April Market Commentary: Earnings in the Second Half of the year may not be as strong as in First Quarter
By Natalie Trunow, Chief Investment Officer, Equities
Calvert Asset Management Company, Inc.
After eight consecutive weeks of appreciation, U.S. equity markets pulled back in the last week of April ending the month with the S&P 500, Russell 1000, and Russell 2000 indexes rising 1.6%, 1.9%, and 5.7%, respectively. Consumer Discretionary, Energy, and Industrial sectors led the charge. At the same time, international equities lagged, with the MSCI EAFE Index down 1.7% for the month.
The April Consumer Confidence Index data were positive, reflecting improving economic growth, an upturn in the securities markets, and stabilization of home prices. In the first quarter of 2010, consumer spending grew at a pace of 3.6% , as U.S. GDP grew at a 3.2% annual rate—both very respectable numbers. However, Consumer Sentiment data produced conflicting results. In April, the Consumer Sentiment Index fell, while the Conference Board’s Survey of Consumer Sentiment data showed good results driven by an improving job market environment.
U.S. retailers, such as The Gap, TJX Companies, and Saks, posted better than expected sales gains, another sign that consumer spending is improving. Nevertheless, U.S. consumers continue to de-lever their balance sheets as unemployment remains high, consumer credit continues to decline more than anticipated, and the housing market is still in negative territory.
The first time home buyer tax credit, historically low mortgage rates, and the new spring home selling season are boosting both existing and new U.S. home sales and benefiting homebuilder stocks like Lennar and Standard Pacific. It remains to be seen whether this pick up in activity is reflective of new or front-loaded demand created by the tax credit, scheduled to expire at the end of April. During the month, median home prices showed a 4.3% increase over the same time a year ago. If the home sales were in fact pulled forward by the tax incentives, we may see a double dip in the housing prices later in the year since foreclosures in the residential housing market remain high, and the commercial real estate market is still in crisis mode.
The first quarter corporate earnings season has shown strong results with bellwether names like Alcoa, UPS, Citi, Morgan Stanley, Apple, and Chrysler all beating their quarterly earnings estimates—this time with an uptick in the top line. While easy year-over-year comparisons are certainly a part of the story, revenues are starting to show growth for many of these bellwether companies. This suggests that the economic upturn can be more robust now since the uptick in the top line is likely to help stop and possibly reverse the negative trend in unemployment. These positive developments, however, seem to have been well-priced into the market during the recent run up, and we are now seeing investors “sell on news” as earnings season unfolds. Both the sovereign risk and financial regulation issues, while abundantly present throughout this year, were unable to stop the equity market rally that continued through April 26th but is now showing signs of fatigue.
M&A activity continues to accelerate, with several companies announcing news of buyouts: China Petroleum agreed to buy Syncrude from Conoco in a quest for foreign oil reserves; Macquarie agreed to pay an AIG unit $2 billion for its aircraft operating lease portfolio, while Oracle agreed to buy Phase Forward and Calpine is said to be acquiring some Pepco assets. Apple and HP also announced new acquisitions. We believe that M&A activity will benefit smaller cap names and hence active equity managers.
Business activity in the U.S. expanded in April at the fastest pace in five years, indicating the manufacturing rebound continues to accelerate. The Institute for Supply Management-Chicago Inc. indicated that its business barometer rose to 63.8 this month (the highest level since April 2005), up from 58.8 in March. At the same time, inflation in the U.S. remains tame, which should help the Fed keep interest rates low longer.
The Financial sector is under the regulatory microscope. The SEC filed a civil law suit against Goldman Sachs accusing the company of fraud related to subprime mortgages. Top executives of Goldman Sachs testified before Congress to refute these allegations. Probes continue to broaden as federal prosecutors are said to now be investigating transactions to determine whether to bring a criminal fraud case against the company. Meanwhile, the Senate finally agreed to bring the financial reform bill to the floor for debate with special focus on the regulation of derivatives.
Economic activity in the United States continues to improve at a faster pace than in Europe, where the economy remains stagnant at 0% GDP growth and companies continue to cut spending and curb investments. It is hard to argue that Greece’s credit rating downgrade to junk status by S&P was a surprise, as the story has been in the news since last fall. Likewise, investors should not be surprised by the contagion or relatively weak credit positions in countries like Ireland, or the two other countries S&P downgraded this week—Portugal and Spain. Having said that, this information failed to impact markets until later in April.
Asset bubbles in China seemingly continue to inflate. If not resolved in an orderly fashion, they could negatively impact growth in that economy, which, in turn, is likely to impact the global economy and depress demand for oil. Currently, China’s economic growth is accelerating at the fastest clip in almost three years, with the country’s GDP rising 11.9% in the first quarter.
The recent pull back in equity markets may signal the beginning of a more significant market pull back as investors start to take some money off the table on good economic and earnings news and in anticipation of potentially more difficult earnings comparisons in the second half of the year, as well as the mounting threat of sovereign risk contagion.
This commentary represents the opinions of its author as of 5/3/10 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.
Calvert Asset Management Company, Inc., 4550 Montgomery Avenue, Bethesda, MD 20814