Investment environment overview 05/2024

May was yet another good month for most asset classes. U.S. equity indices showed significant gains: the Dow Jones Industrial Average added 2.3%, the S&P 500 rose 4.8%, the Nasdaq 100 gained 6.3%, and the Russel 2000 was up by 4.9%. The technology sector traditionally led the way, with Nvidia shares adding 24.9% to their value, Apple being up 11%, and Qualcomm 21%. Dow Jones grew largely thanks to Amgen (+11.5%), Goldman Sachs (+6.6%) and the previously mentioned Apple. Overall, the information technology sector of the S&P 500 index rose 10% in May, solidly taking the top spot. The second place went to the utilities sector, which grew 8.5%, with telecommunications taking third with a 6.6% monthly gain.

On interest rates

The positive sentiment in developed equity markets is supported both by good corporate earnings for the first quarter of 2024 and decent economic data (manufacturing excluded): inflation is stabilizing, although slower than the market would like; unemployment is still low, but there are early signs that we will soon see it rise, which will reduce inflationary pressures. Naturally, the sooner inflation is contained, the sooner the Federal Reserve, which seems eager to cut rates, will act, following its EU, Canadian and Swiss counterparts.

Expectations for interest rate cuts by the Fed continue to differ: the futures market expects a first 25 basis point rate cut with a 30% probability in July and already with a 100% probability in September, with another minimum cut before the end of the year. At the same time, the zero-coupon Treasury bond market sees the first 25 bps cut only towards the end of the year (and as the only cut this year). Treasury yields may well be pressured by a slight decline in demand, which exceeded supply by a factor of 2.3 in recent auctions of 2- and 10-year Treasuries, compared to the recent average of 2.45. It is also likely that yields may be under pressure due to the refinancing of short-term bills issued last year, when the Fed changed its borrowing strategy from longer to shorter maturities. We are inclined to believe that in this situation the timing of the first interest rate cut is more accurately predicted by the futures market, and we will see Fed cutting rates in September, especially since the ECB (and not only) has already made this expected move.

European and US equity markets

Source: Bloomberg and Signet Bank

Little to say about alternative instruments

Consolidation in FX markets continues and there is not much to add to our previous outlook – we continue to tactically buy the EUR/USD pair at 1.0500-1.0600 levels and sell it on rallies closer to 1.1000. First warning signal we see is January high of 1.1055, until then we will just play this simple EUR/USD 1.06-1.10 trade. A very cheap natural gas finally had a period of decent gains and we are happy to have a small portion of long positions here. Oil still looks contained within recent price ranges and we would contemplate going long closer to $70 a barrel mark.

Gold hit the new all-time high at $2440 an ounce, though there are some signs that this run might be losing steam. We have said before that taking come chips off the table here might be a good idea. Silver, which broke a $30 per troy ounce resistance level and touched a XAG/USD 32.50 mark (highest reading in 12 years), presents a different picture. Metal (hopefully) seems to be breaking out of a long-term consolidation phase and still can run to XAG/USD 36-38 zone were some profits could be taken. Platinum broke higher too, but still lags both gold and silver. We continue to stay long silver and platinum and are comfortable with 15-20% price swings.

Benchmark 10-year bond yields

Source: Bloomberg and Signet Bank

Manufacturing in U.S. and EU continues to suffer

U.S. GDP grew at an annualized rate of 1.30% in the first quarter, which was in line with market expectations. The core personal consumption expenditures price index (PCE), the Fed’s gauge for the underlying price pressures, was in line with the predicted 0.2%, which gives hope for a long-awaited rate cut in September. However, the year-over-year PCE readings, as well as University of Michigan’s expectations still remain well above the Fed’s 2% target. Purchasing Managers’ Index (PMI) from the Institute for Supply Management came in at 48.7, down 0.5 points from a month ago, showing continuous problems in U.S. manufacturing. Meanwhile the services sector grew significantly in May, with the non-manufacturing PMI coming in at 53.8, up from the 49.4 reading in April.

Core CPI came in hotter than expected in the Eurozone, climbing to 2.9% in May, up from April’s 2.7%. While food inflation slightly slowed, prices for energy and services accelerated. Building on top of the rapid business activity increase in April, the HCOB Eurozone Composite PMI rose to 52.3 from 51.7. In addition, the final Eurozone manufacturing PMI, though rising to 47.3 from 45.7 a month ago, is still showing a decline in production, which is now more than a year old.

China’s factory activity grew at the fastest pace in almost two years, largely driven by new orders and production gains at smaller firms. The Caixin/S&P Global manufacturing PMI rose to 51.7 in May from 51.4 the previous month, the highest level since June 2022. This uptick in production has prompted the IMF to nudge up the forecast of economic growth in China to 5% from an earlier forecast of 4.6%. However, it is still unknown if exports will stay resilient. According to Caixin, new export orders grew at a much slower pace in May, coming off April’s 41-month high, largely due to the global economy remaining in a relatively vulnerable state.

High Yield bond Indexes

Source: Bloomberg and Signet Bank

Markets deserve a rest

The stock market may well be in for a summer hibernation. According to the CFTC (Commodity Futures Trading Commission) reports, the S&P 500 index futures market is almost in a state of equilibrium, i.e. without skewing towards bulls or bears. Technically, charts suggest that volatility will slowly decrease, and the S&P 500 will continue its upward movement to the 5600 zone (4.5% from current values). Forming long positions in equities, in our opinion, is now worthwhile only for trading purposes. In the perspective of the next 12 months we still see a high probability of a 10-15% correction.

And a little more about interest rates in the United States. The terminal rate in the upcoming downward cycle is still seen by market participants at the level of 4.25-4.50%. According to the Taylor rule, this rate level corresponds to an annual inflation rate of 2% and an unemployment rate of 4.5%. This is fully in line with the current expectations of both the Fed and the market. However, if the annual inflation rate does not fall below 2.5% and the unemployment rate stays within 4%, we should not expect the Fed to lower interest rates below 5%. In such a situation, bonds with a duration of more than 10 years will come under pressure. For now, we see no reason to change our recommendation to increase duration in fixed income portfolios, but we advise to keep a close eye on leading economic indicators such as consumer confidence, jobless claims and durable goods orders.

Gold price, USD/oz

Source: Bloomberg and Signet Bank