Market Analysis May 2023

US equities faced challenges in May, showcasing divergent sector returns. Despite broadly supportive economic data, apprehensions about a potential government default created market volatility. As expected, the Federal Reserve (Fed) raised rates by 25 basis points.

The US labor market remained tight, with the unemployment rate falling from 3.5% to 3.4% in March. Consumer Price Index (CPI) inflation rose by 0.4% month-on-month in April, following a 0.1% increase in March. Core CPI, which excludes volatile categories, also saw a 0.4% uptick, consistent with expectations.

Preliminary composite Purchasing Managers' Index (PMI) data for May indicated slight improvement in industrial activity. The PMI indices, which gauge sentiment in the manufacturing and services sectors, showed expansion (above 50) in business output for the fifth consecutive month.

While the Fed's rate hike was anticipated, the central bank's messaging saw a subtle shift. The Fed expressed uncertainty about future policy tightening, emphasizing the need for flexibility.

The debt ceiling dominated discussions throughout the month. After a compromise was reached between Democrats and Republicans, Congress approved an agreement to raise the country's borrowing limit during the final weekend of May.

While technology stocks surged due to excitement around AI potential, energy and materials stocks lagged, driven by demand concerns. The divergence between sectors was particularly evident, with technology stocks, especially chipmakers, experiencing strong gains.

Eurozone shares faced weakness in May, following a generally positive year. The MSCI EMU index returned -2.5%. All sectors, except for information technology, experienced declines. Semiconductor stocks propelled the technology sector, buoyed by higher-than-expected sales projections from US chipmaker peers, highlighting AI's growth potential.

Revised data revealed that the German economy did not escape recession in the winter. Q4 2022 GDP contracted by -0.5% quarter-on-quarter (q/q), followed by an additional -0.3% (q/q) decline in Q1 2023.

Recent data indicated a slowdown in momentum in the current quarter. The flash eurozone composite PMI for May dipped to 53.3 from April's 54.1, representing a three-month low, primarily attributed to manufacturing sector weakness.

Eurostat reported a euro area annual inflation rate of 7.0% in April 2023, up from March's 6.9%. The European Central Bank (ECB) raised all three key interest rates by 0.25%, while also announcing plans to end reinvestments under its Asset Purchase Programme (APP) from July 2023.

Encouraging preliminary data for May hinted at easing price pressures. Germany and France reported drops in inflation, raising hopes for potential rate stability in the eurozone.

UK equities dipped in May, with energy and basic materials groups experiencing significant declines due to weakness in commodity prices. Technology was the only sector to post positive returns, while financials also performed relatively well, driven by a resilient banking sector.

The Bank of England (BoE) increased the base rate for the 12th consecutive time, raising it by 25 basis points from 4.25% to 4.5%. The BoE also revised growth and inflation forecasts upward. Additionally, the Office for National Statistics (ONS) confirmed 0.1% Q1 2023 economic growth, reinforcing expectations that the UK would avoid recession this year.

Consumer price inflation slowed to 8.7% in April from March's 10.1%, according to the ONS. Core inflation rose versus March to 6.8%, marking its highest level since 1992. Elevated UK interest rate expectations persisted, underscoring the BoE's ongoing efforts to curb underlying inflation.

The Japanese stock market continued its robust momentum in May, with the TOPIX Total Return index rising by 3.6% in local terms. The Japanese yen further weakened against the US dollar, reaching the 140 yen level.

Foreign investors sustained their interest in Japanese stocks, driven by improved sentiment towards the semiconductor industry. This contributed to the market's favoring of large-cap growth. The Nikkei 225, comprising large-cap stocks, exceeded the 31,000 yen mark and reached its highest level in 33 years.

Full-year earnings results were positive, marked by increased shareholder returns through dividends and share buybacks. Initiatives by the Tokyo Stock Exchange played a role in driving stock prices higher, especially for companies with low valuations.

Domestic demand in Japan benefited from reopening efforts and inbound tourism, resulting in positive Q1 GDP growth figures. Recovery in visitor numbers and tourist spending supported economic momentum.

Asia ex Japan equities encountered negative performance in May. Hong Kong and China experienced sharp declines, while South Korea, Taiwan, and India managed share price gains.

Hong Kong and China underperformed as earlier optimism following China's post-Covid economic reopening waned due to disappointing data and weakened demand. Manufacturing activity contracted, and service sector expansion slowed in May.

Taiwan outperformed, driven by technology stocks, particularly those associated with AI. South Korea also ended the month positively, boosted by investor interest in AI-related shares. India's stocks achieved modest gains, supported by favorable economic data.

Emerging market (EM) equities underperformed the MSCI World Index in May. South Africa faced the most significant loss in US dollars, influenced by various factors including arms sale allegations, electricity challenges, and the declining rand.

The Czech Republic, China, Kuwait, UAE, Saudi Arabia, Colombia, Peru, and Chile also underperformed. China's economic recovery showed signs of moderation, with weak factory activity and slowed service sector growth.

Brazil, Qatar, India, Hungary, Taiwan, and South Korea emerged as outperformers, with positive gains. Greece led the pack as the ruling New Democracy party's election outcome eased concerns of a multi-party coalition, positively impacting the market.

Government bond yields generally climbed in May, with eurozone markets outperforming due to weaker data. The US Federal Reserve, Bank of England, and European Central Bank collectively raised interest rates by 0.25%. The ECB also announced plans to end reinvestments under its Asset Purchase Programme from July 2023.

The US 10-year yield increased to 3.63% from 3.42%, and the two-year rose from 4.01% to 4.40%. Germany's 10-year yield slightly decreased from 2.31% to 2.27%. The UK experienced the largest yield hike, rising from 3.72% to 4.18% for the 10-year and from 3.78% to 4.34% for the two-year.

Global growth concerns resurfaced, particularly in China, leading to increased volatility. The US debt ceiling concerns were alleviated as a deal was reached by the end of the month.

The UK bond market's underperformance was attributed to persistent inflationary pressures. In the eurozone, inflation prints lower than expected offered positive news. Credit markets' performance varied, with European high yield standing out positively.

The US dollar displayed strength against G10 currencies, with the Swedish krona underperforming due to weak activity data.

Convertible bonds experienced a slight gain, while valuations reflected the risk-off market sentiment.