As a result, the FANG+ index, which tracks the top 10 most traded technology firms in the US, advanced 17%. By contrast, the equal-weighted S&P 500 index, which dilutes the impact of the megacap tech firms by allocating each company a 0.2% weight, delivered a 3.8% loss in May.
While the month ended with indications that US lawmakers will reach a deal to allow the US government to borrow more—and S&P 500 futures for Thursday's session are trading 0.2% higher at the time of writing—other economic concerns look set to spill over into June, or beyond. The Federal Reserve raised rates by 25 basis points at its May meeting in what many had expected to be the last interest rate hike of the cycle. That view changed as the month progressed, however, with data showing an acceleration of core inflation in April along with robust consumer spending. Markets moved from pricing a near-zero chance of a June rate hike from the Fed to a near-certainty of such an outcome, before scaling back their expectations again (to around a 33% chance of a hike at present).
Investors were also discouraged by the weaker activity in China. The official NBS manufacturing PMI softened to 48.8 in May, below the consensus forecast of 49.5 and marking the second straight month in contraction territory below the 50 level. Both new orders and production showed weakness, while still-soft export and import orders pointed to weak external and domestic demand.
Fixed income markets were unsettled by the combination of continued high inflation and the potential for further rate hikes. The Bloomberg US Treasury and US credit indexes both delivered negative returns in May, though European fixed income markets performed better.
Against this backdrop, we recommend investors take the following steps:
Buy quality bonds. With policy rates peaking and risks to the economic outlook increasing, we recommend adding exposure to bonds and locking in yields before markets begin to price in much lower interest rates. We see attractive opportunities in high-quality fixed income given decent yields and the scope for capital gains in the event of an economic slowdown. We favor high grade (government), investment grade, and sustainable bonds.
Diversify beyond the US and growth stocks. After a strong start to the year, US equities are pricing a high chance of a soft landing for the US economy. Yet, tighter credit conditions, declining corporate earnings, and relatively high valuations all present risks. We therefore recommend diversifying beyond the US equity market and growth stocks, including into emerging markets and select themes in Europe (e.g., consumer sectors).
Position for dollar weakness. While some top Fed officials have recently sounded more hawkish and data has been relatively strong, we believe the Fed is still closer to pausing rate hikes than other central banks, including the European Central Bank, which looks set to continue tightening. We expect the US dollar to weaken further this year as the US interest rate and growth premiums erode. The Fed is also likely to cut rates sooner than other major central banks, in our view. We advise investors to hedge their long USD exposure. In our global foreign exchange strategy, we maintain a preference for the Australian dollar and Japanese yen, and see relative value in the euro, Swiss franc, and British pound. A weakening dollar should also support gold, which we forecast will rise to USD 2,250/oz by June 2024.
Main contributors - Solita Marcelli, Mark Haefele, Christopher Swann, Linda Mazziotta, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Global equity momentum weakens amid mounting risks, 01 June 2023.