Domestic economic fundamentals continued to strengthen in May, as the labor market witnessed further tightening, current-quarter GDP estimates reflected a nearly 5% growth rate, and most composite measures of business activity signaled an ongoing expansionary bias. Meanwhile, improving U.S. conditions appear to be in the early stages of potentially diverging from key international counterparts, such as the
Economic Fundamentals Diverging Between U.S. and Europe, Japan
Over the 18-month period spanning
While throwing in the towel on ongoing global economic expansion is likely premature, the recent divergence in economic conditions comes at a pivotal time for each region’s central monetary authorities, as the Federal Reserve (Fed), European Central Bank (ECB), and Bank of Japan (BOJ) attempt to shift their monetary policy postures more towards "normal."
Through May, these three key central banks maintained balance sheet assets in
So far, the modest pullback in the collective stock of the Fed, ECB, and BOJ balance sheet assets has generally been well-absorbed by market participants with realized volatility, although elevated from recent levels, remaining low by historical standards. Asset valuations also appear
To summarize, a recent divergence has occurred between economic conditions in the U.S. and abroad, including an acceleration in improvement across many key domestic fundamental indicators, but a modest cooling in the
Volatility persisted in global markets during May. The Trump administration’s global trade approach, the looming North Korean summit, and the U.S. withdrawal from the Iran nuclear deal contributed to uncertainty.
Continued benefits of economic growth and recent tax cuts contributed to strong earnings for U.S. companies. Returns across the Russell 3000 Index sectors were primarily positive in May. The information technology sector was the strongest performing sector, returning over 7%, while the telecommunication sector was the largest detractor,
The U.S. dollar appreciated approximately 2.0% when compared to other major world currencies, negatively impacting returns for U.S. Investors.
European markets experienced mixed results during May. European consumer confidence remained strong as the unemployment rate continued to fall to 8.5% in April, however, a looming trade war coupled with higher oil prices affected corporate sentiment.
Italian markets declined due to the blockage of the Italian president’s attempt to form a coalition government. Due to skepticism of Italy’s participation in the European Union among the political players, fears of an Italian exit from the Union detracted from the broader European region despite a political compromise by month end.
Emerging Markets faced adversity during the month of May, with the broad MSCI Emerging Markets Index declining over 3.0%. The MSCI Emerging Markets Latin America Index had the largest decline, as Brazil experienced a trucker strike in protest of rising fuel costs that hit the nation’s state-owned oil company, Petrobras.
MSCI began their partial inclusion of 226 China large cap A shares into the MSCI Emerging Markets Index during May. The initial inclusion increased China’s weight within the MSCI Emerging Markets Index by approximately one percentage point.
The 10-year U.S. Treasury yield briefly spiked to 3.1%, the highest level since 2011, after positive data on February and March retail sales triggered fears of accelerating inflation.
By the end of the month, yields had fallen to 2.8%, after political fears in Europe triggered a flight to quality that supported fixed income returns for May but still left investors with negative returns for 2018.
The May 1-2 meeting of the Federal Open Market Committee FOMC) left the Federal Funds rate unchanged at 1.5-1.75%. Minutes from the meeting released on May 23 indicated that the FOMC would be comfortable with temporarily overshooting its 2% target for inflation. The minutes also suggested that the FOMC plans to continue the current path of gradual policy normalization.
Euro zonegovernment bonds returned -1.2% during May, driven by uncertainty around Italian elections and fears of a populist Italian government voting to leave the European Union. Performance within the euro zonewas widely dispersed, with Italian bonds falling 6.7% while German bunds, Europe’s perceived safe haven, returned 1.7%.
U.S. REITs returned 3.6% in May on rising valuations across property sectors, as demand for real estate remained robust. Low vacancy rates have persisted as growing demand has kept pace with new construction.
While rising interest rates took a toll on yield-sensitive REITs in the first quarter of 2018, investors may be taking a different view on the prospects of real estate. Investors may be viewing slower rising rates as a sign of an improving economy, which allows landlords to raise rents to cover the rate increase. During the month, retail, self-storage, and health care were among the strongest performing property sectors.
Crude oil prices increased to over $72 per barrel (WTI) in May, reaching a three-year high, as the U.S. pulled out of the Iran nuclear deal toward the beginning of the month and the prospects of renewed sanctions on Iran caused oil prices to rise.
Toward the end of May, however, oil prices started to decline amid reports that OPEC, Russia, and allied producers are discussing a plan to supply additional oil to the market by bringing output back in line with their original target. An agreement may be announced later in June.
Commodity markets gained during May, led by positive performance in both precious and industrial metals and agricultural products. The Trump administration recently announced tariffs on certain goods between the European Union, Canada, and Mexico, leading to increased fears of a global trade war; however, such an event may actually lift the prices of raw materials.
May was a strong month for hedge funds, which benefitted from encouraging economic data and strong corporate earnings. Investment gains were tempered by losses resulting from pockets of elevated volatility in certain financial markets, led by the largest single-day spike in Italian sovereign bond rates due to the uncertainty of the political landscape in the European Union.
Event-driven was the top performing strategy in May. Activist and special situations strategies benefited from rising stock prices and positive price action related to an increasing universe of corporate transactions.
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All data is as of May 31, 2018 unless otherwise noted.
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