Global equities faced a lackluster May, resulting in a negative return of 1.1% for the MSCI All Country World Index. There was, however, a marked difference between sectors, as enthusiasm for Artificial Intelligence drove the stocks of the largest tech companies double-digit upwards. At the same time, the equal-weighted S&P 500 index would have closed deep in the red, as the European stock market did (MSCI EMU: -2.5%). Only Japan's market provided a rare ray of light, returning 4.5% over the month and closing above its post-bubble economy peak for the first time in 33 years, driven by strong foreign investor interest amid solid domestic earnings and Yen weakness. In contrast, the Chinese stock market fell more than 8% as investor optimism seen earlier this year faded amid further evidence of sluggish growth. As economic surprises continued in China and persistent weakness in the global manufacturing sector remained, headwinds for commodities have increased. Industrial metals and energy lost more than 7% in May. Oil now trades 40% lower than a year ago.
Investors breathed a sigh of relief as the debt ceiling has been suspended until 2025, and they no longer need to worry about the US defaulting on its debt. The market impact was muted as enough signals had previously emerged that a deal was imminent. The market focus quickly shifted back to macroeconomic data and future central bank actions.
Overall, the global economy exhibited mixed trends, with regional differences. In the US, the labour market and economy appear dynamic at first glance. According to the latest job report, 339.000 jobs were created in the US in May, surpassing the expected figure by a wide margin. The total number of unfilled jobs stood at 10.1m, meaning there are still two job openings for every unemployed person, with an unemployment rate of just 3.7%. This dynamic continues to drive wages above average (+4.3% p.a.). It is essential to recognize that the labour market tends to be a lagging economic indicator and that monetary policy impacts the economy typically with a significant lag. The high demand for workers continues to come mainly from the service sector. And it was precisely the May ISM PMI report that delivered a disappointing message regarding the activity in the service sector. The headline index dropped to 50.3, its lowest level since December. Particularly concerning was the decline in New Orders. The commentary accompanying the data highlighted that economic uncertainty and pressure on profit margins impede companies from increasing employment. Price increases moderated, and consumers showed increased sensitivity to prices. The largest retailers in the US are confirming the change in consumer taste to less expensive options.
The core PCE, which is the Fed's favored inflation index, hit 4.7% (annualized) in April, remaining substantially above the Fed's objective. However, given the conflicting signals about the US economy, the Fed would do well to skip a rate hike in June to get more time to see weakness appearing in the data. Markets are less patient and have almost entirely priced another 25bp rate hike for the July meeting. The recalibration of Fed expectations pushed yields higher. US government bonds and credit markets were weaker overall in May, producing negative returns of 1,2% and 1,4%, respectively.
On the other hand, yields in the Eurozone fell as economic momentum decelerated further. Technically, the Eurozone slipped into a mild recession in the year's first quarter after official figures were revised downwards (GDP: -0.1%). The Eurozone manufacturing PMI for May dropped to 44.8, with Germany hit particularly hard. Its manufacturing sector is shrinking at the fastest pace in three years. Similar to the US, the Services PMI was also revised downward across economies, with the final Eurozone print indicating a decline for the first time since last November.
Meanwhile, the latest update from the European Commission's business and consumer surveys suggests that sentiment deteriorated in May. In particular, the Economic Sentiment Indicator has been rolling over on lower confidence among manufacturers, constructors and retailers. However, consumers have become less pessimistic as they see their financial situation improving. Headline inflation slowed to an annual 6.1% in May from 7% in April. Core CPI inflation also eased to 5.3%. The disinflation trend will not stop the ECB from further interest rate increases. ECB's president Lagarde sees no clear evidence core inflation has peaked and confirmed that "there is more ground to cover" on interest rates. To the extent that these data are backwards-looking and consumer's inflation expectations have dropped (to 4.1% in April), the hawkish stance raises the risk of a policy error.
Investors were discouraged by weaker activity data in China, with the official PMI falling to 48.8 in May, below the consensus forecast. Weakness was observed in new orders and production, while soft export and import data reflected weak external and internal demand. However, the overall data still reflected a rebounding economy, with retail sales growing 20% (y/y) and home prices rising for the third consecutive month.
Given China's disappointing reopening rebound, faltering European growth, the narrow market leadership, relatively expensive valuations in the US and less favourable credit conditions, we expect higher volatility in the coming months. We view the rally in the US stock market as vulnerable. As policy rates are expected to stay higher for longer, we see limited scope for global equity valuations to expand. Earnings growth projections of 10% for US and European corporations are optimistic given the continued slowdown in economic growth and the trend toward lower margins. We are underweight in the US and Europe and have a relative preference for Asia Pacific and Emerging markets (neutral). Before becoming more positive for equities, we would like to see a turn in economic momentum and a re-steepening of the yield curve. US Treasuries are an attractive value proposition, we believe. We continue to advocate for a below-benchmark duration for European bonds as the ECB still has work to do.
Please find attached our last Asset Allocation Update for March.