Overview
Market sentiment in May extended April’s optimism, as investors responded positively to signs of easing geopolitical tensions. While negotiations between the United States and Iran are still ongoing as of month-end, there looks to be an increasing chance of resolving the conflict.
Brent crude remained above $100 per barrel for most of the month, but started declining in the last week, as the market expectations of de-escalation increased. Market normalization, however, will still depend on the opening of the Strait of Hormuz. Some analysts are expecting Brent to remain above $100 per barrel for the rest of the year.
At month end, easing energy prices helped to somewhat reverse the sharp upward movement in global bond yields seen earlier in the month. The Bloomberg Global Aggregate Index ended May with a small 0.3% gain. As energy prices are still high relative to pre-crisis levels, and producer input costs are rising at a faster two-month pace than in the last 15 years, Central banks are in wait and see mode, waiting for signs of disinflation or renewed price pressures.
First quarter (Q1) GDP releases came out in May. Corporate reporting season highlighted strong earnings growth. The United States posted a resilient annualized real GDP rate of 1.6% (quarter over quarter), supported by private sector investment and government spending. Asian GDP numbers came in resilient as well, with China expanding 1.3% and Japan expanding 1.8%, above expectations. Not all regions saw resilience, however. The Eurozone’s result came in at -0.2%, and Canada’s came in below expectations at -0.01%. The Canadian economy has seen uneven growth since trade uncertainty exploded last year. On a positive note, it provides an incentive for the Bank of Canada to tone down plans for increasing interest rates, as deflationary pressures counteract inflation caused by high energy prices.
Equity markets delivered another month of healthy returns. Strong corporate earnings across the US, Asia, and Europe supported performance, with growth-oriented equities returning 7.0%, outpacing value stocks at 2.3%. Developed markets rose 4.6%, while emerging markets continued to outperform, surging 9.7%. This was driven by the continued exceptional gains from South Korea and Taiwan, both key countries in the global AI supply chain, which have benefited from the large CAPEX spend of hyperscalers into AI development. These returns were all tracked by their respective MSCI indices.
Stocks and Commodities
Globally, the first quarter earnings season delivered strong earnings, with the United States at the forefront. Corporate profits in the US advanced a very strong 30% year-on-year, propelled by the continued momentum of AI-related revenues. Notable was that the strong earnings broadened beyond technology, with broad-based earnings showing around 20% growth. With inflationary pressures high, this showed how resilient US domestic demand has remained. Equity markets responded accordingly, with the S&P 500 gaining 5.3% over the month. The technology sector continued to lead the performance with a 15.6% gain. Investors are displaying greater discrimination within the Magnificent Seven, however. Nvidia once again captured the bulk of investor enthusiasm as demand for advanced semiconductors remained intense. While other large names, such as Meta, Google, and Microsoft, saw more tempered sentiment, with investors continuing to apply heightened scrutiny to their substantial AI-related capital expenditures.
Asia showed exceptional results, with first-quarter profits expanding by around 40%, marking one of the region’s strongest reporting periods in recent years. Investors are increasingly viewing Asian technology companies as a way to gain exposure to AI-related growth at more attractive valuations than US counterparts. This dynamic helped emerging markets extend their strong run, with May returns of 9.7%, tracked by the MSCI Emerging Markets Index. South Korea and Taiwan lead the performance. The key markets in the global semiconductor supply chain, they climbed more than 30%, and 14% respectively.
Despite economic sluggishness, Canadian equities posted respectable gains in May, with the S&P/TSX composite index returning 2.5%. Performance was broad-based but uneven across sectors, with materials leading the way with 6.2%. On the opposite end, Health Care lost -5.0% and Energy lost -2.8%. Energy was weighed down by ongoing volatility due to the conflict in the Middle East. The Health Care sector saw Bausch Health, a stock with a large index weighting, dropping sharply on a disappointing earnings report. Small caps had a strong run, with the S&P/TSX Small Cap Index advancing 3.4% for the month, a notable 22.9% year-to-date.
European earnings growth was moderate, near 5%. The region’s companies surprised positively, however, as more than 60% of firms exceeded analyst expectations. The Eurozone economy is looking soft. Composite PMI slipped to its weakest level since late 2023. Consumer sentiment improved only slightly and remained below long-term norms. These conditions suggested that household spending will likely remain subdued.
Initially, European equities struggled under the weight of the conflict in the Middle East, particularly as energy markets remained volatile, but sentiment improved late in the month as investors anticipated progress towards a diplomatic solution. The region ultimately posted gains of 4.1%, tracked by the MSCI Europe ex-UK index.
UK Equities lagged in May, with the FTSE All-Share index only gaining 1.2%. The index has low relative exposure to AI, and with a large energy weight, the region was stifled by the decline in the price of Brent Crude.
Japan entered the second quarter with economic momentum. First-quarter GDP expanded by 1.8%, driven primarily by household consumption. Exports and public investment also contributed meaningfully, supported by accommodative fiscal measures from the new prime minister. These developments reinforced confidence in Japan’s periodic recovery and helped domestic equities extend their upward trajectory, with the Japanese TOPIX index rising more than 6%.
Inflation in China increasing by 1.2% in April, food prices continued to fall but that was more than offset by the rising prices of other consumer goods, and the continued high price of oil. Despite China’s resilient GDP growth, retail sales softened in May, and industrial production recorded its sharpest monthly decline in three years. Chinese exports became more concentrated in the technology sector, and weak domestic demand reignited debate about whether additional fiscal measures would be needed to stabilize growth for the 2nd Quarter. The CSI 300, the major Chinese index, gaining around 3%, supported by mainland Chinese companies, whilst the MSCI China index, which includes a weighting in globally based Chinese companies declined 2.8%. This was due to forementioned global macro economic headwinds.
Commodities ended the month with a decline of 3.6%, tracked by the Bloomberg Commodity Index. The decline reflected a pullback of oil and precious metal prices. The U.S. dollar index rose 0.3%, reflecting continued demand for it as a safe-haven asset, amid the conflict in the Middle East.
Bonds
Fixed income markets were volatile throughout the month, with global growth and inflation risks elevated. The uncertainty surrounding the Strait of Hormuz kept markets sensitive to geopolitical headlines, and this amplified already heightened volatility.
Across major economies, manufacturing input costs continued to surge, and Inflation data confirmed price pressures. In the United States, April CPI accelerated to 3.8% year-over-year, the strongest pace since early 2023, while core CPI climbed to 2.8% as shelter component prices rose. Even as negotiations between the US and Iran showed tentative progress, policymakers were reluctant to assume a rapid normalization of oil supply routes. This is because even if a deal were reached, the Strait of Hormuz would likely take months to return to full operating capacity.
Kevin Warsh was appointed as the new Chair of the Federal Reserve on May 22nd. From Kevin’s reputation as a hawkish thinker, but with recent dovish commentary, the US market has swung between expectations of rate cuts and rate hikes. For now, it’s expected that the Federal Reserve would maintain its current stance until further evidence of durable disinflation emerges. Current expectations are that rates will stay steady until the end of 2026, or into 2027.
Canadian fixed income faced headwinds throughout May but ultimately finished in positive territory. The ICE Canada Universe Bond Index returned 1.4% for the month. Corporate bonds marginally outpaced Federal government bonds, by 0.1%. The recovery was supported by softer energy prices and a series of weaker than expected Canadian economic data releases.
Europe also saw headline inflation edge up to 3.0%, supported primarily by higher energy costs, specifically motor fuels. Core inflation eased to 2.2% due to calendar effects that shifted some services inflation into March. European sovereign bonds delivered stronger returns as yields fell sharply on optimism that a Middle East agreement was nearing. The European Central Bank, however, is still expected to proceed with a June rate hike.
In the UK, signs of weakening support for the Labour Party intensified speculation about potential shifts in fiscal policy and public debt management. Despite this, UK government bonds outperformed global peers as UK inflation came in lower than expected and labour market softness drove yields lower towards the end of the month.
Emerging market debt returned 0.8%, tracked by the JP Morgan EM BIG index. It benefited from strength in South Korea and India.
Credit markets held up well, with solid corporate fundamentals helping overshadow energy-crisis concerns. Risk appetite was also supported by the rally in global equities. Euro high-yield bonds led the gains, with a 1.0% appreciation.
Conclusion
The geopolitical backdrop has improved as US-Iran negotiations progress, and expectations are rising for the Strait of Hormuz to re-open. This is easing the energy supply uncertainty that has defined the last few months. Equity markets have remained resilient, supported by strong earnings growth, with continued high AI-related capital spend. Bonds, however, remain affected from high inflation. The US dollar’s safe-haven appreciation remains intact but is vulnerable to reverse if the conflict sees a resolution. The AI fueled rally is also leading to very high index concentration. Therefore, it’s important for investors to stay properly diversified across geographies and asset classes.
