May is set to be full of important stock market news, and you definitely don’t want to be caught off guard as it comes down the pike. These are strange and exciting times for stock market investors, and it’s easy to get lost in all the uncertainty. Investors set themselves up for success by crafting a strategy that weathers short-term disturbances while capitalizing on long-term trends.
If you can anticipate the forces that will shape markets next month, then you’re less likely to get thrown off course by emotional, reactionary decision-making. Consider these predictions to prepare yourself for an eventful May.
1. Monster earnings will continue
Earnings season has been fairly spectacular for S&P 500 stocks so far. The big banks kicked things off on a positive note by exceeding expectations for revenue and profits. That’s a bullish signal, because financial institutions are often viewed as bellwethers for overall economic activity.
Corporate results have just improved from there — the S&P as a whole is tracking well ahead of analyst earnings forecasts, and by a significant margin. This outperformance is driven by fantastic revenue growth along with some of the widest margins achieved over the past 15 years. Several large tech stocks dropped eye-popping sales results, with Facebook (NASDAQ:FB) growing 48% year over year and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) expanding 34%. Even industrial Goliath 3M (NYSE:MMM) grew an uncharacteristic 9.6%. Granted, Q1 2020 was influenced by the pandemic, but these figures are still blowing away expectations.
This isn’t necessarily shocking for people who have been reading the economic data tea leaves. ISM’s purchasing manager index indicated very strong economic activity, with high demand putting strain on every level of the supply chain. Input prices have been rising for manufactured goods, while tech companies are benefiting from surging activity and better pricing for digital ads.
Investors will be listening critically to corporate commentary on the full-year outlook, but we should see results to support bullish sentiment for the rest of the Q1 earnings season.
2. Fed chatter will get louder
The market has become fixated on interest rates and inflation in recent months, and this will likely become an even more prominent theme in May. There are signs that the economy is springing back to life more quickly than anticipated, especially in sectors that were relatively unharmed by the pandemic. Many investors are speculating that the Fed will abandon its stimulative policy much earlier than it has communicated. The prevalence of these suspicions is confirmed by recent bond market activity and a survey of economists by Bloomberg.
Commentary from the Federal Reserve has not officially wavered, but Jerome Powell has recently acknowledged the uptick in economic activity and potential inflation on the horizon. If the central bank moves to raise rates ahead of schedule, that might be great news for the economy — but it’s likely to trigger some volatility or modest corrections in the stock market.
Cash allocations for large fund managers are near all-time lows, and stock indexes are near all-time highs. As such, investors should expect monetary policy to be under the microscope as one of the most important short-term forces driving the stock market.
3. Tax policy will be an important narrative
President Biden’s capital gains tax proposal has made headlines recently, and it might exert some influence over the market in the short term. Rates on the highest-income earners could double, which would create an incentive for some stock market investors to realize gains before new laws go into effect. You can see why someone would want to lock in returns at a lower tax rate while stock indexes are near all-time highs.
That might well cause some market volatility in the short term, but it shouldn’t affect most people’s investment strategies. The new capital gains rates only apply to households with income above $1 million, and there are even exceptions for gains on residential real estate sales. Most people won’t notice any change whatsoever. However, this does make the Roth IRA an even more attractive option for retirement savers. Qualifying distributions from Roths are exempt from capital gains taxation, so they can be perfect vehicles for high-growth investments.
4. Indexes will get pulled in different directions
We aren’t out of the COVID-19 woods quite yet, and harrowing news from India is troubling from a humanitarian and economic standpoint. However, we do seem to be on the verge of economic recovery coupled with rising interest rates, which will pull major indexes in different directions. High-growth stocks will benefit from inflation fears, but that could flip if economic fundamentals remain strong as the Fed moves to address inflation.
A sturdy, self-sufficient economy would pull capital away from high-valuation tech stocks, and cash would flow to value stocks and sectors that have been beaten down over the past year. Travel, hospitality, entertainment, dining, and energy could have demand drivers and relatively cheap valuations that excite investors.
That rotation sounds like a neutral move for markets at first glance, but it might actually hurt major index performance. The S&P 500 is weighted more than 34% to the tech sector. Meanwhile, utilities, industrials, and energy combine for less than 15% of the index. A reopening rotation would disproportionately squeeze the largest stocks, putting downward pressure on the market as a whole. Don’t panic if headlines look a bit ugly while allocations adjust.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.