The Big Picture
May offered equity investors plenty to celebrate, even as the broader macro backdrop remained uncertain. Stocks climbed to fresh all-time highs fueled by one of the strongest earnings seasons in years — a testament to the resilience of corporate America and AI-driven growth. But the month was not without turbulence, as a series of unsettling headlines took turns rattling markets before equities found their footing and pushed higher. For investors, May was a useful reminder that strong corporate earnings can carry markets a long way even when the headlines related to geopolitical tensions and inflation are anything but reassuring. Once again, the market demonstrated its tendency to climb a wall of worry, rewarding those who stayed the course despite the noise.
What Moved Markets in April
If there was one theme that defined May’s market advance, it was the strength of corporate earnings. With 84% of S&P 500 companies beating first-quarter earnings estimates as of May 11th — the highest beat rate since Q2 2021 — investors had plenty of fundamental reasons to push stocks higher. AI-related capital spending continued to surge, with semiconductor stocks reporting strong results in May and reinforcing confidence that the AI investment cycle has meaningful runway ahead. However, valuations remain elevated, and the market continues to price in a strong growth outlook.
Alongside the earnings optimism, investors kept a close eye on two key variables: oil prices and the Iran situation. Elevated energy costs have been a primary driver of the recent uptick in inflation, with May’s CPI reading coming in at 3.8%. Higher oil prices are a double-edged concern — they squeeze consumers and make the Federal Reserve’s job harder, raising the risk that interest rates stay higher for longer. Late in the month, markets got a dose of cautious optimism when President Trump stated that a peace deal to reopen the Strait of Hormuz was ‘largely negotiated’ — though as of month-end, no final agreement had been announced and the Strait effectively remained closed to commercial shipping. Oil prices fell sharply on the news, though mixed signals kept investors from fully embracing the development.
One theme worth continuing to monitor is the growing concentration at the top of the S&P 500. The index’s ten largest companies now account for roughly 40% of its total weight — more than double the concentration seen just a decade ago. This means that index investors are increasingly exposed to the fortunes of a small group of mega-cap technology names. While those names have delivered, the lack of breadth is a risk factor that bears monitoring as valuations stretch and the AI narrative matures.
Performance Snapshot
Equity markets extended their rally from the previous month, delivering broad gains yet again in May. The S&P 500 rose 5.3%, the Nasdaq Composite added 8.4%, and the Dow gained 2.9%. Small caps participated as well, with the Russell 2000 climbing 4.4% — an encouraging sign that the rally extended beyond mega-cap technology names.
At the sector level, Technology continued its remarkable rally, leading all groups with a 19.8% monthly gain as AI enthusiasm and strong semiconductor earnings drove outsized performance. Health Care and Consumer Discretionary posted modest gains of 2.4% and 2.1% respectively. On the other end of the spectrum, Energy was the notable laggard, falling 5.6% as oil prices retreated on optimism surrounding a potential U.S.-Iran deal. Utilities also slipped 5.2%, reflecting investor rotation away from defensive names and into higher-growth areas of the market.
Treasury yields drifted modestly higher in May, with the 10-year note finishing the month at 4.45% and the 2-year note ending near 3.98%. With inflation still running above comfort levels and the Federal Reserve showing no inclination to cut rates, bond prices remained under modest pressure. Overall, fixed income continued to deliver exactly what it’s designed to — stable and modest returns in an uncertain environment.
Final Thoughts
Bull markets have a way of breeding exuberance, and the AI-driven rally of the past year is no exception. When a sector captures the imagination of investors the way AI has, valuations can stretch well beyond what fundamentals alone would justify. Whether the optimism around AI is justified remains to be seen, but this level of enthusiasm is certainly worth reflecting on.
AI is truly a revolutionary force, and there is good reason why the leading players have generated extraordinary returns in recent years. That said, when certain stocks are performing well, it can be tempting to “bet big” with the hope that strong performance will continue. As human emotions like greed and fear come into play, a confluence of biases can affect our decision-making, including overconfidence, recency bias, and fear of missing out.
P&A continues to believe in our core investment principles, which include maintaining adequate diversification and avoiding the trap of FOMO. We want to participate in the continued growth of the AI industry, while also being mindful of the risk of becoming overexposed should valuations get ahead of themselves and the cycle turn.
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