The S&P 500 rose modestly in May, but foreign markets and smaller US stocks were lower. This is a continuation of what markets have experienced on the year, as a small number of mega-cap technology companies have become increasingly responsible for returns in the large company indices. This can be seen by comparing the divergence between the S&P 500 weighted by company size and the S&P 500 positions weighted equally.
As you can see from the chart above, the divergence started in March, coinciding with the regional banking crisis. Since then, much of the variation in returns appears to be related to enthusiasm over artificial intelligence (AI) and concentrated in a few very large companies that the market anticipates will benefit in one way or another. The excitement over AI technology may be warranted, but how much excitement should be incorporated into the valuation of a handful of companies is, in our minds, an open question. To us, it’s largely been a tale of two markets. One where perceived beneficiaries of AI generate much enthusiasm and another where the prevailing attitude seems more apathetic. We think that short-term moods tend to be more volatile than long-term fundamentals.
In the bond market, interest rates rose slightly as economic data seemed supportive of the current short-term interest rate regime. That led to bond price declines that outpaced the interest income generated. There is uncertainty as to the Federal Reserve’s next move. Board members have been sending mixed messages with some favoring a pause to assess the impact of previous interest rate hikes, while others favoring more hikes sooner.