Executive Summary
Mixed bag: It was a mixed bag for investors in May, as the technology-heavy Nasdaq 100 posted another strong month of returns driven by the optimism of an artificial intelligence revolution. Other asset classes were not as lucky in May, posting negative or flat returns for the month, except for the US Dollar, which caught a bid on the prospect of additional rate hikes by the Federal Reserve.
Narrow market returns: The S&P 500 index has posted strong returns this year, but returns have been concentrated in a small number of large-cap stocks. In fact, just seven companies - Apple, Amazon, Microsoft, Alphabet (Google), Tesla, Meta (Facebook), and Nvidia - account for 80% of the S&P 500's year-to-date returns. Skeptics point to the narrowness of the rally, making the market vulnerable to setbacks; however, this doesn’t tell the whole story.
Mixed bag: It was a mixed bag for investors in May, as the technology-heavy Nasdaq 100 posted another strong month of returns driven by the optimism of an artificial intelligence revolution. Other asset classes were not as lucky in May, posting negative or flat returns for the month, except for the US Dollar, which caught a bid on the prospect of additional rate hikes by the Federal Reserve.
In May, the Nasdaq 100 showed exceptional performance with a return of +7.73 percent. This was primarily driven by outstanding gains made by companies perceived to be on the cutting edge of an Artificial Intelligence revolution, such as Nvidia (+30.7), Broadcom (+26.65), Microsoft (+7.71%), Alphabet (+14.6), and Amazon (+18.16) percent. It is important to note that these are only the May returns, not year-to-date ones.
The S&P 500 had a minimal increase of +0.29 percent, while the Dow Jones Industrial Average experienced a decline of -3.36 percent.
The mid-caps fell by -3.14 percent, and the Russell 2000 Small-cap index fell by -0.87 percent.
Developed international equities fell -3.86% as investors continued to worry about inflation, slowing growth, and a stronger US dollar.
The MSCI Sweden Index fell the most, by -7.59%, followed by the MSCI France (-6.52%), MSCI Italy (-6.37%), MSCI United Kingdom (-5.68%), MSCI Spain (-5.49%), and MSCI Germany (-4.93%).
These declines come as the European Central Bank raised interest rates again in May to combat inflation.
Emerging Markets fell by -2.08 percent, the All Country World Index lost -0.92 percent, and the All Country World Index ex-US fell by -3.57 percent.
The CRB Total Return Index, a measure of the performance of a basket of commodities, took a beating in May, losing -4.27%. The damage was widespread, with energy, metals, and agriculture all suffering because of a strong dollar and uncertain future demand.
West Texas Intermediate crude oil led the way down, falling 10%. Heating oil was not far behind, declining -5.52%. Copper also took a hit, falling -7.03%. Aluminum was down -5.09%, wheat was down -1.57%, and corn was down 7.11%.
The Barclays Aggregate Bond Index remained stable, declining by only -0.12 percent, as interest rates on the US 10-year treasury remained steady. The US Dollar rose 2.56 percent, sending year-to-date returns positive.
Narrow market returns: The S&P 500 index has posted strong returns this year, but returns have been concentrated in a small number of large-cap stocks. In fact, just seven companies - Apple, Amazon, Microsoft, Alphabet (Google), Tesla, Meta (Facebook), and Nvidia - account for 80% of the S&P 500's year-to-date returns. Skeptics point to the narrowness of the rally, making the market vulnerable to setbacks; however, this doesn’t tell the whole story.
Legendary Wall Street analyst Bob Farrell, Chief Market Analyst (CMA) for Merrill Lynch from 1967 to 1992, published his 10 Market Rules to Remember in a note to clients in 1998, near the peak of the Dot.Com bubble. Rule # 7 seems applicable to today’s environment:
Markets are strongest when they are broad, and weakest when they narrow to a handful of blue-chip names.
While it’s true that 80 percent of year-to-date returns are due to a handful of blue-chip names, it is not true that this handful of blue-chips are the only stocks rallying this year. In fact, 55 percent of the stocks (274) in the S&P 500 are up on the year. Moreover, 34 percent (171) have posted year-to-date returns exceeding the S&P 500 index.
The chart below shows the market-cap-weighted S&P 500 (SPX) and the equal-weighted S&P 500 (RSP) year-to-date performance through May.
What’s striking is how closely the two tracked each other until early March, when the first tremors of regional bank stress led to the failures of Silicon Valley and Signature Banks. Since then, the equal-weight S&P 500 has struggled to gain traction and is flat on the year, while the cap-weighted S&P 500 has pushed to 52-week highs.
Market skeptics would argue that it’s only a matter of time until the handful of leaders stall out, roll over, and join the rest of the laggards. That’s certainly a possibility, but history argues that that’s not an odds-on bet. If fact, two-thirds of the time, under similar circumstances, the rest of the market rallies as the “soldiers join the generals.”
While still early, it’s worth pointing out that over the last few days, there’s been a noticeable change underneath the market's surface. The chart above shows the advance/decline line (A/D) for the S&P 500. This is a technical indicator that plots the cumulative number of advancing or declining stocks on a daily basis.
Investors want to see a rising advance/decline line when major indexes are rising to confirm the market advance. This appears to be the case now, and should the rally start to broaden to small- and mid-cap companies, that would be a welcome development.
Additional evidence of a broadening market rally includes the percentage of stocks above their 200-day and 50-day moving average, rising from below 40 percent to over 60 percent since the end of May.
Again, while still early, these recent developments increase our conviction that the rally will spread to small- and mid-cap companies whose year-to-date returns are essentially unchanged.