Fund investors who bought into Wall Street's bearish "Sell in May and Go Away" mantra paid a hefty price last month as the stock market — led by large growth — resumed its upward climb on AI-driven optimism.
A blowout earnings report on May 22 from AI chip leader Nvidia and its upcoming 10-for-1 stock split sent a reassuring message to investors. The artificial intelligence-driven stock market boom is still very much alive.
"It seems like there's nothing really to stand in the way of the ongoing strong momentum that we're seeing in the tech sector, and that obviously has continued to lift the broad market," said Conor Muldoon, co-manager of Causeway Global Value Equity Fund.
Stock Market: Don't Go Away In May
In May, the average U.S. diversified stock mutual fund gained 3.78%, according to Lipper Refinitiv data, erasing a big chunk of April's 4.8% decline. In a sign of the market's continued momentum, both the S&P 500 (up 4.96% in May and 11.3% year to date) and Nasdaq (up 6.98% last month and 11.82% in 2024) posted their best May returns since 2003.
The S&P 500 posted its 24th record high of the year on May 21, according to S&P Dow Jones Indices. The blue-chip Dow Jones Industrial Average lagged, rising 2.3% in May, boosting its year-to-date gain to 2.64%.
Stocks got needed relief from the bond market, where the yield on the 10-year Treasury ticked down nearly 20 basis points to 4.5% after spiking above 4.7% in late April. The rate decline provided a boost for fixed-income investors. In May, general bond funds rose 1.54%, general U.S. Treasury funds gained nearly 2%, and high yield funds gained 1.16%.
Watching Inflation
Inflation worries abated a bit, too, as did fears of a Fed rate hike. The CPI in April declined to 3.4%, down from 3.5% in March. Traders now place 55.3% odds on a quarter-point Fed rate cut at the central bank's September meeting and 40% odds that rates will be half-of-a-percentage-point lower after the Fed's December meeting. The Fed's key short-term rate is now 5.25% to 5.5%.
The "growth is good" stock market story is illustrated by the names of the funds that rose to the top of the stock ETF performance list. Sure, Invesco WilderHill Clean Energy ETF posted the best performance in May with a 12.81% gain. But the rest of the top-10 performers were all about growth, momentum and innovation.
Fidelity Blue Chip Growth ETF clocked in with a 7.87% gain last month. The Innovator IBD 50 ETF jumped 7.44%. Invesco S&P 500 Momentum ETF rallied 7.34%. And Vanguard Mega Cap Growth ETF rose 6.95%. Similarly, Vanguard Growth ETF, the largest ETF measured by assets, posted a 6.32% return, the best return of the top 10 biggest ETFs.
Finding Winners In The Stock Market
When it comes to returns by market cap and style in the mutual fund world, large-cap growth also led the way in May with a gain of 5.41%, according to Lipper Refinitiv. The next best was S&P 500 index funds' 4.92% gain. In the small-cap and midcap space, value funds posted better returns than growth funds.
Solid corporate profit results, softer inflation data, an eventual Fed pivot to lower rates and surging investment in AI infrastructure are bullish trends. They prompted David Lefkowitz, chief investment officer and head of U.S. equities at UBS Financial Services, to boost his year-end S&P 500 target to 5,500 in late May. "Those four (bullish) things are still in place," said Lefkowitz. "So, it's still a constructive environment."
Plugging Into AI
The power of AI in driving markets shouldn't be underestimated, says Lefkowitz. "It's the very early days," said Lefkowitz. "You've got very deep pocketed tech companies with so much capital to deploy. What we're seeing now is a race to be in the game, and potentially be a leader in the development of these AI tools. And that's a really big story."
When it comes to stock investing, Lefkowitz says investing in tech companies who make key AI components that are in short supply or have overwhelming demand is a good way to go. "Look for the bottlenecks," said Lefkowitz, noting that investors should monitor shortages in GPUs, which are key chip components in machine learning, or memory chips or electrical transformers. "That's where we're seeing some outsized profit moves," he said.
He's also bullish on the industrial sector, citing these catalysts: resilient economic growth, improving manufacturing sentiment, aerospace demand and the re-industrialization of the U.S. economy.
Parsing The Stock Market Sectors
In sector performance, utilities funds surprisingly ended up at the top. They gained 8.13% amid growing demand for power to keep AI and cloud computing centers humming. Precious metals equity funds were second-best with a gain of 7.2%. Metals are booming as demand for industrial uses rise. Telecommunications funds rose 6.98%, and science and technology funds gained 5.11%.
The growth vs. value divide is highlighted by the Vanguard Growth Index (VIGRX) rising 6.4% last month, vs. a 2.93% increase for Vanguard Value Index (VIVAX).
In terms of risks, Muldoon, the value manager at Causeway Funds, cites economic headwinds caused by the prolonged period of high interest rates. A slowdown in GDP, such as the recent downward revision of first quarter growth to 1.3% from 1.6%, is something to watch out for. "If the economy starts to slow, that could be a headwind for earnings," Muldoon said.
Growth Tops Value, Again
Muldoon says there is more value in stocks outside the U.S. The market multiple for the S&P 500 is around 22 times, while overseas markets trade between 10 to 15 times earnings, Muldoon says. The only member of the Magnificent Seven megacap techs he owns is Alphabet. "We think Alphabet is going to be an AI winner," said Muldoon.
Causeway Global Growth Equity, which is a 2024 IBD Best Mutual Funds Award winner, takes a bottoms-up approach to stock picking and looks for stocks trading at a material discount to fair value. One foreign stock Muldoon is bullish on is top-holding Rolls-Royce Holdings, which he says is rebounding from a tough go after the pandemic. While the U.K. company is best-known for its automobiles, its aircraft engine business is also attractive from a cash flow generation standpoint.
Muldoon also likes over-the-counter stock Kering, the French-based luxury goods maker known for brands such as Gucci, Saint Laurent and leather goods maker Bottega Veneta. The company, due to sales headwinds in Asia and a recent transition at Gucci, is now selling at half the P-E multiple of its luxe peers like LVHM and Hermes, says Muldoon. "We think it has material upside over the next two years," said Muldoon.
In the financial space, Muldoon likes UK-based bank Barclays. The appeal is a P-E of around six and it plans to return close to a third of its market value over the next three years to shareholders. "Buybacks tend to be very accretive," said Muldoon.
How Bonds Are Faring
Core bond funds, which track the benchmark Bloomberg U.S. Aggregate Bond index and hold a broad mix of investment grade bonds, gained 1.7% in May. That trims the 2024 loss to -1.19%.
The slowing GDP growth in the U.S. coupled with still-plump bond yields, however, offer good risk-reward metrics for bond investors, says Celso Munoz, manager of Fidelity Total Bond Fund (FTBFX), a 2024 IBD Best Mutual Fund Award winner.
"There's a lot to be excited about within fixed income looking forward," said Munoz.
A big part of the upbeat bond investing story has to do with the high starting point for yields, says Munoz. Bond yields are near 20-year highs. And that extra yield provides a sizable margin of error in the event inflation remains stubborn and the Fed becomes more hawkish and must push rates even higher and bond prices fall. "Where yields are right now, there's a lot of income, and that gives the bond market a lot of cushion," said Munoz.
The risk/reward for bondholders with yields around 5% are in their favor, says Munoz. Here's how the upside and downside math work. If bond yields climb a full percentage point to 6%, because the bond market has a duration of around six years, your capital loss will be 6%. "But you also have income of 5%, so net you're down just 1%," said Munoz.
On the bullish side, if rates fall a full point from 5% to 4%, you'll get 6% in capital appreciation on top of the 5% yield. "That's an 11% total return," said Munoz. "So, in this simple example, on the downside you have a negative 1% return and on the upside you've got an 11% return."
Positive Returns For Bonds
And right now, of the more than 5,000 rate simulations Fidelity runs daily, 80% of those scenarios result in a positive bond return over the next 12 months, adds Munoz. Currently, Munoz is positioned in intermediate-term Treasury and short- to intermediate investment grade corporate bonds that benefit from high yields but are also well-positioned for capital appreciation when the Fed finally moves to cut rates.
Mutual Funds Lift The Stock Market
Green arrows were plentiful in May. Virtually every type of mutual fund posted gains, Lipper Refinitiv fund data shows. Betting against bonds and stocks did not pay off. Dedicated short bias funds, which make money when stocks fall in value, cratered 6.74% last month. Similarly, the worst-performing bond ETF was Simplify Interest Rate Hedge (PFIX), which posts positive returns when yields rise, but declined 8.47% in May, trimming its year-to-date gain of 25.09%.
And the stock gains weren't just confined to the U.S. World equity funds rose 3.72%, just shy of gains of U.S. diversified funds. The big region winner was Europe region funds, which gained 6.13%. Japanese funds rose 2.32% and Pacific region funds gained 2.3%. Value funds outpaced growth in both the large-cap and small-cap categories.
Cash kept its steady pace of returns as the Fed stands pat with rates. Money market funds gained 0.4%, boosting their one-year return to 4.78%. Still, that nearly 5% return pales in comparison to the 28.19% one-year return for the S&P 500.
