchase $2 billion of the $41.5 billion on offer and a resulting rise in the 30 Year US Treasury rate to its highest weekly close, 5.08%, since 2007. Equity market investors were reminded that it is the increasing challenges the US Government faces in financing itself that is the challenge that matters most.
Evidence in the financial markets concerning this country’s public finances has been apparent since the Global Financial Crisis of 2008-2009 but is becoming increasingly difficult to ignore. It had long been an axiom that rising inflation adjusted interest rates were negative for the price of gold, an asset that does not pay interest. Since 2020 inflation adjusted 10-year US Treasury rates have risen from 0% to 2 ½% and the price of gold has doubled. Perhaps more ominously still is the rise of US Treasury rates in the face of declining inflation with the ten-year rate rising since year end 2022 from 3.88% to 4.43% and thirty-year from 3.97% to 4.92% while inflation fell from 6.42% to 2.31%.
We hear or read a great deal about our budget deficit and the rising amount of interest the treasury is paying to service it. Less commented upon but possibly of greater significance are two additional factors. Purchasers of treasury debt often employ borrowed money to purchase those treasuries, and those borrowings are most often collateralized with other pre-existing treasury debt. When interest rates are volatile as they have been more collateral it is required to support those borrowings making it more expensive to obtain. The second risk is that as the mountain of treasury debt has grown an increasing share of new borrowing represents the need to pay off maturing pre-existing debt. In Fiscal Year 2023 (ending September 30th) $18.1 trillion of the $20.1 trillion borrowed was required for that purpose with those amounts rising to $22.7 trillion and $26.7 trillion in 2024. As the treasury employs more bills with maturities of one year or less and a smaller share of notes and bonds, that number is poised to grow significantly.
It is not often that one is able to make predictions about the future while feeling confident in the near certainty of those predictions being proven correct but on this topic that may be possible. The Federal Reserve will lower interest rates and by a substantial amount lowering the government’s cost of borrowing. The treasury will be creative in discovering sources of capital to purchase its debt and those purchases may not always be voluntary. The federal government will employ inflation to deflate the outstanding value of its debt.
40% (equity) & 60% (non-equity) portfolios returned 2% for the month and have returned 6.65% year to date. In contrast to April the entirety of the return was from equities with the non-equity share breaking even.
Mark H. Tekamp