January Market Commentary: Equity Markets Correct in Response to Concerns about the Pace of Economic Recovery, Financial Regulation, and China’s Economic Tightening
By Natalie Trunow, Chief Investment Officer, Equities
Calvert Asset Management Company, Inc.
Equity markets posted strong returns in 2009. For the year ended 12/31/09, the Russell 1000 Index rose 28.4%, and the MSCI World Ex US Index gained 34.4%. From the market trough in March 2009, both domestic and international indexes gained over 60%. In 2009, we commented that mixed economic reports were confirming that the U.S. economic recovery is on track but is likely to be more protracted than the market originally expected, with consumer demand slow to recover and manufacturing providing a larger portion of the economic growth than usual.
While equity markets started the New Year off positively, posting small but steady gains, in the second half of January they reacted negatively to the signs of low probability of a V-shaped economic recovery, new financial regulation, and potential economic slow-down in China. For the month of January, large cap, small cap, international, and emerging market stocks were all down, returning -3.6% (Russell 1000 Index), -3.7% (Russell 2000 Index), -4.0% (MSCI EAFE IMI), and -5.6% (MSCI Emerging Market Index), respectively.
Inventory Rebuilding Boosts GDP
December’s manufacturing growth was the highest in three years, and factory orders in the United States rose, beating consensus estimates and providing a foundation for optimism. Some of the business spending was reflective of businesses compensating for the slowdown in spending during 2009. As we commented throughout last year, U.S. corporations were able to generate better-than-expected earnings for most of 2009 by aggressively cutting costs, while top-line (revenue) growth remained anemic. We noted that the same pace of cost cutting will be difficult to maintain going forward, and sustainable earnings growth will have to come as a result of renewed top-line growth. We indicated that the markets may trade off as a result of disappointing data that doesn’t confirm a V-shape recovery that 2009 market action seemed to indicate.
In fact, in mid January, markets started to correct as corporate earnings reports proved robust but didn’t indicate a V-shape recovery in the top line. The January correction continued after the fourth quarter GDP numbers were reported, coming in at a higher than anticipated annualized rate of 5.7%. Inventory rebuilding contributed 3.4% of that growth—an unusually high proportion—confirming that the U.S. manufacturing sector, and not the consumer sector, is driving the economic improvements we've seen so far.
U.S. Consumer Remains Constrained
The consumer continues to be constrained, although retail sales figures, especially for discount retail stores, improved in December, at least relative to the dismal holiday sales in 2008. U.S. mortgage delinquencies (excluding foreclosures) hit a record high of 9.8% during the month, a 21% increase from a year ago. The government’s first time home buyer credit that was originally due to expire in November (and was later extended into 2010) appears to have pushed some of the home sales forward, negatively impacting December data. Existing U.S. home sales data came in significantly lower than expected, falling 17%—the biggest drop since 1968 when data records originated. Consumers continued to save more and borrow less, with revolving consumer debt plunging by a record $13.7 billion in November.
Employment Data Remain Weak
During January, reported unemployment data continued to be negative. Payrolls unexpectedly dropped by 85,000 jobs in December, and the unemployment rate stayed at 10%. Additionally, approximately 661,000 of unemployed Americans, representing 0.4% of the workforce, dropped out of the unemployment statistics in December (making for a total of 1.1% of the work force over the last six months), discouraged by lack of employment opportunities. The under-employed work force continued to grow with the under-employment rate rising to 17.3%. So far this year, initial jobless claims numbers reported in January surprised on the downside, rising by 36,000 to 482,000. Unemployment claims came out higher than anticipated, as applications that were delayed during the holidays rolled in, which further fueled the market sell off.
Financial Sector Comes Under Renewed Pressure
Also during the month, President Obama announced plans to raise as much as $120 billion from large financial institutions that benefited from TARP now that these institutions are profitable again. This further raised the question about long-term profitability for the sector, as the new tax will represent as much as 20% of earnings for some banks. The burst of a bubble in the financial sector may prove to be similar to a Tech bubble burst and haunt the sector for many years to come.
During the month, markets were also focused on China’s tightening as that country’s government was raising bank reserve ratios in order to curb lending and deflate the country’s property and asset bubbles.
Inflation in the U.S. remained in check according to the new CPI numbers released during the month.
Market Analysis and Outlook
At the end of the month, we saw a correction in the equity markets worldwide, taking equity indexes into negative territory for the year. Information Technology and Materials names sold off the most having out-performed the rest of the market considerably in 2009. Globally, emerging markets equities were among the worst performers in January returning -5.6%, having been the top performers for 2009. The sell off seemed to indicate some adjustment between the asset markets' V-shaped move off March 2009 lows and the economy's U-shaped recovery. The earnings season is still in progress and any significant upside earnings surprises could support the market, while negative earnings surprises from bellwether companies will weigh on market sentiment.
If the economic data continues to confirm a slower, more protracted economic recovery, markets may be further discouraged and continue to trade off. The concern is that once strong inventory contribution to GDP from crisis lows subsides and the effects of the stimulus wane, GDP growth may slow. We believe that, while this is a real concern, this is unlikely to result in negative GDP growth that would lead to a double-dip recession in 2010. Once the markets come to terms with the slower-than-anticipated pace of the economic recovery and expectations become more realistic, longer-term market performance should improve. In January, U.S. consumers were more confident about economic prospects despite dismal employment environment. If the U.S. consumer shows signs of improving sentiment and spending by the end of the year, equity markets should react positively. During the first half of 2010, however, we may continue to see some renewed market volatility, as was the case in the second half of January.
This commentary represents the opinions of its author as of 2/3/10 and may change based on market and other conditions. The author’s opinions are not intended to forecast future events, guarantee future results, or serve as investment advice.