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May Market Rally – questioning its sustainability

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Over the month of May, the covid-19 pandemic remained the centre-focus for financial markets, overshadowing even the spark of US-China tension escalations. Equity markets continued on their recovery, with US and European equity indices rallying circa 5%, as risk appetite increased.

The May equity market rally reflected a positive performance across all sectors, but was characterised by a sector rotation into more risky assets. Given their defensive qualities in a risk-on period, the health care and consumer staples sectors were the key monthly laggards, alongside the energy sector. Meanwhile the sectors most exposed to a business cycle recovery outperformed the market across both geographic regions, with most notably the industrials and materials sectors and consumer discretionary stocks which led the gains.

The technology sector, particularly in the US, remained the clear winner for the year, providing downside protection when markets sank and gaining as the equity market continues to recover. On a year-to-date basis, the Nasdaq, which represents the largest US technology companies has outperformed the general US equity market by 10%. The cloud-computing stocks continued to boost the technology sector performance, as companies such as Amazon and Microsoft managed to reach new all-time highs during the month of May.

The surge in equity prices during the month of May was driven by a more positive growth outlook to the economy that is primarily based on three key developments: the peaking of covid-19 cases and easing of lockdowns, announcements from key vaccine developers and the expectations for continued economic stimulus from governments and monetary authorities.

With the number of cases reaching a peak across most developed economies, governments initiated their exit plans from the emergency phase of the pandemic. So far, the equity markets have rewarded economies that are reopening. Needless to say, the emergency phase reflected drastic action to manage the containment of the novel coronavirus and the name itself suggests that the phase was always expected to be temporary in nature.

While noting that the re-opening of economies is an encouraging signal to economic expectations, the level of economic output will be far below capacity. This is where economic stimulus comes into play. Markets continue to price in further support to bridge the gap in economic output as governments shut down economies. Case in point, last week, the European Commission proposed the largest stimulus package in history; a €750 billion EU Recovery Plan to battle the economic recession triggered by the covid-19 pandemic.

Going forward, the key catalyst remains the speed of economic recovery. The equity market rally from March lows, especially in the US, has been both fast and significant. The S&P 500 is up 32% from the trough and only 12% down from its all-time high, suggesting a much faster economic recovery than initially estimated. However, the high risk for US China trade tension escalations and the occurrence of a second wave both present downside risks to the current valuations.

Disclaimer:

This article was issued by Rachel Meilak, CFA Equity Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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