The old adage of ‘sell in May and go away’ may not apply this year as investors seem to be looking through concerns such as a US debt default, high inflation and an uneven recovery in China. The economic outlook for the UK and Japan is improving and China is continuing its recovery, albeit unevenly. Even though the US Federal Reserve raised rates again, Fitch, the credit ratings agency, placed the US country's ‘AAA’ rating on watch for a possible downgrade as the growth investment style continued its domination in 2023, lifting tech indexes to almost double digit returns in May.

Regions

The possibility of the US defaulting on its debt took centre stage in May. If it happens, it could be catastrophic for markets. Despite this the S&P 500 rose 1.80%, helped by tech stocks. Fitch placed the US gold plated ‘AAA’ rating on watch for a possible downgrade over the debt ceiling standoff. While a default could spell disaster, a satisfactory conclusion to the talks could lead to a market rally. The US Federal Reserve (Fed) raised rates again in May to 5.00 - 5.25%.⁽¹⁾ While signalling it may pause raising interest rates in the months ahead, indications are that the Fed is unlikely to cut rates in 2023, even if there is a mild recession in the second half of the year. US Gross Domestic Product (GDP) growth rose quarter on quarter to 1.3% which was more than the 1.1% forecast, while consumer confidence was stronger than expected, suggesting consumers remain optimistic on increased consumption growth ahead.⁽²⁾

The IMF upgraded its outlook for the UK economy, stating it now expects the country to avoid a recession in 2023.⁽³⁾ Despite the 12th consecutive rate rise to 4.50% by the Bank of England, the improving growth outlook for the UK means that they are not finished with rate rises yet in order to control inflation. This is due to a tight labour market, with fewer available workers leading to employers having to offer higher wages to attract and retain staff, resulting in increased inflation. The Bank of England remains consistent in their message that further rate rises may be necessary.⁽⁴⁾ The UK inflation rate fell to 8.7%, the first dip below double digits since August 2022, though it was above consensus estimates of 8.2%.⁽⁵⁾ In May, UK stocks slipped, returning -3.98%.

The European Central Bank shared a similar message to the Bank of England in May as it too raised rates again, saying it will keep increasing borrowing costs until it sees core inflation decline sustainably. Germany’s DAX index hit a record high while also becoming the largest economy in Europe to enter a technical recession, as Germany’s growth data for Q1 was revised lower. A technical recession is widely regarded as two consecutive quarters of negative growth. The MSCI Europe ex-UK index reported European stocks slipping, returning -4.33% after a strong run over the past few months.

Japan's Nikkei 225 index rose to its highest level since 1990, up 5.79%, as investors eye low valuations and corporate reforms as potentially leading to a more sustainable recovery. In May, Japan reported core inflation rising year-on-year to 3.4% in April, remaining above the Bank of Japan's target of 2%.⁽⁶⁾ (Core inflation is the change in the costs of goods and services but does not include those from the food and energy sectors). Despite inflation above the target rate, the Bank of Japan's governor Kazuo Ueda recently warned of the ‘extremely high’ cost of premature monetary tightening that would dampen prospects of attaining a stable 2 percent inflation rate, giving investors some optimism that any growth prospects in the region are not likely to be dashed in the short-term. The region is currently trading on a price-to-earnings (PE) ratio of 17.6 compared to the S&P 500 trading at 22 times earnings. (The price to earnings ratio measures the share price of a stock compared to its annual profits. It is often used as a measure of how expensive or cheap a stock is; a higher PE ratio could indicate an over-valued investment, whilst a lower PE ratio could indicate a more attractive investment).

China's recovery continues to be lumpy, as evidenced by its April industrial production and retail sales data, reported in May, which missed expectations. Despite the data coming in lower than forecast, it continues to improve. The Chinese stock market was the worst-performing region in May with the MSCI China H Index returning -5.03%, as investors remained nervous about geopolitical and policy risks. Despite China’s performance, emerging markets finished the month down slightly, with the MSCI Emerging Market index returning -0.29%, helped by the MSCI India index rising 4.36%, improving on gains made in previous months.

Assets

Growth as an investment style has been firmly back in the driving seat in May, with the MSCI ACWI Information Technology and Communication Service index rising 9.67% and the Nasdaq up 9.88%. Elsewhere, commodities fell, returning -4.13%, which illustrates the point further.

Equities were the standout asset class again in May, rising despite the shadow cast by the US debt ceiling negotiations. All other asset classes fell, with infrastructure and REITs being the worst performers. Equities, as represented in this report by the MSCI World Index, gained 0.40% over the month.

Bloomberg Sterling Gilts were down considerably, returning -4.54%, as investors added to bets that high inflation will force the Bank of England to carry on raising interest rates. ICE Bofa US Treasuries returned -0.28% in May as elevated worries about a default pushed yields higher. The Bloomberg Global Aggregate index of bonds returned -0.84%.

Gold and silver saw big corrections in May off the back of US debt-ceiling talks and strong gains in previous months, sliding to a two-month low at one point. In sterling terms, gold returned -1.32%, in May, based on the LBMA Gold Bullion Sterling Troy Ounce index.

REITs and infrastructure investors remain concerned that stubborn inflation will continue to see rates rise and increase the borrowing costs for the asset classes. Rising government yields are competing for the riskier returns offered by these assets. It is worth noting that the contractual components of these asset classes that aim to protect against inflation through contractual lease or rental payments tend to have a c.12-month lag before the benefits start to be realised by investors. MSCI ACWI REITS index returned -3.58%.

Considerations for long-term investors

The market is presenting a mixed picture. Europe's largest economy is in a technical recession whilst the IMF is backtracking on the possibility of the UK following suit this year. US equity market indicators suggest it is mostly overvalued to significantly overvalued, yet the NASDAQ has been rising at a fast pace year to date. REITs do not appear to be the inflation-protection asset class investors have been historically led to believe. Then there are various predictions to consider, such as Japan becoming a region that foreign investors should allocate to in their portfolios once more. Additionally, there is anticipation that inflation will settle at higher rates than we have become accustomed to, along with the eye-watering debt levels of governments. Whilst it can be challenging to stick to a long-term investment strategy amidst this noise, it is still crucial to have one.

With a constant news flow, predicting market direction and timing investments can be difficult. It is essential to have a well-diversified portfolio and many investors use pound cost averaging to smooth out market volatility. Regularly reviewing and rebalancing your portfolio to align with your objectives and changing personal circumstances is also important.

It has also never been more important to understand what you’re buying. When it comes to investing this means understanding the funds and the managers that you’re choosing. Want more insight into the fund you invest in or are thinking of contributing to? As a TILLIT customer you can now access our Investment Committee Quarterly Reports, where you can find the fund reviews we conduct each quarter. Not got an account? Open an account today and get instant access to all reports. Or do you have a question for one of our managers? You can now ‘Ask a fund manager your questions’ and we will seek out their response on your behalf.

Sources: FE Analytics (monthly performance figures for funds and market 30/04/2023 to 31/05/2023). Qualitative commentary from TILLIT meetings with fund managers.Index returns are expressed in sterling terms unless otherwise stated.

(1) Source: US effective federal funds rate

(2) Source: US GDP

(3) Source: IMF UK recession

(4) Source: UK base rate

(5) Source: UK headline inflation rate

(6) Source: Japan core inflation rate

Date of publication: 2nd June 2023