May 2023 Monthly Market Review

Global risk assets posted mixed results in May.  U.S. equities climbed a wall of worry—the ongoing debt ceiling debate,  monetary policy uncertainty and global growth concerns—and finished the month higher, boosted by a narrow group of tech-related stocks.  In contrast, international developed and emerging markets (EM) equities declined due to the lack of tech stock exposure and dynamics in China, respectively.  Fixed income yields rose across the curve and corporate spreads modestly widened, leading to negative returns.  Lastly, rising global yields and a lack of visibility on global growth led to poor returns across real asset categories.

Of the many risk factors facing investors, the debt ceiling impasse captured a great deal of attention. As is typically the case, an eleventh-hour deal was reached and passed through both chambers of Congress and was signed by President Biden a few days before the “X-date.” Notable was Speaker McCarthy’s need for Democratic support to get the deal he negotiated with President Biden out of committee and to the House floor, where it was ultimately passed with Democratic support.

The other risk factor on the top of mind for investors was the upcoming June FOMC meeting.  Through mid-May, markets appeared comfortable with the notion of a pause in the tightening cycle.  However, several strong macroeconomic reports and hawkish speeches from several Fed officials in the latter half of the month caused markets to increase the chances for  another 25 bps rate hike at the mid-June meeting.

Despite these risk factors, domestic equity markets posted modest gains in May, with both the S&P 500 and the broader Russell 3000 Index returning 0.4%.  Mega cap tech/tech-related stocks once again drove the broad market performance, propelled by investor optimism about the prospects of artificial intelligence (AI) adoption.  AI market leader NVIDIA (+36.3%) was the single largest contributor to S&P 500 performance due to  strong earnings and guidance sharply above the consensus forecast.

Just seven stocks (Apple, Microsoft, NVIDIA, Alphabet, Amazon, Meta, and Tesla) accounted for over 100% of the S&P 500 performance through the end of May.  Year-to-date (YTD), the S&P 500 Equal-Weighted Index declined 0.6%, lagging its cap-weighted counterpart by 1,020 bps. The two indices started to diverge sharply in the first half of March as concerns about the U.S. banking system emerged, prompting investors to seek safety in mega caps.

Similarly, large caps outpaced their small cap counterparts by 140 bps for the month and 930 bps YTD, as measured by the Russell indices.  The IT sector accounted for roughly two-thirds of the YTD outperformance for large caps over small caps.  Large caps had a materially higher IT weight than small caps (27% vs. 13% at month-end).  In addition, large cap IT stocks significantly outpaced small cap IT stocks over the YTD period (+36.0% vs. +15.7%).

From a style perspective, growth stocks outperformed their value counterparts by 810 bps in May and 2,040 bps YTD.  Growth-oriented IT, communications services, and consumer discretionary sectors led the market both for the month and YTD.  Recent growth/value performance trends were mostly driven by multiple expansion.  The Russell 3000 Growth Index forward P/E rose from 21.4x at year-end to 24.7x; by contrast, the Russell 3000 Value Index P/E remained essentially unchanged at around 14x.

Outside of the U.S., recent strength of developed non-U.S. equities came to a halt in May.  Compared to the domestic market, the MSCI EAFE Index (‒4.2%) lacked exposure to the large cap tech names that buoyed U.S. returns.  Foreign tech companies were up 6.8% in the MSCI EAFE for the month, but the IT sector accounted for only a quarter of that sector in the Russell 3000.

While foreign equity performance on the whole was weak, Japan was a standout performer as the Nikkei 225 (+7.0%) hit its highest level in over three decades.  The impact of this strength was dampened for U.S. investors by weakness of the yen (‒2.5%) relative to the U.S. dollar (USD), but even in USD terms it was the best performing developed non-U.S. country for the month.  Investors have increasingly embraced Japanese equities for myriad reasons, including, attractive valuations, loose monetary policy, access to China’s reopening with less geopolitical risk, and better corporate governance.  Regarding the latter, corporate governance reform has been a priority in Japan over the past decade, which has resulted in a broad improvement in corporate performance.  Of note, dividends paid by Japanese companies have increased significantly, while corporate buybacks on the Tokyo Stock Exchange hit an all-time single-month high in May.

Like domestic equities, EM equities (‒1.7%) also benefited from optimism surrounding AI adoption.  NVIDIA’s chip supplier, Taiwan Semiconductor (TSMC), was up 12.7% at its high during the month on NVIDIA’s earnings projections.  TSMC is the world’s leading chip supplier and it estimates 44% of its revenues are derived from its high-performance computing segment, which produces chips used in AI.  While not pure-play AI stocks, Asian chip suppliers such as TSMC were a source of strength and may continue to benefit if the structural AI trend continues.

The strength in EM tech stocks was not enough to offset weakness within China (‒8.4%), where sentiment turned negative.  In addition to ongoing geopolitical uncertainty, investors became skeptical about China’s economic recovery following weaker than expected industrial output and consumer spending figures.  Industrial output of +5.6% in April was below its +10.6% forecast and retail sales growth of 18.4% in May also missed forecast estimates.

Fixed income markets were largely negative across sectors and indices throughout May. The yield curve underwent a bearish flattening with the 3-month Treasury yield rising 34 bps and the 10-year Treasury yield increasing 19 bps.  The Fed raised rates as expected in May; however views regarding potential actions at the June meeting shifted from a pause to possibly another hike.  In addition, the debt ceiling negotiation and the potential for a U.S. default remained as a small but important risk.  As a result of the shift in yields and in the shape of the curve, longer-dated bonds lagged their short to intermediate-term counterparts.

Credit spread movement was muted.  Investment-grade corporate bond issuance was stronger than expected, which contributed to a 2 bps increase in spreads.  High yield corporates widened by 7 bps; both investment grade and high yield spreads remain at average historical levels.  The longer duration of investment grade caused it to lag high yield even with its more modest change in spreads.

All major real asset indices declined in May.  Global REITs (‒4.4%) were down amidst rising interest  rates, headline reports of increased stress in the office and retail sectors, and fears a potential economic downturn could crimp demand for real estate space.  European REITs (‒10.4%) underperformed the broader global real estate index, primarily due to a weaker euro and concern rates would remain higher for longer than previously thought.

Within the U.S., office (‒7.3%) underperformed due to increasing vacancy rates in many markets, news that some high-profile  landlords had relinquished assets to lenders, and credit downgrades of select office REITs.  It is notable that the office sector represents less than 15% of most REIT indices, but still had a significant impact on the overall market.  Retail (‒5.2%) underperformed on concern that consumer balance sheets have been stretched and that a downturn could impact retail sales, while infrastructure REITs (cell towers) declined 9.9% on growth concerns and higher financing costs.  Few areas of REITS delivered positive performance in May.

Commodity prices dropped 5.6%, led by declines in energy (‒8.8%) and industrial metals (‒8.4%).  Investors feared that a global slowdown, including a weak economic recovery in China, could impact demand. Natural resource equities declined 8.6% on lower oil and gas prices, and concerns over a downturn.  Rising rates dampened investors’ outlook on global infrastructure (‒5.5%) and utilities.  Clean energy stocks, which are more growth-oriented, dropped 2.0%.

Indices referenced are unmanaged and cannot be invested in directly.  Index returns do not reflect any investment management fees or transaction expenses. This report is intended for informational purposes only; it does not constitute an offer, nor does it invite anyone to make an offer to buy or sell securities.  Information herein has been obtained from third-party sources that are believed to be reliable; however, the accuracy of the data is not guaranteed and may not have been independently verified. The content of this report is current as of the date indicated and is subject to change without notice.  It does not take into account the specific investment objectives, financial situations, or needs of individual or institutional investors.   All commentary contained within is the opinion of Prime Buchholz and intended solely for our clients. Unless otherwise noted, FactSet was the source for data used in this report. Some statements in this report that are not historical facts are forward-looking statements based on current expectations of future events and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Past performance is not an indication of future results.