Fourteen consecutive months of better-than-expected non-farm payrolls reports pretty much says it all – economists can’t seem to figure out this economy. The latest report showed that the U.S. added another 339k jobs in May vs. expectations for only 190k (oh, and the prior month’s report was revised upward by 90k as well). Wage gains don’t seem to be overly concerning to the market, but it’s worth noting that non-management roles are seeing larger gains, pointing to where companies are struggling to fill positions. Also, the participation rate among the prime age workforce, defined as the share of people between the ages of 25 and 54, increased to 83.4% last month, according to the Bureau of Labor Statistics, which is the highest level since 2007. While that could help normalize the job-openings-to-unemployed imbalance, the impact will likely be nominal, leaving the ingredients for higher wage pressures in place, especially should the consumer keep the dial set to “spend.”

The fact that Apple’s market cap exceeded that of the entire Russell 2000 during the month is indicative of the times. Indeed, the winner’s circle has a minuscule population, and the diversification banner has been drooping, waiting for that fresh gust of air to breathe life into it. But investors need to remember that these cycles don’t last forever. Allow me a blatantly cherry-picking moment, albeit an important one. For those who jumped in at the top of the market in March of 2000, it took about 13 years to get back to even and stay above water. There was a moment just prior to the Global Financial Crisis (GFC) when investors were made whole, but if you blinked, you missed it and then had to wait another six painful years or so to see your large-cap stock investment turn positive. And over that very same 13-year period, you could have thrown a dart to choose asset classes, and you would likely have done better than the S&P 500®. On an annualized basis from March 2000 to February 2013, REITs were up +13%, international small value +9%, long-term Treasuries +8.5%, high yield bonds, U.S. small caps, and TIPs were all up about +8%, core bonds were up 6.3%, and commodities returned almost 5%.

With hindsight, it’s always easy to believe that a particular outcome was obvious in advance, but if we’re honest, that’s disingenuous at best. What we at Frontier have done for more than two decades is build highly diversified, multi-asset, multi-manager portfolios to give our clients the best chance of thriving in different and unknowable environments. It’s been a rough patch, but we most assuredly know what we are doing; we’ve never had a stronger team, we’ve never produced better research, and we’re going to win for all of you yet again. Stick around.

What happened in the markets in May?

EQUITIES: CHASING THE A.I. PROMISE

Corporate America keeps humming right along. The (almost) final estimate for Q1 operating margins stands at 11.7%, which is higher than all but five quarters over the last two decades (and likely longer) and a meaningful uptick from 4Q22 at 10.9%. Further, analyst estimates for the remaining quarters of the year have moved upward. But the story in the stock market continues to be the dominance of a handful of companies. According to Bespoke, and as reported by the Wall Street Journal, shares of the ten largest firms in the S&P 500 were up 8.9% in May, while the remaining 490 issues fell by 4.3%. In fact, while large caps in aggregate greatly outperformed small caps during the month, the equal-weighted S&P 500 fell by 3.8%, while small caps held up better, losing 0.9% (Russell 2000) and 1.8% (S&P 600). The rabid pursuit of the perceived winners in the A.I. space has pushed the NASDAQ 100 up 31% year-to-date, while the global stock market, represented by the MSCI ACWI Index, is up a respectable, but far distant, 7.7% for the year.

Overseas, China’s less than robust economic “re-opening” continues to weigh on the performance of emerging markets, with the MSCI China Index losing 8.4% for the month. Value stocks in developed markets, both large and small, also suffered during the month, falling by 5.4% and 4.9%, respectively. The U.S. dollar also failed to help on the international front, as it pushed returns to U.S.-based investors 260 basis points (bps) lower than the underlying performance of stocks in Europe and Japan, collectively.

BONDS: AGG-RAVATION

With the debt ceiling drama behind it, the bond market turned its attention back to jobs and inflation, sending the yield on the 10-year up 20 bps to end the month at 3.6%. At this point, the rate-cut crowd is thinning, and the probability of easing by year-end has fallen from over 90% just a couple of weeks ago to about 44% at present. The entire yield curve shifted upward during the month and became more inverted, whether measured by the 10-year minus 2-year or the 10-year minus the 3-month. Should we dodge a recession in the coming months, this heretofore reliable indicator will certainly suffer a black eye because the message it is currently sending is unmistakable.

With the increase in yields, all major fixed-income sectors ended in the red for the month. Leveraged loans held up the best, losing about 50 bps, while high yield fell by 0.9%, and their more interest rate-sensitive investment grade peers dropped by 1.5%. The bond market as a whole returned -1.1% and long-term Treasuries pulled back by 2.9%.

COMMODITIES: ECHOING THE CURVE

It was a rough month for commodities, which fell by 5.6% as a group, signaling a global slowdown and aligning with the yield curve inversion. All the major sub-components were down: agriculture -4.2%, industrial metals -8.4%, and energy -8.8%. In addition to macro worries, good weather conditions and strong competition have contributed to the declines in the space. Of note, crude oil is back to levels seen just before Russia invaded Ukraine, which is no doubt a contributing factor for the Saudi’s decision to announce another production cut.

How are Frontier strategies positioned?

ALLOCATION CHANGES

Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, Multi-Asset Income, and Faith-based Strategies, and the additional difficulties of properly conveying how those asset allocation changes flow through to trade-level activity, we are instead directing clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.

Focusing on our Core Strategies relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we continue to favor U.S. and international small caps, emerging market equities, managed futures, long-term Treasuries, and floating rate loans. We are generally underweight U.S. and international large-cap stocks, REITs, commodities, and both high-yield and high-quality bonds at the asset allocation level. Still, differences between the asset allocations and actual exposure at the fund level can and will occur.

Emerging market equities and international small caps continue to hover near the tops of their respective 20-year ranges in terms of expected return, while U.S. large caps and REITs languish near their 20-year lows.

PERFORMANCE ATTRIBUTION

For the month, the biggest and only positive contributors at the asset class level were cash and U.S. large caps. The S&P 500 was up 0.43% and 3-month T-bills advanced by 0.45%. The T-bill gain also positively impacted the performance of managed futures funds, which we are generally overweight. The four funds we currently utilize were up between 0.5% and 3.7%, making them the biggest contributors to absolute performance. Beyond that, while our small cap preference would have paid off if not for the top ten S&P names, reality exists, and those ten names did indeed negatively impact relative performance. Underweights to commodities and REITs were quite beneficial, but long-term Treasuries hindered overall performance.

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