Market Overview
Global equity markets advanced in May, as risk appetites continued to ebb and flow with each twist and turn on the inflation front.
With markets growing increasingly fearful about the potential consequences from stubbornly high inflation in the U.S., all eyes were on the Federal Reserve (“Fed”) during the month. As expected, the Fed held interest rates steady at a 23-year high in May, marking the sixth consecutive policy meeting that it has done so. More importantly for investors, the world’s most influential central bank commented that an interest-rate hike was unlikely, though it did acknowledge that progress in driving domestic inflation down towards its 2% target had slowed, which would probably necessitate a delay in lowering borrowing costs. The Fed’s remarks, along with news that the most recent data from a closely watched gauge of U.S. inflation showed a modest slowdown in price growth in April—the first such positive reading in four months—sparked a market rally fueled by revived hopes for rate cuts later this year. In subsequent weeks, however, a slew of mixed economic reports led global stocks to swerve between gains and losses, highlighting the topsy-turvy logic that has taken hold of markets lately: solid data has stoked fears that a strong U.S. economy would continue to put upward pressure on prices—thus potentially keeping interest rates higher for longer—while softer data has been cheered on hopes that a weaker economy would have the opposite impact. Stocks found themselves under additional pressure in late May from rising U.S. government bond yields stemming from worries about lukewarm demand at a U.S. Treasury auction. By the end of May, traders in future markets were betting that the Fed would lower interest rates by 25 basis points (“bps”) in September, assuming no further impediments to slowing inflation that could undercut stocks. The yield on the benchmark 10-year U.S. Treasury note ended May at 4.50%, 19 bps lower than a month earlier.
While persistent inflationary pressure will likely force the Fed to maintain a restrictive monetary policy stance until later this year, the interest-rate outlook in Europe was brighter. In the eurozone, the European Central Bank (“ECB”) was expected to lower rates in June despite data suggesting that inflation in the common currency bloc in May had ticked up for the first time in five months. While the disappointing inflation reading was seen as a temporary setback, it did cast doubt on the possibility that the ECB’s expected action in June will be the start of an aggressive rate-cutting campaign. In the U.K., news that domestic inflation in April had decelerated to its slowest rate in three years and was nearing the Bank of England’s 2% target fueled hopes that the British central bank will lower interest rates in the summer. In Sweden, Riksbank became only the second central bank from an advanced economy to start a monetary easing cycle when it lowered interest rates for the first time in more than eight years with a 25-bp cut. In May, the yield on the 10-year German Bund, Europe’s principal safe-haven asset, rose 8 bps, ending the month at 2.67%.
With the earnings season in full swing, investors got a clearer picture of how interest-rate headwinds have impacted company profits. In the U.S., 80% of the companies in the S&P 500 Index that reported results topped consensus estimates, which was above the long-term average of 67%. The first-quarter earnings growth rate is estimated to have increased 6.0% from a year earlier. In Europe, 53% of the companies in the STOXX 600 Index that reported results posted better-than-expected earnings, slightly below the 54% that do so in a typical quarter. The year-over-year first-quarter earnings growth rate is expected to have contracted 5.7%. In Japan, 56% of the companies in the TOPIX reported positive earnings surprises, which was below the 59% beat rate over the past four quarters. The first-quarter earnings growth rate is estimated to have increased 11.3% from a year earlier. In Hong Kong, 60% of the companies in the Hang Seng Index that reported results registered better-than-expected earnings, surpassing the 50% beat rate over the past four quarters. The first-quarter earnings growth rate is estimated to have increased 3.4% from a year earlier.
Against this backdrop, equity markets in the developed and developing worlds advanced in May, with the former outperforming the latter. In the U.S., the S&P 500 outperformed and recorded its best performance for May since 2009, thanks to strong quarterly earnings results and revived hopes of interest rate cuts later this year. Across the Atlantic, the pan-European STOXX 600 outperformed and posted its best May performance since 2020 on growing optimism that interest rate cuts from the ECB were imminent. In Japan, the TOPIX lagged the broader global index after the Bank of Japan warned that it may need to hike interest rates if inflationary pressure begins to exert itself more forcefully due to the steep depreciation of the yen. Elsewhere in Asia, the Hang Seng Index, which is comprised mostly of companies from mainland China and serves as a gateway for foreign investors wanting to invest there, gained but lagged the broader global index on news that the U.S. planned to raise tariffs on imports from China, an unexpected contraction in China’s manufacturing activity in May, and lingering concerns about China’s beleaguered property market.
Outlook
May’s performance represented a welcome reversal to a good deal of the setback experienced in April and serves as an important reminder to take short-term reactions to changes in interest rate expectations in stride. We maintain our investment outlook and believe the portfolio is designed to both structurally take advantage of compelling opportunities that go well beyond excessive concentration in traditional utilities, and tactically, for an inflection in monetary policy, with decelerating inflation allowing for stabilization in interest rates before an eventual reduction. We remain highly confident and enthusiastic about our investment strategy and positioning for the long-term.
Moreover, while performance of infrastructure as an asset class, with its above average sensitivity to interest rates, has had a tough time keeping up, performance-wise, with broad-based growth equity indices recently, the combination of defensive business models, highly predictable revenues and cash flows, and strong inflation pass-through characteristics has demonstrated commendable resilience and we find the investment category trading at considerably more attractive valuations vis a vis broad market indices.
We believe this leaves publicly-listed infrastructure equities well positioned to benefit from a continued brisk pace of investment, with plenty of runway ahead, and an end to the rate-hiking cycle, when we expect eventual lower interest rates will be used to discount cash flows that have been adjusted higher either for regulatory or contractual inflation-adjustment, or the indirect benefit of inflation adjustment that tends to stem from owning and operating high fixed-cost, long-life assets.
The information contained herein provides general information about the Fund at a point in time. Investors are strongly encouraged to consult with a financial advisor and review the Simplified Prospectus and Fund Facts documents carefully prior to making investment decisions about the Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated.
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Allocations and security selection are subject to change. The performance quoted represents past performance. Past performance is not a reliable indicator of future results. Mention of these securities should not be considered a recommendation or solicitation to purchase or sell the securities. It should not be assumed that any investment in these securities was, or will prove to be, profitable, or that the investment decisions we make in the future will be profitable or equal to the investment performance of securities referenced herein. There is no assurance that any securities referenced herein are currently held in the portfolio or that securities sold have not been repurchased. The securities mentioned may not represent the entire portfolio.
Equity securities will fluctuate in price; the value of your investment will thus fluctuate, and this may result in a loss. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries.
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Published on June 17, 2024.