Over the past month, the financial markets have experienced a notable decrease in volatility, resulting in global stock markets paring year-to-date gains. The MSCI All Country World Index declined in May, leading to 2023 total returns of 8%, or 5% for UK-based investors after factoring in the appreciation of sterling's value.
In the United States, gauges of volatility on stocks have reached their lowest levels in over two years, largely due to the avoidance of well-known risks materializing. Concerns around the federal debt limit were averted by raising it, and fears of contagion in the US regional banking sector did not materialize. As a result, futures markets have repriced the year-end Federal Reserve (Fed) funds rate, bringing it back above 5%, similar to the current 5.25% rate.
US stocks experienced a 0.4% gain in May, with a slight boost for sterling-based investors due to a drop in the pound against the US dollar. The hype surrounding the benefits of Artificial Intelligence (AI) caused significant gains in some of the largest US stocks, notably Nvidia, which achieved a market capitalization of US$1 trillion after impressive first-quarter results.
First-quarter earnings in the US were not as dire as feared, with a 2.1% year-on-year decline, better than the previously forecasted 7% drop. Despite a significant increase in US stocks from the October 2022 lows, the lack of market breadth in the rally has led to concerns about its sustainability.
Nvidia and a handful of other stocks have accounted for most of the 2023 return for US benchmarks, primarily in the technology sector, leading to comparisons with past bubbles. However, historically, periods of concentrated outperformance by large stocks have often been a positive sign for the broader market.
Inflation remains a concern, with the core reading reaching a new peak for the cycle at 6.8%. The International Monetary Fund (IMF) expects inflation to persist and may take three years to return to the central bank's 2% target. In contrast, the UK economy is performing better than anticipated, with both the IMF and Bank of England (BoE) revising their forecasts to predict avoiding a recession.
UK government bond prices have declined in response to the economic outlook, leading to higher yields. UK stocks faced selling pressure, ending May down 5%, influenced by concerns over Chinese economic prospects and demand worries for crude oil.
On a positive note, Japan's stock benchmarks have reached levels not seen since 1990, driven by a shift in corporate attitudes, a return of inflation, and increasing interest from international investors attracted to the market's exposure to the Far East.
Overall, the macroeconomic picture remains uncertain, with labor markets showing strength, but manufacturing data indicating a decline. Central banks are navigating the rate increasing cycle carefully, and equity valuations are modest but not necessarily cheap. The enthusiasm surrounding AI presents both opportunities and concerns. Fixed interest returns are attractive, and a neutral stance is maintained from an asset allocation perspective.