February Market Commentary: Equity Markets Encouraged by Subdued Inflation and Steady Fed Funds Rate
By Natalie Trunow, Chief Investment Officer, Equities
Calvert Asset Management Company, Inc.
For the first part of the month, equity markets sold off after a prolonged run up from the March 2009 lows through mid-January of this year. Equities were due for a correction, given the lack of convincing economic data to confirm a strong, V-shaped economic recovery. Markets repaired most of the losses in the middle of February, as investors found comfort in the Federal Reserve’s indication that the Fed Funds rate would remain unchanged for the near term. However, concerns around high levels of U.S. and European debt (especially Greek sovereign debt), weaker consumer sentiment, and challenging unemployment worldwide fueled market volatility during the month. Against this back drop, U.S. equity market indexes ended the month with gains of 3.29% for the Russell 1000 Index and 3.09% for the S&P 500 Index. The MSCI EAFE Index closed the month down 0.65%.
The Consumer Discretionary sector performed the best, returning 5.76% for the month. The rebound in Consumer Discretionary shares reflected renewed confidence in the sector. We believe that record high efficiency levels at U.S. corporations will lead to incremental hiring in the next few months, which should improve consumer confidence and spending. The Consumer Sentiment Index declined by more than expected during February, as the jobless rate continued to weigh on the consumer. Jobless claims in the United States fell by a more-than-anticipated 43,000 to 440,000 in February, bringing the total number of jobs lost since the recession began to 8.4 million. U.S. corporations continue to hoard cash and reduce spending, a trend that negatively impacts the jobless rate. The Obama Administration has responded by working to stimulate job growth through incentivized bank lending to small businesses.
In residential real estate, U.S. median home prices have fallen 4.1% from last year. However, home sales increased 14% in the fourth quarter of 2009, helped by low mortgage rates and the tax credit for first time home buyers. Foreclosure numbers are still worrisome, rising to 4.58% of all mortgages, while delinquencies on both prime and sub-prime mortgages showed slight decreases.
The Materials and Industrials sectors performed strongly for the month, returning 5.52% and 5.12%, respectively, as investors interpreted the confirmation of low inflation, generally good earnings reports, and an indication of a steady Fed Funds rate policy as positive signs. Utility, Telecom, and Healthcare names lagged and were down 1.09%, 0.60%, and 0.63%, respectively for the month. Political rhetoric around health insurers intensified causing volatility in the Healthcare sector. Manufacturing continued to provide reasons for optimism, expanding at an increasing rate in January and beating estimates. Crude oil prices fell from a 2010 high of $84 in mid January to $79.68 at month end.
Inflation figures reported during the month remained subdued, with the Consumer Price Index rising a less-than-anticipated 0.2% in January. The CPI actually decreased once the impact of changes in food and fuel prices was excluded. At the same time, the U.S. Federal Reserve announced a 25 basis point increase in the discount rate charged to banks for direct loans to 75 basis points. The Fed also indicated that this move wouldn’t affect monetary policy, and that the Fed Funds rate would remain unchanged. This affirmation, supported by the new inflation data, was comforting to the markets, as an increase in the Fed Funds rate is generally viewed as an impediment to economic recovery.
The U.S. dollar reacted positively to the economic news, rising against most major currencies during the month. The euro fell against major world currencies, as the stress and turmoil around the sovereign debt of Greece and Spain came into focus. In the Pacific Rim, China raised its bank reserve requirement twice in one month to cool the economy and avoid a bursting of the multiple bubbles in that market.
Market Analysis and Outlook
The market sell off that started in mid January continued into mid February, with short-term volatility and negative sentiment creeping back into the market as investors came to grips with a slower pace of economic recovery. We welcome a more realistic look at the pace of the current economic recovery by the markets. We believe that this can bring valuations more in line with underlying economic growth prospects and should provide more attractive long-term opportunities for investors.
Overall, the data released during February confirmed an anemic global economic recovery. However, in relative terms, the United States seems to be doing better than other developed market countries. Europe in particular is seeing a slowdown of economic activity. Some of the economic growth seen so far was spurred by federal stimulus programs worldwide that are scheduled to expire this year. We expect that some of the stimulus measures, such as the low Fed Funds rate, are likely to stay in place for some time to stimulate consumer and business demand.
Although the economic recovery may seem slow and painful—especially when it comes to unemployment—it is on track. Industrial production rose 0.9% in January, more than forecast, confirming that the manufacturing sector is still leading the recovery. We believe that the consumer will be the last factor necessary for a robust and extended economic recovery. Any meaningful uptick in consumer sentiment and spending in combination with ongoing recovery in the manufacturing sector could significantly improve the robustness of the economic upturn and energize the markets. We believe that some of the improvement can take place this year, as businesses run out of room to cut costs and start to hire new workers. It appears that the market may be anticipating a similar trend, with the Consumer Discretionary sector firmly in positive territory and out-performing other sectors of the economy for the year so far.
A short-term concern is that once the strong contribution to GDP from inventory rebuilding 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. A V-shaped recovery seems less likely, given the relatively weak consumer demand story. The more likely outcome seems to be a gradual, smile-shaped, slow but robust economic recovery.
This commentary represents the opinions of its author as of 3/26/10 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.
Calvert Asset Management Company, Inc., 4550 Montgomery Avenue, Bethesda, MD 20814