The month of May has proven to be eventful for investors, marked by a notable surge in volatility, particularly within the rates markets. Initial market expectations were high, suggesting that the Federal Reserve's rate hike in the first week of the month would be the final one for this cycle. However, strong consumer spending, higher-than-expected core PCE data, and hawkish comments from certain committee members swiftly shattered those hopes, leading to a significant rise of 70 basis points in short-term treasury yields. This back-and-forth dance between expectations of a soft landing and recession in the US economy over the past two months has drawn striking similarities to the summer of 2008.
We observe familiar signs of stress in the banking system, with a few bank failures already occurring, along with credit tightening through various means, reminiscent of the crashing housing market in 2008. Additionally, a lingering recession looms, yet fails to materialize. Presently, central bankers and investors alike are relying on lagging indicators such as the labor market and personal consumption to signal an "all clear" ahead. While time will reveal who is correct, it is important to note that a stock market rally driven by only a handful of stocks does not bode well for the long run.
However, amid the uncertainties and potential challenges, there is a glimmer of hope on the horizon. Fears of a potential US Treasury default due to the stalemate surrounding the debt ceiling talks had further exacerbated the movements in Treasury bonds and T-Bills. Thankfully, on May 28th, President Biden and Senator McCarthy announced an in-principle agreement, which still requires approval from both parties in Congress before the US Treasury runs out of cash on June 5th. Although some bipartisan disagreements may persist, we are inching closer to resolving the potential default of the US Treasury, akin to the instances in the past when the debt ceiling was reached.
As investors, it is crucial to navigate these volatile times with caution and vigilance. Assessing economic parallels and drawing insights from historical events can help us make informed decisions.
Stay tuned for our comprehensive analysis and expert recommendations to navigate the ever-changing investment landscape in the wake of a swiftly evolving economic climate.
Wishing you successful and insightful investing in June!
We cannot overlook the remarkable performance of AI-related stocks in May, which boosted the tech-heavy NASDAQ100 index in a shape of a mini-bubble. The recent surge, particularly after May 24th, was primarily driven by a single stock: NVDA Corp. The company's announcement of a projected 50% increase in Q2 revenues due to AI-related products triggered an astounding 25% rally in its stock price on that day. This highlights the undeniable influence of AI as a game changer across various sectors, revolutionizing the way we work, enhancing productivity, and potentially even leading to a long-term deflationary trend, akin to the transformative technological innovations of the past 200 years.
However, it is essential to critically examine whether current valuations and expectations are aligned with reality or if Mr. Market has become somewhat overly optimistic. NVDA, for instance, is currently trading at a staggering 180 times its price-to-earnings (PE) ratio. While the outlook for Q2 appears bullish, it is important to acknowledge that the Q1 numbers experienced a year-on-year decline of 14%.
Investors must carefully evaluate the sustainability and potential risks associated with AI stocks, considering both the impressive potential of the technology and the present valuation levels.
One of the most striking phenomena witnessed in equity markets over the past six months has been the growing divergence between passive investing, represented by market-weighted indices, and active investing, measured by the performance of equal-weighted indices. Since November 2022, the S&P 500 has returned a solid 5.3%, while the equal-weighted equivalent, such as the Invesco S&P 500 equal weight ETF, has experienced a loss of -3.5%. This significant gap has sparked discussions among commentators regarding "market breadth," highlighting that the current rally is primarily driven by a handful of stocks.
It is evident that a large number of constituents, as well as small and medium-cap stocks, have failed to participate in the exuberant upward movement and remain in bear market territory. This discrepancy reflects the macro- and microeconomic challenges prevalent in the current environment.
Passive investing has long been praised for its ability to deliver consistent returns by mirroring market performance. However, it is crucial to acknowledge that passive strategies can face limitations at times. We have witnessed a brief period of extreme performance divergence, a pattern that has historically occurred around major turning points, both at market tops and bottoms. Notable instances include the period prior to the COVID crash in 2020, December 2021, and the present situation.
While equity markets have wholeheartedly embraced the underlying strength of the US and global economy, commodities appear to be moving to a different beat. Surprisingly, commodity markets have failed to exhibit the same level of optimism.
Copper, has only managed a meagre -5% year-to-date (YTD) performance. Energy commodities, such as oil and natural gas, have faced even steeper declines, with oil down by approximately 10% and natural gas experiencing a significant drop of around 45%. Notably, only gold and a few agricultural commodities like cattle, sugar, and coffee have managed to remain in positive territory YTD.
This subdued performance in commodities can be attributed to a variety of factors. Firstly, disappointing data from China, a major player in global commodity demand, has impacted market sentiment. Furthermore, concerns of a potential recession on the horizon, have created a cautious environment for commodity investors. These factors have collectively acted as a lid on short-term price increases in the commodities market, restraining their potential for substantial gains.
Despite this current subdued outlook, it is important to remember that commodity markets are known for their cyclical nature. Shifts in global economic conditions, policy changes, and geopolitical developments can all influence the trajectory of commodity prices. As the global economy continues to evolve, there may be opportunities for commodity prices to regain strength, especially as energy transition efforts drive demand for crucial resources like copper.
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By
Kristal Advisors
June 2, 2023
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