Market Musings 230526: Small can still be beautiful
Podcast this week: Is now a good time to invest in bonds? (click title to listen)
The US/Israel-Iran conflict has driven up Brent crude prices to USD 91/barrel (December futures) and USD 115/barrel (spot). Diesel and jet fuel costs have surged more than 50%, triggering demand destruction in industries such as aviation. Rising oil prices have spilled into broader inflation, with US core CPI at 3.8% YoY and core PPI at 5.2%, exceeding expectations. This inflationary pressure has pushed bond yields higher, with US 10-year Treasuries rising from 4.4% to 4.6%, German Bunds from 3.0% to 3.1%, and Japanese yields from 2.5% to 2.8%, driven by persistent inflation uncertainty.
Higher yields are putting pressure on equity valuations, particularly in the US where the S&P 500 and Nasdaq 100 indices are showing signs of weakness after a strong Q1 rally. Meanwhile, corporate bond yields have surged, with European investment-grade bonds at 3.8% (up from 3.2%) and US yields at 5.5% (up from 4.9%), offering higher long-term return potential. Whether the Strait of Hormuz remains closed (risking recession and supporting bonds) or reopens (easing inflation and aiding bonds), the current environment represents a compelling entry point for fixed income, particularly European investment-grade corporates.
While Tech leads the way, Small-Caps and Industrial Metals are strong
Since the lows of mid-March following the start of the Iran conflict, global stocks have recovered impressively to hit new year highs, led by the Technology sector. AI mania is alive and well, driving strong momentum in semiconductor makers in the US, Asia and Europe.
US and Europe Technology: +25% and +16% YTD
I will be interested to see how the Tech sector reacts once the jumbo SpaceX, OpenAI and Anthropic IPOs hit the US stock market later this year. Will there be rotation out of existing tech stock holdings into these new entrants?
Small-Caps quietly outperform
Aside from the obvious tech momentum trade, there are other areas of the stock market that are outperforming with little obvious fanfare. In the US and Europe, small-cap stocks have almost silently achieved new highs this year, in spite of the continued drag on the global economy from continued geopolitical tensions around Iran, Ukraine and now also Cuba.
US small-caps ahead of the S&P 500 index this year
