Fund investors last month were spared from the seasonal
weakness in the stock market known as "sell in May and go
The market shrugged off news that U.S. gross domestic product
shrank 1% in the first quarter. The S&P 500 added 2% for the
month and 4% year to date as it eclipsed the psychologically
significant round milestone of 1900. Stocks were more appealing,
given a persistent slide in interest rates. Yields on benchmark
10-year Treasuries fell 21 basis points from 2.67% to 2.46% at
month's end. They've fallen 54 basis points since Jan. 1.
"Everyone was bearish on rates," said Ari Sass, a portfolio
manager at MD Sass in New York City, with $6 billion in assets.
"Usually when everyone is thinking one thing, usually the
The average U.S. diversified stock mutual fund returned 1.69%
in May and 1.87% year to date, according to Lipper Inc. World
equity funds did better, rising 2.22% and 3.03% in the same
periods. With inflation at 2%, investors have better
opportunities for growth in dividend-paying stocks than
Treasuries as dividends tend to increase with earnings, says an
email from Timothy Malloy, vice president at Birch Hill
Investment Advisors in Boston, with $1.2 billion in assets under
But earnings growth has been driven more by "financial
engineering" rather than demand, as companies are buying back
shares at record levels, making acquisitions and using aggressive
tax strategies, says Charlie Smith, chief investment officer at
Fort Pitt Capital Group in Pittsburgh, which oversees $1.3
billion in assets.
"We remain cautious due to the amount of artifice in the
system, whether as a result of ongoing Federal Reserve
interest-rate suppression or the aforementioned financial
engineering," Smith wrote in an email. "The economic weakness
seen in Q1 2014 will linger for much of the year, meaning revenue
growth will continue to be difficult to come by."
The S&P 500 ended the month at 1923.50, just a hair below
Smith's fair value estimate at 1938, which represents a
price-earnings ratio of 17 on $114 a share in earnings estimated
Most economists expect the economy to improve in the second
quarter, but that factor may already be priced into stocks, says
Damon Barglow, co-manager of Bright Rock Quality Large Cap and
Bright Rock Mid Cap Growth , with $206 million in assets
"Investors appear to be getting more aggressive on equities
just as valuations are getting richer," Barglow said in an email.
"Equity price inflation driven by demand in the absence of
improving fundamentals is not sustainable."
Volume fell deep below average, which means the uptrend may be
growing tired. But the VIX volatility index -- the so-called
"fear gauge" -- fell to a seven-year low, suggesting that
investors are not anticipating a correction by hedging their
"They bought tons of put protection last year, and the market
has done nothing but go up, so investors are protection-fatigued
and are now underhedged," Miranda Davis, portfolio manager of BPV
Core Diversification , with $47.9 million in assets in Knoxville,
Tenn., said in an email. "When this happens, it tends to
exacerbate small downward market movements, which is a
Gold Resumes Meltdown
All major sector funds enjoyed gains except for
precious-metals funds. They fell 6.26% in May, cutting their
year-to-date return to 7.85%. Precious metals and miners resumed
their multiyear meltdown after a short countertrend rally at the
beginning of the year. Gold bullion prices, as tracked bySPDR
Gold Trust (
), fell 3% in May, clipping its year-to-date gain to 3.71%. The
U.S. dollar -- which tends to move opposite gold -- appreciated
nearly 1% against a basket of widely traded foreign currencies
tracked by PowerShares DB U.S.Dollar Index Bullish (
). It is unchanged year to date.
Gold is melting down under the threat of global deflation
because the yellow metal is a hedge against inflation, says
Davis. Gold has become undervalued compared with stocks, which
are "no longer cheap," says Adrian Day, manager of EuroPac Gold ,
with $33 million in assets under management.
"The Fed's tapering is not as bad as feared, and the
possibility of higher rates is viewed as being far off," Day said
in an email. "China's gold demand continues to be robust as the
possibility of a withdrawal of Indian restrictions comes to the
fore and the Ukraine situation is clearly not over. So gold is
set to move higher now."
The markets will increasingly expect a recession, which in
turn will weaken the dollar and strengthen gold, says John
Williams, founder of Shadow Government Statistics. He expects
second-quarter GDP to contract as it did in first quarter.
"Intensifying weakness in the U.S. dollar will place upside
and other commodities, boosting inflation and inflation fears,"
Williams wrote in a commentary May 29. "Resulting higher
inflation should boost the prices of gold and silver, the primary
hedge against the pending inflation and financial crises."
New Hope For India
India funds led all global markets as
bet on new Indian Prime Minister Narendra Modi, who leads the
business-friendly Bharatiya Janata Party, to turn around the
"NaMo has become the economic hope for this country," Peter
Kohli, CEO of DMS Funds, with $2 million in assets under
management in Newton, Ma., wrote in a client note. "He has halted
India from continuing down the path of socialism, and within
eight days of his election has managed to turn it towards
capitalism and prosperity."
India funds rose 12.48% in May, lifting their year-to-date
gain to 23.58. Other gains in May by funds focused on regions
included Japan 3.87%, emerging markets 3.52%, China 3.36%, Latin
America 0.98% and Europe 0.71%.
Wasif Latif, head of global multi-assets at San Antonio,
Texas-based USAA Investments, with more than $62 billion in
assets, has overweighted foreign developed and emerging markets
because of their lower valuations.
Emerging markets, as tracked by iSharesMSCI Emerging Markets (
), trades at 10.8 times forward earnings, 1.3 times book value
and 0.94 times sales, according to Morningstar. Developed foreign
markets, measured by iSharesMSCI EAFE (
), have a P/E ratio of 14.7, P/B of 1.5 and P/S of 0.94. The SPDR
S&P 500 (
) trades nearly 17 times earnings, 2.3 times book and 1.6 times