US equities delivered another strong month in May 2026, with the S&P 500 gaining 5.3%, the Dow advancing 2.9%, and the technology-heavy Nasdaq outperforming by rallying 8.4%.  The equity market was supported by AI enthusiasm, resilient corporate earnings, and generally positive economic data.  Investor sentiment remained positive as inflation concerns and geopolitical risks in the Middle East were offset by strong earnings expansions backed by AI business investments. On the other hand, inflation is ramping up quickly, and Treasury yields spiked with inflationary pressures and repricing of Fed policy.  The lower Equity Risk Premium indicates increasing equity valuation sensitivity.  Economic data signaled slower but continued growth, while the labor market exceeded expectations for a second straight month.
 Looking ahead, the outlook for US equities remains supportive, driven by AI-driven productivity gains and earnings growth, but downside risks have increased with stretched valuations, inflationary pressures, and interest-rate and Fed policy uncertainties. With this backdrop, we slightly decreased our equity exposure from 84% to 74% in our defensive, tailored approach.

What's Driving the Markets?

AI Investments and Earnings: Stocks rallied in May 2026, supported by strong earnings growth driven by AI business investments, offsetting inflation concerns and geopolitical risks in the Middle East.  AI-driven earnings are robust, and the earnings growth gap has narrowed between the “Magnificent Seven” and the broader S&P 500.  Major US tech companies, including Microsoft, Amazon, Meta, and Alphabet, have continued to ramp up AI infrastructure spending, with total industry AI capital spending projected to reach about $780 billion in 2027.  Also, the technology sector accounts for a larger share (42%) of the MSCI EM Index than in the S&P 500, as Taiwan and South Korea played a key role in AI supply.  Taiwan and South Korea now represent 26% and 23% of the MSCI EM Index, respectively, with each market carrying a larger weighting than China.  At the same time, although most institutional investors are still reluctant to trim AI stock positions due to solid fundamentals from AI investments, the market also faces growing caution about AI stock bubbles and potential risks, including slowing AI demand growth and tighter regulatory policies for AI algorithm development across the US.   

Inflation: US inflation ramped up quickly in April, with headline CPI increasing 0.6%, lifting the annual rate from 3.3% to 3.8%, its highest level since early 2023. Core CPI, which excludes food and energy, rose 0.4% in April, leading to an increase in the year-over-year core inflation rate from 2.6% to 2.8%. The acceleration of CPI was largely driven by surging energy prices due to the Iran conflict, which has passed through to higher food inflation and rising transportation costs. At the same time, producer prices jumped in April, with the PPI index rising 1.4% month over month, pushing the annual rate to 6%, its highest level since late 2022. The significant increase in trade services, an index that measures wholesale and retail margins, indicates that businesses are increasingly passing higher costs to consumers. Both the CPI and PPI reports highlight growing inflationary pressures, fueled by an energy shock, despite a softening labor market. As a result, expectations for Fed rate cuts for 2026 have diminished significantly, and some investors even consider the possibility of a rate hike at the Fed’s June meeting.

Fed Policy:  May 2026 saw a significant bond sell-off amid global inflation pressures, hawkish Federal Reserve repricing, and spillover from the UK and Japan, pushing the 10-year Treasury yield to 4.67% and the 30-year yield to a 19-year high of 5.19%.  The spike in bond yields has led to a decline in Equity Risk Premium (ERP) – the gap between equity yields and the real 10-year Treasury yield.  The ERP for the S&P 500 fell to 2.2%, the lowest level since 2007.  In other words, the combination of higher real yields and the AI-driven equity rally has compressed valuation cushions, leaving equity more vulnerable to further increases in interest rates. The spikes in bond yields triggered an immediate valuation reset across the US equity market, with the S&P 500 forward PE ratio contracting notably in the middle of the month.

By the Numbers

As of 5/31/26. Data provided by Bloomberg, NorthCoast Asset Management, Federal Reserve History.

The NorthCoast Navigator is a market barometer displaying NorthCoast's current U.S. and international equity exposure and outlook. This aggregate metric is determined by multiple data points across four broad market-moving dimensions: Technical, Sentiment, Macroeconomic, and Valuation. The daily result determines equity exposure in our tactical strategies. 

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