Markets rebounded in May with strong corporate earnings and buybacks, but underlying risks persist
Greg Taylor, chief investment officer at Purpose Investments, highlighted in his latest commentary that after weak equity performance in April, markets bounced back strongly in May.
The April weakness resulted from investors realizing that anticipated rate cuts wouldn't happen due to persistent US inflation. These fears continued into May but were balanced by strong corporate earnings and significant buybacks, allowing markets to recover losses and reach all-time highs by mid-month.
This rally feels different. Many investors missed the bounce, and there are concerns that the financial markets may not be as strong as they appear. Earnings exceeded early-year forecasts, but signs of stress are emerging in various sectors.
In the consumer sector, there's a performance divergence between companies targeting high-end versus low-end consumers. Higher interest rates and money market returns benefit those with cash and no debt more than those in debt.
It’s important to remember that the stock market and the economy are not the same.
The leadership of semiconductor companies in the AI sector, especially Nvidia, remains a key theme this year. However, sustainability is a concern. Stellar earnings have driven the group, but it's uncertain who will add to positions next.
May ended with increased market volatility. Despite stronger overall equity indices, several days saw almost every sector turn negative, except for a particular technology group. Narrow markets are neither healthy nor sustainable.
In June, focus will shift back to Central Banks. This month brought the long-awaited interest rate cuts in several regions. Divergence in Central Bank policies will emerge as the US stays committed to “higher for longer” in its battle with inflation, likely delaying cuts until the Fall.
With differing Central Bank policies, narrowing equity performance leadership, and a concerning geopolitical backdrop, the year's outlook appears more uncertain. A mid-year pullback for risk repricing is possible.
Markets performed better in the first half of the year than many expected. Earnings have improved, but gains are mostly from multiple expansions, increasing the risk of overpricing.
Despite the risks, there are several areas of opportunity. Valuations in overlooked defensive parts of the market look attractive, especially if bond yields decline. With uncertainty around the upcoming US election, the US dollar may weaken, making real assets like commodities appealing.
Additionally, with volatility near cycle lows, incorporating protection or volatility strategies is prudent.
Markets rebounded in May, but risks remain. With a potentially volatile summer ahead, it's crucial to stay cautious and ready to capitalize on opportunities.
The concentration in a few names makes broader markets more susceptible to swings, but opportunities exist for those looking beyond the noise and into overlooked areas.
