Summary
•The spring rally continued. The S&P 500 returned 5.3% in May and closed the month at a record high, extending April’s surge and marking one of the strongest two-month stretches in years. •Technology stocks led for a second consecutive month.
•Oil prices collapsed in May, with Brent crude falling nearly 20% as optimism around a U.S.-Iran ceasefire grew, even though the Strait of Hormuz remained effectively closed for the entire month.
•The inflation and policy backdrop remains uncertain. April CPI rose to 3.8% and core PCE reached 3.3%. The Senate confirmed Kevin Warsh as Fed Chair by the narrowest margin in modern history, and markets shifted from pricing in rate cuts to debating whether the next move could be a hike.
Market Performance
Equity markets carried April’s momentum into May. The S&P 500 returned 5.3% and finished the month at an all-time high. This caps one of the index’s strongest two-month runs in recent memory—adding to April’s 10.5% gain. This represents a remarkable reversal from where sentiment sat at the end of the first quarter. For the quarter, the S&P 500 is now up 16.3%, and the Nasdaq Composite has returned an astonishing 25% over the last two months as the AI trade kicked into overdrive.
Leadership came from technology stocks, and it was narrow at the top even as it broadened underneath. The technology sector advanced 16% in May and accounted for every one of the S&P 500’s 10 best-performing names. Some of the single-day earnings reactions were extraordinary: Dell rose 32.8% in a single session (its best day on record), Snowflake jumped more than 36%, and HPE surpassed expectations in early June and soared nearly 20% on the day. Demand for AI infrastructure was confirmed by these earnings releases.
International equities were mixed. Emerging markets led global equity returns, helped by the AI and memory-chip cycle that is playing out in Asia. South Korea’s KOSPI set record highs late in the month, once again powered by Samsung, SK Hynix, and the broader high-bandwidth-memory complex. Korea and Taiwan’s strong returns powered the MSCI EM Index to a return of 9.7% in May. On the other hand, European stocks remain stalled due to a lack of genuine AI exposure in their indices and an economy that is much more reliant on energy imports. The MSCI Europe Index gained 2.6% in May but is now trailing the S&P 500 on a year-to-date basis.
Fixed Income
The bond market told a more complicated story than the equity market. The 10-year U.S. Treasury yield finished May at 4.45% and the 2-year at 3.98%, leaving the curve positively sloped. The action, though, was at the long end. The 30-year yield spiked to 5.18% on May 19, its highest level in nearly 19 years, as fears of a sustained energy shock pushed term premium higher. It then eased back toward 5.00% into the month-end as ceasefire talks with Iran gathered momentum and oil prices fell.
On the other hand, credit markets were conspicuously calm. High-yield spreads tightened modestly over the month to around 274 basis points, with only a brief widening around the May 19 yield spike, and investment grade spreads held near the tight end of their multi-decade range. The combination of strong corporate earnings, low default expectations, and healthy demand for income kept spreads compressed even as the risk-free curve moved around. We would note that spreads this tight leave very little cushion if the growth picture deteriorates, and they offer thin compensation for the inflation risk now embedded in the long end.
Transition at the Fed
There was no FOMC meeting in May, but the month nonetheless reshaped the leadership of the Fed. On May 13, the Senate confirmed Kevin Warsh as the next Federal Reserve Chair by a vote of 54 to 45—a historically narrow margin. Jerome Powell’s term as Chair ended two days later, on May 15. In a break with nearly eighty years of precedent, Powell chose to remain on the Board of Governors rather than leave the Fed entirely, citing the ongoing investigation into the central bank’s headquarters renovation. Powell’s term as governor doesn’t end until January 2028.
New Fed Chair Warsh inherits a sticky situation. He has been a vocal advocate for lower interest rates and has been openly critical of the institution he now leads. Further complicating his job is a divided committee at a moment when inflation is accelerating rather than fading. At Powell’s final FOMC meeting, the committee held its policy rate steady, but there were four dissents (the most at a single meeting since 1992). That split captures the bind the Fed is in. As May closed, futures markets placed the odds of a June hold at virtually certain, and a growing share of traders had begun to price in the possibility of a rate increase before year-end. Current probabilities from the CME show just a 0.7% chance of a Fed funds rate lower than it is today by the December meeting. The shift from a market that expected cuts to one debating hikes has taken shape in the face of soaring commodity prices as a result of the conflict in Iran. It sets up Warsh’s first meeting in June as a test of both the committee’s cohesion and its independence.
Iran, the Strait of Hormuz, and the Oil Reversal
The conflict in the Persian Gulf remains a variable, but the market’s interpretation of it changed dramatically over the course of the month. Operation Project Freedom launched on May 4 to escort commercial vessels through the blockaded Strait of Hormuz but was paused within days of its start. The Trump Administration framed the pause as a function of progress toward a broader agreement with Iran. The Strait itself remains effectively closed, and tensions flared again late in May as both sides traded strikes.
Oil prices dropped nearly 20% in May, their worst monthly decline since the depths of the pandemic. Brent crude closed the month at $92.05/barrel after having been above $118 in late April. The decline was driven almost entirely by the growing belief that a ceasefire framework, reportedly built around a 60-day memorandum of understanding, would ultimately reopen the Strait and restore flows. The reality in the Strait is that it did not improve much in May, and the late-month strikes were a reminder of how fragile the situation remains.
The Data: Strong Markets, Strained Consumers
The economic releases during May painted a picture increasingly hard to square with equities at record highs. Inflation moved firmly in the wrong direction. April CPI rose 0.6% on the month and 3.8% from a year earlier, the highest reading since May 2023, with energy responsible for more than 40% of the increase and gasoline up more than 28% year-over-year. The April PCE report at month-end told the same story, with headline PCE at 3.8% and core at 3.3%. Notably, real average hourly earnings declined as inflation outpaced wage growth for the first time in three years, and the personal saving rate fell to 2.6% (its lowest since mid-2022).
Perhaps the most striking data point of the month came from the consumer. The University of Michigan’s sentiment index fell to a May reading of 44.8, an all-time low in a survey that dates to 1952, surpassing even the trough reached in mid-2022. The survey’s director attributed the souring sentiment to the persistence of high gasoline prices stemming from the energy supply disruptions and concerns around the cost of living. She also noted that year-ahead inflation expectations had climbed to 4.8%.
Earnings Season Wrap-Up
The first quarter earnings season, which largely wrapped up during May, was unambiguously strong on the numbers. FactSet reports that 85% of S&P 500 companies beat earnings expectations, well above both the five- and ten-year averages. The closely watched earnings release came from NVIDIA on May 20, which posted record revenue of $81.6 billion (up 85% from a year earlier) with data-center revenue nearly doubling. NVIDIA management described the current buildout of AI infrastructure in glowing terms, as Jensen Huang told investors that demand has gone parabolic due to the arrival of agentic AI.
Strong earnings have been a real, fundamental driver behind the current rally. Earnings growth is expected to close the first quarter in the high-20% range. It will likely be the highest year-over-year earnings figure since late 2021 when the global economy was still emerging from a prolonged shutdown during the pandemic. Earnings growth is expected to remain elevated at above 20% for the coming quarters and maintain that impressive figure for the full calendar year. While revenues have been strong, S&P 500 companies continue to expand their profit margins. The trend of margins moving up and to the right continues.
Investment Implications
May reinforced a tension we have been writing about all year. On the surface, this is a powerful bull market: record highs across the major U.S. indices, a second consecutive month of strong technology leadership, calm credit markets, and a volatility index that spent the month in the mid-teens. Underneath, the picture is more uncomfortable. Growth is slowing, inflation is re-accelerating, and consumer sentiment points to an exhausted consumer. Markets and the economy are not telling the same story right now, and reconciling the two will likely be the work of the rest of the year.
Against that backdrop, we are not chasing the rally, but we are also not retreating from it. Our preference is to remain diversified and balanced rather than to take any large directional bets. Our equity allocation remains close to its strategic target. In fixed income, we remain comfortable keeping duration less than the index. There are still attractive current income opportunities on the shorter end of the curve that do not necessitate taking on the full risk of a long end that is now hostage to the inflation data.
The important event on the June calendar is the FOMC meeting, the first under Chair Warsh. With core PCE running at 3.3% and the committee already divided, a rate cut is very difficult to envision. June will also likely kick off the long-awaited trillion-dollar IPOs of some mega-cap companies—SpaceX is likely to be the first to go, while Anthropic and OpenAI wait in the wings.
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