Monthly Market Update – May 2024

Key Points

• HAVE YOUR CAKE AND EAT IT TOO – Virtually all major asset classes saw healthy gains in May that largely reversed the broad-based losses experienced in April. Investors interpreted weaker-than-expected economic reports throughout the month as ‘bad news is good news,’ gaining optimism that Fed rate cuts were more likely. They also took a ‘good news is good news’ approach to better-than-expected corporate earnings growth, pushing markets higher as earnings season progressed.
  
• THE BIGGER THE BETTER – The mega cap Magnificent 7 stocks dominated performance in 2023 and drove the lion’s share of index gains for the year. In February, March, and early April of 2024, that outperformance started to dissipate as smaller companies began to close the gap to the giant caps. However, in late April and most of May, the handful of mega cap tech stocks reestablished their dominance.
  
• FED OFFICIALS REASSERT THEIR HAWKISH TONE – Falling inflation in the second half of 2023 led Fed officials to be more dovish in their public appearances. The J.P. Morgan Fed Hawk-Dove Speech Score slowly shifted from hawkish toward a more neutral stance in the fourth quarter. However, after a string of hotter-than-expected inflation data in the first quarter this year, Fed officials have resumed their hawkish stance.
  
• EARNING IMPROVE – Most U.S. companies have now reported first-quarter earnings, and they show that profit growth is picking up. Earnings for the S&P 500 now look to be up about +5.2% from a year earlier, better than the +3.4% analysts expected at the end of March. Strong corporate profits indicate that U.S. economic activity continues to expand even though other prominent economic indicators have been downbeat.
  
• RECESSION? EARNINGS REPORTS SAY NOT SO FAST – With corporate earnings on the upswing, CEOs and company managements are more upbeat. As a result, the term “recession” showed up in just 100 transcripts of S&P 500 companies’ earnings calls, investor events, and conferences recorded in the first quarter. The upbeat executive sentiment likely means that employment will remain robust and the risk of recession is diminished.
  
• FED BALANCE SHEET BACK TO 2020 LEVELS – The Fed’s balance sheet fell about $118 billion in May, its biggest monthly drop since September 2023 and marking its lowest level since December 2020. However, the Federal Open Market Committee will slow the runoff of the balance sheet to about $25 billion per month starting in June. This may put upward pressure on the U.S. dollar and bond yields and be a near-term hurdle for stocks.
• JUNE SWOON OR SEASONAL STRENGTH? – Summer has historically been known for sleepy returns, and the month of June, specifically, has historically had an uninspiring, flattish performance. However, expanding the horizon a bit and distinguishing between positive and negative year-to-date (YTD) momentum improves results noticeably. The S&P 500 has averaged superior gains from June through year-end, when it is up through May, as it is in 2024.
  

Market Summary

Asset Class Total Returns

Source: Bloomberg, as of May 31, 2024. Performance figures are index total returns: US Bonds (Barclays US Aggregate Bond TR), US High Yield (Barclays US HY 2% Issuer-Capped TR), International Bonds (Barclays Global Aggregate ex USD TR), Large Caps (S&P 500 TR), Small Caps (Russell 2000 TR), Developed Markets (MSCI EAFE NR USD), Emerging Markets (MSCI EM NR USD), Real Estate (FTSE NAREIT All Equity REITS TR).

May followed April’s broad-based losses with broad-based gains that lifted virtually all major asset classes. Investors seemed to take a ‘have your cake and eat it too’ mentality in May, in which bad news and good news were reason to celebrate. Though most economic data released throughout May showed some moderation of economic activity, investors interpreted that as an increased likelihood that the Fed may get started cutting interest rates as soon as September (i.e., bad news is good news). But they were also encouraged by better-than-expected first quarter corporate earnings growth reported throughout May (i.e., good news is good news). The S&P 500 Index rebounded from its worst month since September in April (down -4.2%) with a +5.0% rally in May—its best May performance since 2009. The renewed expectations of falling interest rates lifted the Technology sector and Growth stocks. That helped the Nasdaq Composite Index, which is about 50% technology companies, to a +6.9% return for the month, leading U.S. equity indexes. Unlike April, small cap stocks didn’t lag the larger cap equity benchmarks in May, with the Russell 2000 Index gaining +4.9% for the month. Don’t look now, but small caps have outperformed large cap stocks in 3 of the last 4 months now, after underperforming for most of 2023.

Developed market international stocks were up +3.3% in May, as measured by the MSCI EAFE Index, which was their best month since December. In the eurozone, the European Central Bank (ECB) is expected to lower rates at the June 6 meeting. Improving economic data has helped European equities rally (+5.5% in May) for the sixth time in seven months and have now outperformed global equities for the third consecutive month (and by the widest margin since November 2023). In the U.K., headline inflation fell meaningfully in April, but services inflation remains high, which may dash hopes for a June rate cut by the Bank of England. In stark contrast to western central banks, the Bank of Japan (BOJ) stands ready to hike rates to support an extremely weak currency. The BOJ ended its negative interest rate policy in March, but its monetary policy remains among the most accommodative in the world. With the extremely low levels of the Japanese yen now weighing on consumer sentiment, Japanese stocks were one of the weakest performers in May, returning +1.2%. 

Turning to developing markets, the MSCI Emerging Markets Index was the clear laggard among global equity regions, up just +0.3% for the month—barely enough to keep a four-month win streak alive. Chinese economic data has begun to surprise the upside, which has also coincided with a rebound in the equity market. However, lingering concerns about the real estate sector remain, leaving some doubts about the sustainability of the Chinese rally. Officials in Shanghai, China’s largest city, announced measures to shore up homebuying demand, which followed a historic rescue package for China’s ailing property sector by its central government earlier in May. 

May was also a good month for fixed income as yields tumbled. U.S. Treasury yields were down across the curve. The key 10-year U.S. Treasury yield sank -18 basis points to close the month at 4.50%, while the 2-year U.S. Treasury yield was down -16 basis points to 4.87%. With yields down, Treasury bonds posted their best monthly return this year, up +1.5% in May. U.S. bonds, as measured by the Bloomberg U.S. Aggregate Bond Index, gained +1.7% for the month, while non-U.S. bonds (the Bloomberg Global Aggregate ex U.S. Bond Index) advanced +1.0%. 

The healthy gains in May have pushed equities near all-time highs, and valuations have become quite rich. Nevertheless, the economic backdrop remains supportive for corporate earnings growth, and most major central banks are expected to deliver rate cuts in the near future, which will lend a tailwind to equities. As discussed below, seasonal factors and the presidential election cycle may also provide support for markets in the back half of the year. Overall, as long as solid corporate profits persist, the jobs market remains healthy, and inflation pressures recede, it is hard not to be constructive on capital markets for the foreseeable future.

Source: Bloomberg. Data as of May 31, 2024.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Quick Takes

THE BIGGEST ARE THE BEST THIS YEAR (AGAIN)

It was just two months ago that we were noting how market breadth was improving and more stocks than just the “Magnificent 7”mega-cap,  tech-dominated companies were participating in the market gains. Unfortunately, that trend has reversed, and the largest of the large stocks are back to disproportionately driving markets higher. The biggest stocks—Nvidia, Microsoft, Apple, and Alphabet—propelled the S&P 500 to new record highs in May. In contrast, the S&P 500 Equal-Weighted Index has substantially underperformed the headline S&P 500 Index (which is market-weighted and dominated by mega-sized constituents). In May, the S&P outperformed the S&P Equal Weight by +2.1%. That was the widest monthly discrepancy since January’s +2.5% outperformance, and before that, you have to go back to May 2023 to find a larger discrepancy. The S&P has topped the S&P Equal Weight every month this year except in March, and as seen below, the price of the S&P is up +10.8% compared to the S&P Equal Weight, whose price is up just 4.2%. And the smaller down in capitalization you go, the bigger the performance discrepancy gets with the small cap Russell 2000 Index up just +1.6% in 2024 through June 3, although the Russell did slightly outperform the S&P in May.

The Bigger the Better

Percentage (%) change through Monday, June 3, 2024

Source: LSEG, FactSet, The Wall Street Journal.

FED OFFICIALS REASSET THEIR HAWKISH TONE

Falling inflation in the second half of 2023 encouraged a more accommodative (i.e., more dovish) tone from Fed officials. In fact, Fed sentiment, as measured by J.P. Morgan’s Fed Hawk-Dove Speech Score, slowly shifted from hawkish toward a more neutral stance in the fourth quarter. However, after a string of hotter-than-expected Consumer Price Index (CPI) reports in the first quarter this year, heightened inflation pressures have caused Fed officials to reassert their hawkish stance. In May, the Producer Price Index (PPI) release for April rose by an unexpectedly strong +0.5%. Shortly thereafter, import prices rose by a firm +1.1% annual rate, suggesting that some disinflationary tailwinds from imported goods may be fading. Fed Chairman Jerome Powell managed to grab headlines with comments stating that recent data has hurt his confidence in his outlook for lower inflation, although his base case still calls for falling inflation and a prolonged Fed pause opposed to further rate hikes. So-called “sticky inflation” (items that change price slowly, such as wages, rent, housing, and medical care) is stubbornly high and warrants a hawkish tilt, but most economists are forecasting fading price pressures through the summer, which could keep the door open for rate cuts by the end of the year. 

J.P Morgan Fed Speech Hawk-Dove Sentiment Score

Why doves cry? Fed officials turn hawkish as inflation reaccelerates

Source: J.P. Morgan.

CORPORATE EARNINGS IMPROVING

The bulk of U.S. companies have now reported first-quarter earnings results, and they show that profit growth is picking up. Earnings per share for companies in the S&P 500 now look to be up +5.2% from a year earlier, according to FactSet, better than the +3.4% analysts expected at the end of March and marking the strongest growth in nearly two years. They now expect second-quarter earnings per share to gain +9.8%, compared with +9% at the end of March. The last time analysts spent the first month of a quarter raising rather than lowering earnings estimates was during the fourth quarter of 2021, according to FactSet earnings analyst John Butters. Corporate profits are important because they show the U.S. economy points toward continued expansion even as some other economic indicators, such as consumer-sentiment readings, have been downbeat, and inflation has ticked up.

Corporate Profits on the Upswing

Change in S&P 500 earnings per share from a year earlier

Note: 1Q 2024 onward reflects analyst estimates.
Source: FactSet, The Wall Street Journal.

RECESSION? EARNINGS REPORTS SAY NOT SO FAST

With corporate earnings on the upswing, CEOs and company managements are more upbeat. Among companies in the S&P 500, the term “recession” showed up in just 100 transcripts of earnings calls, investor events, and conferences recorded in the first quarter, according to FactSet. That was down from 302 in the first quarter of 2023 and the fewest in two years. Survey-based measures of corporate sentiment have picked up. The Business Roundtable index of Chief Executive Officer (CEO) economic outlooks rose to the highest level in the first quarter since the second quarter of 2022. Indexes of CEO hiring and capital-spending expectations have gained ground. A survey of Chief Financial Officers conducted by Duke University’s Fuqua School of Business with the Federal Reserve banks of Atlanta and Richmond showed a similar increase in optimism. All that evidence indicates that companies aren’t likely to slash employment, and if the labor market remains healthy, the risk of recession is diminished. When profits start faltering, then it will be time to start worrying about jobs… but they aren’t faltering yet.

As Earning Improve, Recession Worries Wane

S&P 500 company transcripts mentioning ‘recession’

Source: FactSet, The Wall Street Journal.

FED BALANCE SHEET BACK TO 2020 LEVELS

The Fed’s balance sheet fell approximately $118 billion in May, recording its biggest monthly drop since September 2023, and has reached its lowest level since December 2020. However, following the conclusion of the Federal Open Market Committee (FOMC) meeting on May 1, the FOMC announced that it will slow the runoff in the Fed’s balance sheet to about $25 billion per month starting in June. The size of the balance sheet has been declining from almost $9 trillion in June 2022 to $7.3 trillion in May 2024. As their holdings of Treasury securities, agency securities, and other balance sheet assets decline, the level of reserves in the banking system also declines, which could contribute to stricter financial conditions (i.e., put upward pressure on the U.S. dollar and bond yields). Strategas Research also points out that there will be heavy issuance of U.S. Treasurys starting in July, which could also put upward pressure on bond yields and be a near-term hurdle for stocks, though the firm remains optimistic about the overall market path for 2024.

Shrinkage: Fed Balance Sheet is back to 2020 levels

Federal Reserve Total Assets (Less Eliminations from Consolidation)

Source: Board of Governors of the Federal Reserve System via FRED.

JUNE SWOON OR SEASONAL STRENGTH?

The summer months have historically had reputations for sleepy returns, which is largely responsible for the old Wall Street adage “sell in May and go away.” Looking ahead to June, according to Morgan Stanley analysis, the S&P 500’s average June return since 1957 is an uninspiring 0%, with 36 gains vs. 31 losses. Over the past 20 years, only September has had a worse average monthly performance. Since 1990, June’s average return was -0.1%, thanks to several larger-than-average losses, including in 2022 and 2008. However, expanding the horizon a bit and discerning between positive and negative momentum years through May improves the results noticeably. The S&P 500 has averaged a gain of +3.2% from the start of June through the end of August. Years in which the index was up through May had tended to see the S&P’s performance a bit slower than average, with a gain of 2.9%, while the years when it was down through May experienced an average gain of +3.7%. But once the summer winds down, year-end rallies tend to be stronger when the S&P 500 was higher, with an average gain of +3.6% compared to a +1.8% average for all years and a decline of -1.3% when it was down year-to-date through May.

Source: Bespoke Investment Group.

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment. It offers many long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.

Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different from the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Chris Bouffard is CIO of The Retirement Planning Group (TRPG), a Registered Investment Adviser. He has oversight of investments for the advisory services offered through TRPG.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.