STELLAR•
5 June, 2024
Financial Markets Overview - May, 2024
May saw positive returns in both equities and fixed income. Investor optimism about the economic outlook boosted risk assets, with developed market stocks gaining 4.5% for the month. Global bonds also performed well, with a 1.3% return, as markets anticipated summer rate cuts, though the timing varied between the US and Europe.
Expectations of falling interest rates benefited Growth sectors, outperforming Value sectors by 2.4 percentage points. Small-cap stocks gained momentum, achieving 4.6% returns, aligning closely with large-cap peers.
Oil prices declined in May after peaking in April, yet broader commodity indices still posted a 1.8% return due to solid global demand and ongoing conflicts in the Middle East and Ukraine.
The US economy remains strong, but May data indicated some moderation, with capital spending and home sales plateauing. The Flash Purchasing Managers' Index (PMI) was a highlight, with manufacturing rising to 50.9 and services to 54.8. US equities rebounded with a 5.0% return in May, driven by better-than-expected first-quarter earnings.
In Europe, May PMI data confirmed improving economic activity. The services sector remained robust, and manufacturing showed signs of recovery. First-quarter GDP growth was confirmed at 0.3% quarter-over-quarter, with corporate profits exceeding expectations. This economic reacceleration and relatively low valuations attracted international investors, leading to a 3.6% return for European equities excluding the UK, and 2.4% for UK equities.
Asian economies showed signs of improvement, with Chinese data generally positive, coinciding with a rebound in the equity market. However, the recovery details were less convincing due to weak domestic demand and unresolved real estate sector issues. In Japan, despite typically benefiting from a weak yen, consumer sentiment was affected, resulting in Japanese stocks being the weakest regional performers with a 1.2% return in May.
The divergence in regional economic conditions is leading to varied central bank policy expectations. In the US, disinflationary trends are stalling, especially in the services sector. May's inflation data showed only modest slowing, with YoY rates at 3.4% and 3.6%. The Federal Open Market Committee (FOMC) minutes raised concerns about the lack of progress on disinflation, diminishing hopes for an imminent rate cut. However, Chairman Powell's comments against further rate hikes helped US Treasuries rally, with 2-year and 10-year yields falling by 17 and 19 basis points, respectively.
In the eurozone, the European Central Bank (ECB) is optimistic about the disinflationary path, with wage growth moderating despite economic recovery. May saw headline and core inflation accelerate to 2.6% and 2.9% YoY, respectively. Despite this, the ECB signaled confidence in a June rate cut.
UK headline inflation dropped significantly in April to 2.3% YoY, but high services inflation at 5.9% makes a June rate cut from the Bank of England unlikely. Conversely, the Bank of Japan faces the challenge of needing rate hikes to support a weak currency without threatening the return of reflation.
Divergent monetary policies and interest rate uncertainty are likely to continue causing volatility in government bond markets. However, the reset in yields over the past two years has restored bonds' dual role in portfolios: providing income and diversification against growth shocks, though yields will remain sensitive to incoming data.
Overall, May's economic data eased concerns of US economic overheating and indicated a rebalancing in economic momentum. Corporate fundamentals are strong, and the next move for Western interest rates is likely downward, despite regional timing differences. These factors should support risk asset valuations, shifting investor focus from the US to more regionally diversified opportunities with greater potential for catch-up.