May 2025 Index Market Overview: Navigating Valuations and Headwinds

May 2025 has seen equity markets stage a significant rebound, driven in large part by retail investors looking to "buy the dip." While this surge in investor appetite has helped indices recover and volatility decrease, a closer look at various indicators suggests that some markets may be becoming overbought. Economic policy uncertainty remains a significant factor, with ongoing concerns about tariffs, fiscal policy, and monetary policy influencing the market landscape.

Key Highlights from May 2025

Equity indices experienced a strong performance in May 2025. The S&P500 climbed 9.6% month-over-month (MoM) and 11.5% year-over-year (YoY) to 5,917. The Nasdaq saw an even larger jump, increasing by 13.3% MoM and 14.7% YoY, reaching 21,336. The Dow Jones also posted gains of 4.2% MoM and 6.1% YoY, closing at 42,323.

European markets also showed strength. The FTSE100 rose 4.7% MoM and 2.2% YoY to 8,634, while the DAX surged 11.5% MoM and an impressive 25.6% YoY to 23,969.

This market recovery was largely attributed to robust buying from retail investors. However, despite the rally, sentiment towards equities remained mildly negative. Indicators like the S&P500 VIX index and the US equity put-call ratio suggested that the recovery might be maturing.

Factors Influencing the Market

Several factors contributed to the market dynamics in May 2025:

• Retail Investor Activity: Retail investors played a crucial role in the market rebound by actively buying during the dip.
• Economic Policy Uncertainty: Uncertainty surrounding economic policies, particularly trade tariffs, continued to be a major concern. While initial reciprocal tariffs were walked back, the average effective tariff rate remained elevated compared to the end of 2024. This uncertainty raised the risk of increased precautionary household saving and reduced business investment and employment.
• Fiscal and Monetary Policy: Concerns about fiscal and monetary policy also lingered. The US fiscal position remained problematic, with projected sustained large-scale primary budget deficits. In terms of monetary policy, the Federal Reserve maintained a watchful stance, suggesting policy would remain on hold for the time being despite some investor expectations for rate cuts. The European Central Bank, however, did cut its deposit facility rate and futures suggested further cuts were possible.
• Earnings and Valuation: Corporate earnings in the first quarter were resilient, but models suggested that slowing earnings growth might be on the horizon. The rebound in equity indices also led to concerns about stretched valuations, particularly for the S&P500 and DAX indices. The S&P500's forward P/E ratio was estimated at 21.4x, above its past decade average. The DAX's forward P/E ratio also rose to 15x, exceeding its long-term average. In contrast, the FTSE100's valuation appeared more relaxed with a P/E ratio of 12.2x, below its post-millennium average.

Index-Specific Overviews

• S&P500: The index staged a significant recovery and traded above its 200-day moving average. However, momentum indicators suggested overbought conditions. Further significant gains might require positive news such as a corporate tax cut or a shift in the Federal Reserve's stance on interest rates.
• Nasdaq: The Nasdaq100 index also experienced a strong rebound. Its forward P/E ratio was 25.9.
• FTSE100: The FTSE100 rebounded from its April lows but upward momentum appeared to have stalled. While valuations were supportive, the index faced earnings headwinds from subdued global growth and tight UK monetary policy. Tariffs on UK goods exported to the US were also a factor.
• DAX: The DAX40 index rallied sharply, but this occurred amidst what was described as "dire sentiment" following tariff announcements. Earnings per share lagged behind the index's growth, leading to stretched valuations. The valuation was becoming a concern.

Overall, May 2025 has been a month of significant market movement, largely driven by investor sentiment and influenced by ongoing economic policy developments and concerns about earnings and valuations.

For a more in-depth analysis, download the full Index Monthly report.