May Market Update: Taking Stock

What’s moving markets

Markets diverged in April with recent winners pausing for breath; leaving room for the laggards to catch up. Macro-economic news continues to influence the trajectory of stock markets and with concentrated, elevated valuations for some market indices, sensitivity to the macro seems to be increasing. 

Where the US goes, the rest of the developed world tends to follow, but the recent divergence in inflation levels is telling a different story. Where the UK and Europe are seeing inflation consistently decline, the US is seeing persistently stubborn levels of inflation.

For the second month, the annual US inflation rate accelerated to 3.5% in March (up from 3.2% in February) and month-on-month inflation increased by 0.4%. 

Alongside a persistently strong US labour market and solid economic growth (1.6% for Q1 of 2024), this reacceleration of headline inflation gave the FED cause for concern. The potential for FED rate cuts this year now looks increasingly unlikely with markets pricing in a single 0.25% cut in December, when at the beginning of the year 1.25% of cuts were priced in. The FED held rates at 5.25 – 5.50% at their latest meeting, and despite the talk of FED rate hikes, Jerome Powell stated in the post meeting conference that policy is ‘sufficiently restrictive,’ putting to bed those rumours for now. 

The UK’s disinflationary journey continues into Q2, with headline inflation falling to 3.2% in March (the lowest rate since September 2021), down from 3.4% in February. Headline inflation is set to fall further in the coming months due to favourable base effects from a lower energy price cap. The Bank of England can expect to hear strong calls to outline its potential path for rate cuts at its May meeting, given the progress made on lowering inflation. 

We are now entering a phase where monetary policy across the US, Eurozone and the UK will start to differ.  

The European Central Bank (ECB) maintained its interest rates at current levels for the 5th consecutive meeting, leaving the main refinancing rate at a 22-year high of 4.5% and the deposit rate facility at an all-time high of 4%. Euro area inflation remains at 2.4%, and it is likely the ECB will begin to cut rates at their June meeting. Europe’s April composite Purchasing Managers Index (PMI) reached its highest level in 11 months, mainly due to a resurgence in the services sector. Germany’s PMI also climbed into expansionary territory for the first time in nearly a year.

Despite the continual headwinds China is facing in its property sector, year-on-year GDP growth was above market expectations at 5.3% for the first quarter of 2024. Key interest rates remained unchanged in April at record lows with the 1-year loan prime rate (LPR) held at 3.45% and the 5-year LPR held at 3.95%. 

Asset class implications

April saw a sharp rise in government bond yields in the UK and US, with 10-year yields rising by 40 bps and 47 bps respectively as economic data muddied the path towards interest rate cuts. A “higher for longer” narrative had the effect of pushing down bond prices, leading to a fall of 2.90% in the FTSE Actuaries UK Conventional Gilts All Stocks Index. The rise in yields affected the investment grade and high yield fixed income space where, despite the compression in spreads, bond prices fell by 1.81% and 0.70% respectively, despite their lower sensitivity to rate movements. 

In equity markets, the UK powered forward with the FTSE 100 reaching several new all-time highs during the month. The FTSE All Share also rose by 2.47% as positive factors including falling inflation; increasing recognition of the value on offer; and positive economic data all helped drive the index upwards.

This could be the beginning of a period of outperformance as investors look to allocate away from those concentrated and highly valued areas of the market (i.e. US tech). 

The FTSE USA fell by 3.28% on the month following a solid period of outperformance. So far, the market had been looking ahead to a time when rate cuts would begin but has since started to realise this is a long way off. Markets re-priced on these expectations, punishing stocks that met or slightly missed on earnings. Expectations on US stocks are now so high given the elevated valuations in some of the larger tech stocks, that even small and sometimes inconsequential pieces of information can drive significant changes in the share price. This sensitivity is likely to remain until valuations are reset or earnings continue to beat expectations. 

Japanese equities also retreated in April following a strong run. Downward pressure on the Yen coming from the interest rate differential between Japan and other developed currencies saw the Japanese central bank intervene to prop up the currency, causing wild swings in the FX market. 

The macro environment continued to be the driving force of returns in April, but company fundamentals and valuations look as though they are beginning to matter more. The rotation in market leadership seen during April could continue as investors look to take stock and temper allocations to markets more at risk of corrections. This may bode well for the UK. We have seen these false dawns before, but perhaps this time is different. 

Disclaimer: Any information contained within this article is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.

Journey Invest Limited accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.