May 2024: Market rally fueled by improving inflation and strong earnings

The month at a glance

Equity markets rallied in May as inflation fears eased and company earnings reports were generally strong. Inflation reports for April showed slower monthly price increases after unexpectedly rising in the prior month. The Fed’s preferred price gauge, the core Personal Consumption Expenditure index (PCE) — which excludes food and energy — rose 0.2% in April, down from the 0.3% increases in the prior two months.¹ The core PCE index remained at 2.8% above year earlier levels. After the Fed’s early May meeting, Chairman Powell indicated that inflation remains too high and expressed concern about the March inflation data, but also calmed fears that another rate hike, rather than a rate cut, was the Fed’s likely next move.²

The Fed also pointed to the continued strong economy. That strength was evident in solid Q1 corporate earnings growth. With 95% of S&P 500 companies reporting, trailing 12-month operating earnings were up almost 8% from a year earlier.³ The overall strength in earnings was underscored by especially strong results from market leader and artificial intelligence poster company NVIDIA.⁴

• Equity markets gains were strong across the board.⁵
• Fixed income returns also rallied as longer-term rates fell modestly. ^{6 7}
• 76% of S&P 500 companies have beaten earnings estimates for Q1.⁸
• NVIDIA reported Q1 earnings of $16.9 billion, a 629% increase from a year earlier.⁹
• Inflation came in cooler in April than in March for both the CPI and PCE indices.^{10 11}

Inflation eases, AI surges and market responds

A return to the slow, but steady progress on inflation narrative combined with continued strength in the economy and solid first quarter earnings to boost equity returns in May.

• The S&P 500 rose 4.96% for the month and is now up 11.3% year-to-date.¹²
• US large cap growth stocks returned to the market leadership, with the Nasdaq and the S&P 500 Growth indices up over 6.5%.¹³
• International stocks, both developed and emerging markets, trailed US indices.¹⁴
• Technology and communication services stocks once again show impressive gains.¹⁵
• Utilities continued their recent strong run.¹⁶

Slight pull back in interest rates boost fixed income

Longer term interest rates reversed course to start the month, with the 10-year rate falling 33 basis points between the end of April and May 15th. Rates rose in the second half of the month, but still ended down 14bp for the month.²⁰ The fall in long-term rates was matched by moves in the shorter end of the yield curve, so that the “inverted yield curve” measure (10-year rates less 2-year rates, for example) ended the month at -38bp, about the same level it has been since the end of February.²¹

• All segments except municipal bonds saw positive returns for May.
• Ultra short duration treasuries lagged other segments for the month.
• Emerging market bonds rallied after a very weak April.
• Preferred stocks, which tend to move with equities, moved back to the market leadership.

As NVIDIA (and big tech) goes, so goes the market  

All eyes were on NVIDIA’s first quarter earnings release on May 22nd and the company most associated with the AI revolution did not disappoint. Revenue for the first quarter ended April 28, 2024 came in at a record $26 billion, up 18% from the previous quarter and up 262% from a year ago.²² Operating earnings were also a record at $16.9 billion, up 21% from the previous quarter and up 629% from a year ago.²³ Management commented on the strength in their data centers as companies and countries partner with NVIDIA to “build a new type of data center — AI factories — to produce a new commodity: artificial intelligence”.²⁴ NVIDIA’s earnings growth has indeed been impressive and the stock price reflects an expectation that this trajectory will continue for the foreseeable future.

Investor enthusiasm for this AI revolution has fueled outsized price gains for the companies involved beyond NVIDIA. Earnings growth for the broader tech sector has far outpaced the full market, especially in the past several years, in support of the price gains.²⁶ Still, the valuations for many of these companies are high relative to history and other segments of the market. The price-to-estimated 2024 operating earnings ratio for the tech sector is currently 30.92x, compared with 22.09x for the full S&P 500.²⁷

Tech companies generally — and AI related stocks more specifically — are priced for perfection, or at least for continued astronomical growth in revenues and earnings. Any stumble in that path, especially from one of the bellwether companies, would rapidly unwind the lofty valuations. This could happen even if the AI revolution is transformative to the way the economy works and the way we live our lives. That broader macro outcome is already priced into stock prices. Since these companies have become such a major part of the overall growth in stock prices and earnings, it’s hard to see a scenario where a reconsidering of the earnings path does not bring about a broader market correction. Still, there are other parts of the market that show more reasonable valuations that would likely (finally) move to the market leadership. Investor’s would be wise to watch the path of the AI leaders as well as the breadth of the market for clues on the markets likely trajectory.

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^[1] https://www.bea.gov/news/2024/personal-income-and-outlays-april-2024

^[2] https://www.federalreserve.gov/newsevents/pressreleases/monetary20240501a.htm

^[3] https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx

^[4] https://www.thestreet.com/investing/stocks/nvidia-earnings-seal-big-tech-stock-dominance

^[5] https://www.spglobal.com/spdji/en/index-family/equity/

^[6] https://www.spglobal.com/spdji/en/index-family/fixed-income/

^[7] https://fred.stlouisfed.org/series/DGS10

^[8] https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx

^[9] https://www.macrotrends.net/stocks/charts/NVDA/nvidia/operating-income

^[10] https://www.bls.gov/news.release/cpi.nr0.htm

^[11] https://www.bea.gov/news/2024/personal-income-and-outlays-april-2024

^[12] https://www.spglobal.com/spdji/en/index-family/equity/

^[13] https://www.spglobal.com/spdji/en/index-family/equity/

^[14] https://www.msci.com/end-of-day-data-search

^[15] https://www.spglobal.com/spdji/en/index-family/equity/

^[16] https://www.spglobal.com/spdji/en/index-family/equity/

^[17] https://www.spglobal.com/spdji/en/index-family/equity/

^[18] https://www.nasdaq.com/market-activity/index/comp/historical  

^[19] https://www.spglobal.com/spdji/en/index-family/equity/

^[20] https://fred.stlouisfed.org/series/DGS10

^[21] https://fred.stlouisfed.org/series/T10Y2Y

^[22] https://nvidianews.nvidia.com/news/nvidia-announces-financial-results-for-first-quarter-fiscal-2025

^[23] https://nvidianews.nvidia.com/news/nvidia-announces-financial-results-for-first-quarter-fiscal-2025

^[24] https://nvidianews.nvidia.com/news/nvidia-announces-financial-results-for-first-quarter-fiscal-2025

^[25] https://www.macrotrends.net/stocks/charts/NVDA/nvidia/operating-income

^[26] https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx

^[27] https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx

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