Earnings Season & Defensive Sectors Lead Markets Higher in May

Markets regained their footing in May following their first down-month in 2024, as the S&P 500 rose 3.7%, mirroring the return of the MSCI All Country World Index, while the TSX moved to the back-burner with a 1.4% return as commodities dragged. On a sector level, U.S. Utilities led the way, rising 7%, followed by the regular Communications and Technology names. Energy, Consumer Discretionary and Industrial names lagged. It is unusual for defensive businesses to lead when the broad market is near or above all-time highs. Typically, this group wins during bear markets.

The rebound in May was sparked by a generally solid Q1 earnings season. Markets continue to digest economic data that is not revealing many surprises, as the Federal Reserve delays the start of a policy easing cycle. According to Factset, 78% of S&P 500 companies reported a positive earnings surprise, while 61% beat on revenue in Q1. The blended year-over-year growth rate in earnings is 5.9%, which marks the highest year-over-year growth rate since Q1 2022. Obviously with Big Tech’s impact on mostly market-cap weighted indices, it is important to focus there. All six (AAPL, AMZN, GOOG, META, MSFT) beat on both top- and bottom-line estimates, and more importantly, five of six registered share price rallies on their respective earnings reaction days. Rather than trying to guess any unknowable data point, we typically evaluate the reaction to the news to gauge what was already priced-in. In line with this, it was the Nasdaq that regained its leadership in May, rising 4.9%. Again putting positive news in perspective, the forward 12-month P/E ratio is now 21.1x which is above the 5- and 10-year averages of 19.2x and 17.8x, respectively. Sentiment remains frothy but as usual, timing is a difficult exercise when it comes to markets. Certainly, advancements in AI combined with an income-driven economic cycle have already started to make their way through corporate income statements, helping to expand margins and in turn earnings, but no doubt a great deal of optimism is reflected in price.

While it’s nice to daydream of a purely fundamentals-driven rally, the realist in us must respect the interrelationship of factors that are responsible for each market squiggle. The U.S. Dollar pulled back (DXY fell 1.6%) during the month and bond yields dropped across the curve. Both events helped grease the wheels of bullish sentiment. While economic data points like CPI fell in-line with expectations, we commented last month on the consensus building in a ‘higher for longer’ market narrative, so a reversal in U.S. Treasury yields’ rapid ascent was to be expected. With bond prices now approaching key resistance levels (yields falling) across the board, the next couple months will be telling to determine the likelihood of this being anything more than a relief rally. Similarly, U.S. dollar weakening acts as a loosening lever on the economy so more vulnerability will likely be necessary for equity markets to follow-through to the upside. Despite the dollar’s softness, commodities started to lose some of their steam. Copper opened the month up 11.8%, and without any specific news gave up almost all its gains in the final eight trading days of the month to finish up just 0.9%. Oil fell 5.5% to make it two successive monthly losses in a row, while gold reversed a strong start to finish up 1.3%. Grains, however, continued to claw back since their lows in early March, as wheat and soybeans both rose 11% and 3%, respectively. As always, with the markets watching key inflation data to gauge the Fed’s bias in their next direction of interest rate moves, it is important to monitor the push and pull of commodity prices.