After a weak April, stocks rallied in May. All major indices were higher, with the NASDAQ taking the lead with a 7.5% gain. The S&P 500 advanced 5%, while the rest of the developed world (CWI) gained around 3%. S&P 500 equal weight gained 2.5% and the DOW lagged the others with gains around 2%. Value (RPV) was flat for the month as of May 29th but ended the month up 2.5%. Small caps gained around 4%, and bonds increased around 1.5% as rates pulled back.
Notable strength was seen in mega cap tech, as market breadth narrowed again during the month. The return dispersion is evident if you look at the 5% return differential between QQQ and RSP. Both the S&P 500 and the NASDAQ recouped all of April’s declines and made new all-time highs towards the end of the month.
TWG portfolios performed in line with their benchmarks, with TWG Growth, Moderate and Conservative advancing around 4%, 3.5% and 3%, respectively.
WHAT MOVED THE MARKET
The month got off to a good start, with the May Federal Reserve policy meeting setting a more upbeat tone. Rates were unchanged, as expected, but Powell effectively declared that further rate hikes were probably not likely. Coming into the meeting, market participants were concerned that the recent “hot” economic and inflation data not only pushed rate cuts farther out in the future, but potentially put a rate hike back on the table.
On Friday, May 3rd employment data came in much cooler than expected, pointing to a slowdown in hiring to the lowest level in some months. The strong labor force was a concern for the ongoing fight to bring inflation back down to 2% as plentiful jobs would support ongoing wage gains, challenging continued declines in inflation. Markets rallied on the news with sentiment turning to “bad news is good news.”
In the middle of the month April CPI data came in cooler than expected. This print breaks the prior three-month trend of rising inflation, calming investors’ jitters that inflation is picking up steam again. Markets rallied to new all-time highs on the news and recovered all of April’s declines.
At the very end of the month Personal Consumption Expenditures (PCE) data indicated inflation held steady from the prior month. This is a welcome data point as inflation stabilized following the early years’ spike higher.
With earnings season wrapping up, there is very little fundamental data to drive the market over the next month. The net results from earnings reflected 6% year-over-year growth, the strongest in nearly two years. However, looking under the surface reveals that large companies drove the bulk of the earnings growth, particularly in the mega cap tech space. AI-related sectors saw 25% YOY earnings growth, while healthcare, energy and materials continued their earnings recession. “Everyone else” saw 4%-10% earnings growth on a year-over-year basis, still benefiting from a strong economy.
PORTFOLIO ADJUSTMENTS
In May, we heavily rotated back into large cap growth/tech via QQQ, which ended the month being our largest position by a wide margin. The second largest position was in the S&P 500, with both funds totaling around 75% of our equity exposure.
Most of our value positions were either trimmed (VTV) or evacuated (NOBL, SPYV, COWZ) over the course of the month, as were our small cap positions. Europe was trimmed as well.
With the NASDAQ easily outperforming most other areas of the market, it makes sense that we ended the month overweight in QQQ as we increased exposure to what was working best and reduced exposure to what lagged.
LOOKING AHEAD
As we enter the early summer months, trading volume will likely be below average. This does present the possibility of increased volatility, as fewer players can move the market more than normal. With earnings season almost concluded, all eyes will be on inflation data leading up to the June Federal Reserve policy meeting in the middle of the month.
Bad news has become good news for the market, as continued signs of an economic slowdown both take a potential rate hike off the table and slightly increase the chance of seeing the Fed cut rates during the summer/fall.
Overall, strong earnings growth helps justify valuations, which are extended. Such earnings growth should support current prices, but we are hard pressed to see the market continue its advance in the near term. A pause is more likely, in our opinion, as the market digests all of the data to determine the direction of the next move.
We take comfort in the fact that earnings growth is higher than at any point in the past two years in a 5% rate environment. Not quite the adverse impact that analysts have been surmising since the start of the Fed’s rate hike cycle. This exemplifies the importance of owning assets not based on what one would expect should happen considering higher rates, but instead on observing the price of stocks continuing to move up and to the right. If we traded based on what we would expect to happen, or out of fear of an immediate adverse impact of higher rates, we would not have captured our fair share of market gains over the past 18 months.
We’ll keep an eye on the market each day and will adjust as our research identifies areas of strength and weakness.
We hope you have a great start to the summer – break out the grill and loungers!
