May 2019 Market Commentary
Global equity markets abruptly reversed course in May, after four consecutive months of positive returns. In the U.S., large cap stocks retreated -6.4%, after reaching an all-time high the prior month. Abroad, both developed and emerging markets also performed poorly, falling by -4.5% and -6.6%, respectively.
Chinese equities fell the most out of the major equity regions, dropping -13.1%. Weakness came from contracting manufacturing data and the ongoing trade dispute with the U.S. The U.S. raised tariffs on $200bn of imports from China, and China retaliated with tariffs on $60bn of imports from the U.S.
After four months of positive performance, crude oil plunged -16.3%. Concerns around the slowing global economy and subsequent demand put pressure on oil prices. Natural gas speculators have shifted to net shorts from net longs for the first time in several years¹.
The U.S. dollar was up +0.55% in May and +0.86% YTD. The currency was supported by the Fed indicating that near-term rate changes were unlikely and that the drop in inflation may be “transient”, continued weakness in Eurozone data, and political turmoil in the UK. The GBP was the worst performer against the USD amongst the G10 currencies, as PM Theresa May announced her departure from her position in June.
The U.S. ten-year yield dropped thirty-eight basis points during May and the yield curve inverted, with the yield gap between the three-month and 10-year treasuries reaching negative thirteen basis points. Global trade war concerns drove the drop in the U.S. ten-year yield and the market is now pricing in two rate cuts by early 2020.
U.S. equity volatility, as measured by the VIX index, sharply rose and ended the month at 18.7. This marked a +43% rise versus April’s month-end level. Despite this sharp increase, the month-end level remained slightly below the index’s long-term average of 19.2.
Source: Bloomberg* and 1 Reuters.
Short-Term Market Outlook
Our proprietary leading economic indicator declined slightly month-over-month and moved into negative territory. Weakness in the past month has come from global trade data, manufacturing data and the change in initial claims data.
QS Leading Economic Indicator
Our outlook for U.S. stocks outperforming investment grade bonds remains in positive territory. Valuation, as measured by comparing the earnings yield to the ten-year treasury yield, continues to be the largest driver of this preference, as the factor’s strength ranks in the top quartile on a historical basis. The thirty-eight basis point drop in the ten-year treasury yield in May drove the valuation factor.
In U.S. fixed income, we think that investment grade bonds will outperform high yield bonds over the next month, a significant reversal compared to last month’s forecast. This change has been driven by spread widening between high yield and investment grade bonds and the rise in equity volatility.
We continue to believe that U.S. stocks are positioned to outperform their international developed market counterparts, however the position has moderated after reaching the strongest level in five years in April. The model’s preference is driven by options market data (which shows greater demand for volatility protection in international-developed markets than in the U.S.), better price momentum in the U.S. and yield curve dynamics. Yield curves in other developed markets are flattening at a faster rate than in the U.S. which we interpret as a sign of lower economic prospects.
European stocks are forecasted to outperform European bonds in our model. Five of the six explanatory variables built into the model concur with this conclusion, including European stock price momentum, valuation, spreads on short-term banking lending rates, and European government yields.
Asset Class Preferences
Asset Class Preferences are based on QS Investors proprietary quantitative factor models. These rules-based financial models use a combination of indicators that analyze asset valuations, investor sentiment, and the broad economy.
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*Global Equities represented by the MSCI ACWI Gross Total Return Local Index; Emerging Market Equities represented by the MSCI EM Gross Total Return Local Index; International Equities represented by the MSCI EAFE Gross Total Return Local Index; U.S. Equities represented by the S&P 500 Total Return Index; U.S. Small Cap Equities represented by Russell 2000 Total Return Index; European Equities represented by MSCI Europe Gross Total Return Local Index; Italy Equities represented by MSCI Italy Index (MXIT Index); Spain Equities represented by MSCI Spain Index (MXES Index); Greece Equities represented by MSCI Greece Index (MXGR Index). China Equities represented by MSCI China Net Total Return Local Index; U.S. Dollar (USD)represented by the Bloomberg Dollar Spot Index; Global Fixed Income represented by the Bloomberg Barclays Global Agg Total Return Index Value Unhedged USD; U.S. Fixed Income represented by the Bloomberg Barclays U.S. Agg Total Return Index Value Unhedged USD; Emerging Market Fixed Income represented by J.P. Morgan EMBI Global Core USD Index.
QSCR-18802 (June 2019)