Market Review

Global equities experience their strongest May since 2020 as markets rebound to all-time highs

The common investment adage “sell in May and go away” proved to be more myth than fact this year, as the MSCI All Country World Index recovered from a 5% pullback to reach new highs during the month. The brief pullback and subsequent recovery were a testament to the positive momentum supporting markets. Performance during the month largely reversed April’s trends, as domestic equities outpaced their global counterparts, large-cap stocks outperformed small, and quality growth led over value.

In May, interest rates moved lower on data that indicated slowing economic growth, which led to positive fixed income returns for the month. One key economic release during the month was the second revision to first-quarter 2024 U.S. real GDP growth. It was revised lower to an annualized rate of 1.3% from 1.6%, due to a notable decline in personal consumption growth from 2.5% to 2.0%. The decline leaves GDP at the weakest growth rate since it turned negative in the first half of 2022. Despite the revision, other economic data continues to suggest the business cycle is in a slowing expansion phase and does not face an imminent slowdown. 

Theme of the Month

Market concentration, a sign of the times

 As domestic large-cap equity performance climbed higher in May, the price ratio of the S&P 500® relative to its Equal Weight Index reached the highest level since 2009 (Figure 1). This rising market concentration has drawn significant attention, particularly as many of the stocks leading the market also have above-average valuations. Furthermore, given mega-cap tech is leading the pack, some comparisons are alluding to the late-1990s “dot-com” era and pondering whether valuations are reaching unsustainable levels.

Figure 1. Price Ratio of the S&P 500 Relative to its Equal Weight Index
Market concentration is increasing, but remains far from extreme levels

Source: As of 5/31/2024. Source: Bloomberg L.P.

 

View accessible version of this chart.

Despite the fanfare around the perils of market concentration in the media, we believe much of the hype is unfounded and, rather, reflects the dynamics of the current business cycle environment. Furthermore, seemingly elevated valuations among market-leading stocks are, in our view, backed up by fundamentals, making a bubble unlikely. Here are six aspects of the current period of market concentration we believe are missing from the narrative: 

  • Historical context: Market concentration occurs with relative frequency and is not unique to the current environment, nor is it approaching extreme levels relative to history. Based on Figure 1, there remains a significant gap between current levels and those of the dot-com era. Additionally, we would not expect approximately one third of S&P 500 stocks to be outperforming the overall index through the end of May, as was the case, if market concentration was at troublesome levels.
  • Ubiquity: Market concentration is not unique to U.S. large-cap stocks. Several asset classes across global markets are facing heightened levels of concentration, including the Russell 2000®, MSCI Europe and MSCI Emerging Markets indices. For example, the Russell 2000 was up approximately 3% through the end of May, while on an equal-weight basis, the index is negative for the year. 
  • Earnings: The concentrated market narrative extends beyond performance, as earnings growth has also been narrowly led. While the concentrated group of stocks leading the market have high valuations, we believe these valuations are supported by fundamentals. This subset of companies continues to deliver outsized earnings growth, free cash flow and profit margin expansion amid a challenging macroeconomic environment. The same holds true for companies that have not fared as well; we believe their valuations reflect their underlying fundamentals. For example, both the Russell 2000 and MSCI Europe indices had just two sectors deliver positive earnings growth in 2023, and earnings revisions for 2024 have already been cut in half for both indices since the start of the year.
  • The macro environment: In our view, the divergence between the companies thriving and those that are not, reflects the macro environment, which is characterized by elevated inflation and high interest rates across the globe. This phenomenon is particularly pronounced in developed markets where economies rely heavily on consumers and services. For a small subset of leading companies in innovative industries, macro conditions are less of a headwind, and therefore their earnings keep growing while those of their peers slow, ultimately widening the performance differential.
  • Diversified leadership: While most investors are familiar with the mega-cap “Fab 5” U.S. stocks — Microsoft Corp., Amazon.com Inc., NVIDIA Corp., Alphabet Corp. and Meta Platforms Inc. — they are not the only market leaders. For example, the majority of the Russell 2000’s performance leadership stems from just two stocks; a semiconductor company and another company that is heavily invested in bitcoin. Within the MSCI Europe Index, leadership similarly stems from a semiconductor company, as well as pharmaceutical companies manufacturing the trending GLP-1 diabetes and weight loss drugs. Emerging markets have been led by several semiconductor companies as well as a rebound in equities in China. The macro headwinds and tailwinds vary by region, but what these companies have in common is strong, innovation-driven demand that supports growth even amid challenging environments. For example, certain companies continue to thrive in Europe despite continued high inflation and nonexistent economic growth (Figure 2). Despite this backdrop, innovative companies continue to be met with strong demand for their products, enabling strong earnings growth, solid balance sheets and low leverage.

Figure 2. Inflation and GDP by Region 
Concentrated markets reflect the current phase of the global business cycle

Region

3-mo. Avg. CPI (y/y)

10 GDP (q/q)

China

0.4%

1.6%

Europe

2.5%

0.3%

U.S.

3.3%

1.3%

Source: As of 5/31/2024. Source: Bloomberg L.P.

  • Phase of the business cycle: As the slowing expansion phase of the business cycle continues, concentrated market and earnings leadership are not surprising, because the slowing expansion suggests the economic cycle in aggregate is weakening. However, while some areas may already be in a recession, there remain drivers of the expansion — in this case, semiconductors, pharmaceuticals and large-cap tech — which are still flourishing.

So, what’s an investor to do? While concentration may persist for some time, as we see no immediate change to current market drivers (i.e., high inflation and interest rates), we underscore that the underlying stocks comprising the concentrated leadership can certainly change. Thus, we recommend maintaining a diversified portfolio across asset classes and geographies, with a focus on exposures to quality stocks. Overall, we view the current market’s narrow leadership as emblematic of the current phase of the business cycle.

For more information, please contact your PNC advisor.

TEXT VERSION OF CHARTS

Figure 1: Price Ratio of the S&P 500 Relative to its Equal Weight Index
Market concentration is increasing, but remains far from extreme levels (view image)

Date

Ratio

S&P500 and Equal Weight Same Price level

12/1989

1

1

4/1994

0.92

1

8/1998

1.13

1

11/2002

0.9

1

3/2007

0.73

1

7/2011

0.65

1

10/2015

0.65

1

2/2020

0.71

1

5/2024

0.79

1

Source: As of 5/31/2024. Source: Bloomberg L.P.

Figure 2:  Inflation and GDP by Region 
Concentrated markets reflect the current phase of the global business cycle (view image)

Region

3-mo. Avg. CPI (y/y)

10 GDP (q/q)

China

0.4%

1.6%

Europe

2.5%

0.3%

U.S.

3.3%

1.3%

Source: As of 5/31/2024. Source: Bloomberg L.P.