U.S. equities posted positive returns in May. However, equity results were mixed across the globe following the rise of several geopolitical risks. These include a fiery presidential campaign in Mexico, fears that Turkey may lessen central bank independence, and heightened concerns of growing populist pressures in Europe. Trade policy initiatives once again spurred uncertainty.
The Russell 3000 Index gains were largely driven by growth stocks—a trend that has persisted since the end of 2016. Technology was the top performing sector. Market gains were disproportionately driven by Microsoft and the FAANGs. In aggregate, these stocks represented nearly 13% of Russell 3000 Index assets, but accounted for nearly 40% of the total return of the benchmark during the period.
EM equities fell sharply. Weakness in Brazil and Mexico accounted for the majority of losses. Brazilian equity markets were pressured by a trucker strike that began on May 18th. The strike was in response to rising fuel prices following a shift from a subsidized to a free market pricing policy. A temporary price response led markets to fear a shift back to populist pricing policy and dealt a blow to the nation’s already fragile economy. EM currencies also came under pressure. In addition to country-specific issues, the strength of the USD served as a notable headwind. The Turkish lira experienced the biggest decline. The lira rebounded after the central bank hiked policy rates by 3% and committed to tightening monetary policy further if necessary. Despite the bounce, the lira closed the month down over 10% versus the USD. Argentina also experienced significant currency depreciation. Argentina’s central bank responded to the fall in the peso by hiking rates three times before holding steady at 40%. Additionally, the government entered into talks with the International Monetary Fund for assistance in continued efforts to stabilize the currency.
Political issues in Europe took center stage once again during May. Italy has been without a government since the March 2018 elections left no party with a large enough share of parliament to form a government. After weeks of deadlock and negotiations, a government was formed and Giuseppe Conte was sworn in as Prime Minister (PM), ushering in Italy’s first populist government since World War II. In response to this political turmoil, Italy’s sovereign bond market experienced a steep sell-off at the end of the month. In Spain, PM Mariano Rajoy became the first PM in Spain’s democratic era to be removed from office by a vote of no confidence. Opposition party leader Pedro Sánchez was sworn in as PM. However, his socialist-led, minority government appears weak and early elections may be called. During the last week of the month, Spanish 10-year government bond yields moved higher by 14 bps.
Since 1999, European equity volatility has traded higher than the VIX 90% of the time. This relationship diverged earlier in the year for the first time since the financial crisis in late 2008/early 2009. However, in May, volatility reverted back toward historical norms amid the increase in geopolitical risk in Europe. Amid the volatility and uncertainty, investors flocked to safe haven assets, resulting in declining yields in both the U.S. and Germany. Also, marketable real asset categories performed relatively well, despite falling inflation expectations.