Market Recap 5/31/2024: Dow Leads Monthly Gains

U.S. stocks ended the week on a high note, rallying sharply on Friday after fresh inflation data came in largely as expected, bolstering hopes for a potential pause in the Federal Reserve’s rate-hiking campaign. The Dow Jones Industrial Average led the charge, surging 1.5% in its best session of the year to close at 38,686.32. The S&P 500 also gained ground, climbing 0.8% to 5,277.51, while the Nasdaq Composite finished flat at 16,735.02.

Key Takeaways

• Dow jumps 1.5% on Friday, posts 2.3% monthly gain despite weekly dip
• S&P 500 rises 0.8%, ends week down 0.5% but rallies 4.8% in May
• Nasdaq flat, slips 1.1% for week but leads May advance at 6.9%
• Core PCE inflation meets expectations at 0.2% MoM, 2.8% YoY
• 10-year Treasury yield falls as rate cut expectations build
• Dell sinks on AI cost warning, Salesforce rebounds on robust outlook

Inflation Picture Clears, but Tech Struggles Persist

The main catalyst for Friday’s rally was the release of the April Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge. The core PCE, which excludes volatile food and energy prices, rose 0.2% from March and 2.8% from a year earlier, matching economists’ forecasts.

The tame inflation reading was seen as a green light for the Fed to potentially pause its rate-hiking cycle at its upcoming meeting in June. While policymakers have signaled that they are not yet done tightening, the absence of any upside surprise in the PCE data suggests that the central bank may have room to take a more patient approach in the months ahead.

The prospect of a less aggressive Fed helped fuel a broad-based rally in stocks, with economically sensitive sectors like consumer discretionary and industrials leading the way. Shares of companies that have been battered by concerns about rising borrowing costs, such as homebuilders and automakers, also posted strong gains.

However, the technology sector continued to struggle, with the Nasdaq underperforming its peers for much of the week. The sector was weighed down by ongoing concerns about slowing demand for tech products and services, as well as warnings from some companies about rising costs associated with the push towards artificial intelligence (AI).

Dell Technologies was a notable laggard, with shares plunging nearly 18% after the computer maker forecast lower profits due to the high costs of building AI-capable servers. The warning underscored the challenges some tech companies face as they race to capitalize on the AI boom while also grappling with supply chain disruptions and margin pressures.

Dow Shines in May as Value Stocks Outperform

Despite Friday’s strong showing, the major indexes still ended the week in the red, with the Dow and S&P 500 slipping 1% and 0.5%, respectively, and the Nasdaq falling 1.1%. However, all three gauges posted solid gains for the month of May, with the Dow leading the way at 2.3%.

The outperformance of the blue-chip index reflected a broader rotation into value stocks, which have been benefiting from the economy’s resilience and the Fed’s efforts to keep inflation in check. Shares of consumer stalwarts like McDonald’s and Home Depot rose sharply on Friday, as investors bet that the combination of stable prices and rising wages would continue to support consumer spending.

The healthcare sector was another bright spot, with shares of insurers like CVS Health climbing on optimism about the industry’s prospects under a divided government in Washington. The sector has been buffeted by policy uncertainty and cost concerns in recent years, but some investors see value in the group’s defensive characteristics and attractive valuations.

With traditional long/short equity strategies struggling to navigate the market’s twists and turns, some hedge funds are turning to convertible arbitrage as a way to generate returns and manage risk. The strategy involves buying convertible bonds, which can be exchanged for shares of a company’s stock while simultaneously shorting the underlying shares.

The goal is to profit from the price discrepancies between the two securities, which can arise due to changes in interest rates, credit spreads, or volatility. When done correctly, convertible arbitrage can offer investors a way to generate steady returns with lower correlations to the broader market.

Hedge fund giants like Man Group have been leading the charge into the space, with the firm’s AHL unit recently launching a new convertible arbitrage strategy. Other prominent managers, including Citadel and Millennium Management, are also said to be ramping up their exposure to the trade.

The renewed interest in convertible arbitrage comes as the market for convertible bonds has been booming, with issuance hitting a record high last year as companies sought to raise cash amid the pandemic. The surge in supply has created more opportunities for hedge funds to find mispriced securities and exploit inefficiencies in the market.

However, the strategy is not without risks, as the complex structure of convertible bonds can make them difficult to value and trade. Managers must also be careful to manage their exposure to interest rate and credit risks, which can quickly erode returns if not properly hedged.

Conservative Investors

With inflation showing signs of stabilizing and the Fed potentially nearing the end of its rate-hiking cycle, conservative investors may want to consider adding some duration to their bond portfolios. Look for high-quality corporate and municipal bonds with maturities in the 5-10 year range, which could benefit from falling rates and tightening credit spreads. Dividend aristocrats and low-volatility stocks may also offer a measure of stability in a still-uncertain market.

Growth Investors

Growth investors may want to focus on companies that are benefiting from long-term secular trends, such as cloud computing, cybersecurity, and renewable energy. While valuations in some of these areas have become stretched, there are still opportunities to find reasonably priced stocks with strong growth prospects. Healthcare and consumer discretionary are other sectors that could see robust demand as the economy continues to recover.

Opportunistic Investors

For investors with a higher risk tolerance, the recent pullback in some tech stocks may present buying opportunities, particularly in areas like AI and semiconductor equipment that are seeing strong secular tailwinds. Convertible bonds and other hybrid securities may also offer attractive risk/reward profiles for investors looking to generate income and participate in equity upside. As always, diversification and rigorous due diligence are key to managing risk in a volatile market.

Our Take: Goldilocks Scenario in Play, but Risks Remain

The combination of stabilizing inflation, solid economic growth, and a potentially less hawkish Fed has created a “Goldilocks” scenario for stocks in recent weeks. With the PCE data coming in largely as expected and Treasury yields falling, investors are increasingly betting that the central bank may be able to engineer a soft landing for the economy.

However, we caution against getting too complacent in the face of the market’s recent strength. While the inflation picture has indeed improved, price pressures remain elevated by historical standards and could quickly reaccelerate if growth picks up steam in the second half of the year. Moreover, the Fed has made clear that it is not yet done tightening, and any signs of renewed economic vigor could prompt policymakers to ramp up their hawkish rhetoric.

At the same time, the tech sector’s headwinds cannot be ignored, with rising costs and slowing demand threatening to weigh on profits in the quarters ahead. While the long-term outlook for many of these companies remains bright, investors may need to be more selective in their exposure and prepare for a period of heightened volatility.

Given these crosscurrents, we believe that a balanced approach to portfolio construction remains prudent. By maintaining exposure to both growth and value stocks and a mix of cyclical and defensive sectors, investors can participate in the market’s upside while also building resilience against potential downturns.

The holiday-shortened week ahead will be relatively light on economic data, but there will still be plenty for investors to chew on. The May jobs report will be the main event, with economists expecting another solid month of payroll gains and a further decline in the unemployment rate. A stronger-than-expected reading could reignite fears of wage inflation and prompt a hawkish response from the Fed.

Other data points to watch include the ISM manufacturing index, factory orders, and the trade balance, all of which will provide clues on the health of the industrial sector and global trade flows. Investors will also be keeping a close eye on developments in Washington, where lawmakers are still haggling over a deal to raise the debt ceiling and avert a potentially catastrophic default.

On the earnings front, a smattering of notable companies, including Zoom Video Communications, CrowdStrike Holdings, and Lululemon Athletica, are slated to report results. While the bulk of earnings season is now over, these reports could still provide insights into key trends in the tech, cybersecurity, and consumer discretionary sectors.

Finally, geopolitical tensions will remain a wild card, with the ongoing war in Ukraine and rising frictions between the U.S. and China over Taiwan threatening to disrupt the market’s fragile calm. Investors should stay attuned to these risks and be prepared to adjust their portfolios as conditions evolve.

Views expressed here should not be considered personal investment advice.

Sources:

Investopedia

Reuters

MarketWatch

Hedgeweek