Monthly CIO Update | June 2024

MARKET WRAP

After a weak April, major equity indices rebounded in May as better-than-expected earnings and optimism about the economic outlook supported risk assets (S&P500 +5% m/m, NASDAQ +7% m/m, Dow Jones Industrial Average +2.6% m/m).

Corporate earnings continued to deliver relative to expectations, with the blended growth rate for S&P companies reaching its highest level since Q1'22 (5.9%). However, as big tech stocks logged outsized performance again, concentration worries have reemerged, and equity breadth approached its worst level since March 2009. More than 50% of the S&P’s monthly gain was attributable to 5 stocks and after stripping out the Magnificent 7 names, the blended earnings growth rate for the remainder of the S&P 500 was 1.80%.

On the sector level, Utilities notched the top spot for the 2^nd month in a row (+8.96%) with Technology (+7.08%) and Communication Services(+6.94%) outperforming as well. Only Energy was negative in May (-0.34%) and while Real Estate rebounded (+5.14%), it remains the worst-performing sector YTD.

US Treasuries rallied in May despite some late-month weakness tied to hawkish-leaning Fedspeak, lingering fiscal anxieties and supply concerns (three auctions totaling $183bn last week). Yields across mid and long-term Treasuries declined by double-digits with the 5Y note seeing the largest movement for the second month in a row (-20bps). Meanwhile, Treasury Bill yields on the frontend of the curve remained largely unchanged.

While the US economy remains on solid footing, some data released in May indicate early signs of moderation, with capital spending trending sideways and new/existing home sales slumping. The unemployment rate increased slightly to 3.9%, and April’s reported job gains hit a 7-month low. On the inflation side, Core CPI cooled for the first time in 6 months (+0.3%) and Core PCE posted the smallest advance of the year (+0.2%). The S&P Global Flash Purchasing Managers’ Index (PMI) was the bright spot, accelerating at the fastest pace in over a year to 54.4 (>50 indicates expansion).

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INVESTMENT OUTLOOK

MACRO: There remains significant focus on the Fed, though little changed in terms of our expectations in May. CPI decelerated but remains stubbornly high behind continued stickiness on services side and the market is now pricing in 45bps of cuts vs. 28bps at the end of April. We expect policymakers to hold rates firm until Q4, contingent upon further evidence of disinflation throughout the summer. In our view, heightened market uncertainty and bond volatility have provided a headwind to valuations, and greater clarity from the Fed, even if hawkish, could alleviate these pressures. As such, the exact timing of rate cuts does not significantly impact our long-term view on equities, particularly if delays are driven by strength in the US economy. In aggregate, we believe economic momentum is rebalancing, the next move for interest rates will be lower and that this backdrop will prove supportive of risk asset valuations.

EQUITIES: Within equities, we anticipate a widening bifurcation in the Technology sector. We see Big Tech powerhouses continuing to grow and the correction in unprofitable software persisting, driven by an elevated cost of capital as well as business model erosion by AI. We stay overweight large growth and on the sector level we expect further outperformance in energy, financials and consumer staples over consumer discretionary.

FIXED INCOME: Uncertainty around the path of interest rates is likely to remain a source of volatility for bond markets. With the anticipation of rate cuts no sooner than Q4, we remain tactically overweight short and intermediate-term bonds. While many investors remain parked in money market assets (see chart below), we believe strongly that some duration is better than no duration. Awaiting a specific signal (i.e., disinversion of the yield curve) before incrementally legging out of MMFs may be too late, as we expect intermediate yields to decline materially by that time.

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CHART OF THE MONTH

Under normal conditions, a rising Federal Funds Rate would result in positive flows to money market funds and downward pressure on equity and credit markets. However, risk assets have continued to rise alongside money market assets, which have now seen six straight weeks of inflows. While the exact drivers of this behavior are unclear (relative strength of the US economy, continued enthusiasm for the AI theme), the result is that over $6 trillion in money market assets remains on the sidelines. These assets will eventually flow back into public equities, private equity and private credit.

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