May Wrap Up - Big but not so beautiful?

A back down on tariffs, a supportive US company earnings season and a big, albeit potentially less beautiful, tax bill in the USA combined to reverse recent market declines. Global markets rose 5.28% (MSCI World Net Index), despite a strong New Zealand dollar blunting some of those returns. It was a tougher month for fixed income investors with increased government spending, particularly in the US, denting confidence and putting upward pressure on long term interest rates.

A strong month for growth investors. It was the combination of a de-escalation of the trade war between the US and the rest of the World, China in particular, and strong corporate earnings growth that reignited investor enthusiasm.

Corporate earnings were a standout. We pay a lot of attention to the profitability and growth of companies. This is because ultimately it is the path of earnings that drives the value of shares. All other things being equal, strong profit growth over time translates to higher share prices. 

Profit results for US companies came out over May. They were very robust. The blended year over year earnings growth rate for S&P500 companies was 13.3%, well above initial expectations and marking the second consecutive quarter of double-digit gains. 

Once again it was technology stocks that were the standout. The Magnificent 7, the well-known tech giants including NVIDIA, Apple and Meta posted earnings growth of 27.7%, widely exceeding expectations and fuelling a strong rally in share prices. 

We are a little more cautious. Valuations of US shares in particular look stretched once again, trade tensions continue to bubble away under the surface, forward looking economic growth indicators are pointing to future weakness and rising interest rates, as we will discuss below, create risk. 

We have modestly less invested in growth assets than is typical in portfolios and are biased away from the US mega caps. We also initiated a risk mitigation trade in our KiwiSaver and Investment Funds portfolios during May which helps protect downside risk in the event of a sharp market fall. The enthusiasm of the past month looks a little misplaced in our view.

While the share market was breaking out the champagne, life for conservative investors was much tougher. 

In last month's commentary we talked about the idea of a multi polar world and the breakdown of US exceptionalism. One place this was being vividly demonstrated was in the fixed income markets. Specifically, there were signs of capital exiting US capital markets, resulting in rising long-term interest rates and a weakening US dollar.

This theme continued to play out in May with US treasury yields rising across the maturity curve. The two-year yield rose over 0.3% with 10-year and 30-year yields up around 0.25%. Rising interest rates hurt the value of existing fixed income investments leading to depressed returns. 

Sentiment wasn't helped by the passage of President Trump's "Big Beautiful Bill" through the Congress. Should this make it through the Senate it threatens, according to the Congressional Budget Office, to increase the US federal deficit by US$2.4t over the next decade taking US debt to gross domestic product (GDP) from around 98% at present to 125%. 

More debt equals more risk and resulted in a downgrade in the US credit rating by rating agency Moody's. Investors demand compensation for bearing more risk, hence higher interest rates. 

The impacts of this are being felt in more than just the US. Investors are waking up to the increased level of borrowing from governments all around the world. Interest rates are rising. For example, Japanese 10-year government rates have risen from near zero in much of the 2010s to circa 1.5% today. German bond yields currently sit at their highest level in over a decade. These are big moves and have a material impact on the value of other assets.

Our portfolios have been cautiously positioned with the expectation of these risks materialising but also reflecting concerns that inflation will be hard to stamp out and may surprise on the upside. This means we prefer corporate debt to government debt and prefer intermediate maturity bonds to longer maturity bonds.