The U.S. economy is taking its foot off the gas. While the economic expansion continues to chug along, there are discernible signs of a slowdown following a period of robust growth in 2023.

Paradoxically, that’s a good thing. The slowdown eases inflation worries, which in turn brings down bond yields and gives the Federal Reserve confidence to cut interest rates.

The latest ISM Manufacturing index, released this week for the month of May, revealed a downturn in factory production, driven by a stark decline in new orders. This unsettling revelation has diminished the risk-on appetite of equity investors.

Economic activity in the manufacturing sector contracted in May for the second consecutive month and the 18th time in the last 19 months, reported the nation’s supply executives in the latest Manufacturing ISM Report on Business.

The Manufacturing PMI registered 48.7% in May, down 0.5 percentage point from the 49.2% recorded in April. The overall economy continued in expansion for the 49th month after one month of contraction in April 2020.

The economy is slowing, but neither is it imploding. A Manufacturing PMI above 42.5%, over a period of time, signals economic expansion. Economic growth and solid corporate earnings should keep stocks aloft.

Down the rabbit hole…

However, most Americans continue to live in an upside-down “Alice in Wonderland” world.

According to a recent Harris poll, 55% of Americans believe the economy is shrinking, and 56% think the U.S. is experiencing a recession, despite a slew of data that shows the economy has been growing.

The poll also found that 49% believe the S&P 500 stock market index is down for the year, though the index went up about 24% in 2023 and is up more than 12% this year.

As Alice says in Lewis Carroll’s book: “If I had a world of my own, everything would be nonsense. Nothing would be what it is because everything would be what it isn’t. And contrary-wise; what it is it wouldn’t be, and what it wouldn’t be, it would.”

That sounds like an accurate description of today’s politics in America. As an investor, just be sure to deal with reality. And the reality is this: the economy is growing (albeit decelerating), inflation is falling, and the stock market is thriving.

So far in 2024, equities have maintained their dominance over bonds and cash, with U.S. large-cap stocks boasting an impressive 11% increase year-to-date. Growth-oriented investments, particularly in the technology and communication services sectors, have spearheaded this ascent.

Amid the incessant buzz surrounding tech giants and artificial intelligence (AI), there’s been a shift in market leadership. We’ve witnessed a noteworthy rise in performance across diverse sectors such as utilities and energy.

Additionally, sporadic surges have taken place in the financials, industrials, and health care sectors, signaling a broader spectrum of market influence. Real estate stands as the sole sector to suffer losses this year.

U.S. investment-grade bonds have experienced a slight dip, while high-yield and international bonds have inched upwards. International stocks have enjoyed gains, with developed markets surpassing their emerging-market counterparts, mirroring the resurgence of growth in Europe juxtaposed with lackluster performance in China.

If you’re leery of over-hyped Silicon Valley darlings, consider reasonably valued smaller tech companies with greater room for growth.

Economic deceleration puts downward pressure on bond yields, with market sentiment interpreting weakening manufacturing output and moderating input prices as harbingers of relief in the battle against inflation. The benchmark 30-year U.S. Treasury yield has eased off in recent days, a positive move for equities (see chart).

Bond yields and stock prices tend to move in opposite directions. Higher interest rates on essentially risk-free bonds erode the premium investors can expect from riskier assets such as stocks, making it much less appealing to purchase shares.

The confluence of these trends should pave the way for rate cuts by the Fed later this year. The Fed’s next policy-making meeting is on June 11-12; the bond market is betting that a cut won’t occur until September.

In the week ahead, a full week of pivotal economic data awaits, poised to shape market sentiment leading up to the release of the latest consumer price index (CPI) report on June 12.

Of particular interest will be the wage-growth figure in Friday’s employment report, shedding light on the delicate balance between sustaining consumer spending power and alleviating inflationary pressures.

The main U.S. stock market indices closed mostly higher Tuesday as follows:

• DJIA: +0.36%
• S&P 500: +0.15%
• NASDAQ: +0.17%
• Russell 2000: -1.25%

The 30-year Treasury yield slipped 1.47% to settle at 4.48% (see above chart).

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John Persinos is the editorial director of Investing Daily.

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