Equity Markets Rebound in July
Mixed economic data continue to signal a slow recovery
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Asset Management Company, Inc.
The global equity markets rebounded this month with the Standard & Poor’s 500, Russell 1000 and Russell 2000 Indices each returning close to 7%. International developed markets moved up the most from the previous month's slump, with the MSCI EAFE Index adding close to 10%. Developing markets also rebounded, with the MSCI Emerging Markets Index returning 8% for July.
As we commented in the beginning of the year, recovery in the second half of 2010 is likely to be slower than was originally forecast. This position is now more broadly accepted by the market and seems to be reflected in more widely discounted stock prices, which gives us reasons for optimism for the next 6-12 months. Inflation remains tame and, combined with slow economic growth, makes it easier for the Fed to maintain low interest rates, which will eventually need to be raised from almost-zero levels.
A Month of Mixed Economic Data
During the month, investors globally remained somewhat optimistic, despite lower-than-forecast U.S. GDP growth reported at 2.4%.
Commerce Department data released at the end of July confirmed that the recession was deeper than previously thought. The economy contracted at a 4.1% pace (versus the 3.7% rate previously forecast) from the fourth quarter of 2007 to the second quarter of 2009.
The U.S. consumer, the main area of focus for many investors, showed some cause for optimism, with consumer confidence falling less than was expected at the end of the month, at the same time that consumer spending was cooling off. The positive trend of de-leveraging of consumer balance sheets continues. U.S. consumers are borrowing less and saving more. Credit card and non-revolving loan debt is falling at higher-than-expected rates.
Housing data continues to be soft and foreclosures and housing inventory continue to mount. Homebuilders in the U.S. turned more pessimistic in July than was forecast, primarily owing to continually high unemployment and the expiration of the government tax credits depressing home construction. U.S. jobless claims increased more than forecast as firings remain high through the slow economic expansion.
Corporate Earnings a High Point
Corporate earnings reports continued to come in strong with more than three-quarters of companies in the S&P 500 Index reporting higher-than-expected earnings in July. Several companies reported earnings with results being generally positive, not only from an earnings standpoint but also from the top-line growth perspective. IBM reported good earnings numbers but disappointed on the top line as its services division was hurt by corporate customers delaying service projects. Apple reported large increases in profits (up 78%) and sales (up 61%), resulting largely from the debut of the iPad and the iPhone 4. Microsoft’s reported earnings also topped analysts’ estimates on higher personal computer operating system purchases. Microsoft’s top-line growth also showed a healthy increase of 22%.
Morgan Stanley and Wells Fargo also reported positive earnings beating analyst estimates. American Express benefited from higher credit card spending by its customers and posted higher-than-expected earnings and sales numbers. Ford and McDonald’s also reported profits ahead of estimates. Intel’s earnings were particularly encouraging as revenues reached record levels on a rebound in corporate spending on IT budgets.
M&A activity continues to be strong for the year, with Nokia Siemens agreeing to pay $1.2 billion for Motorola’s wireless network assets. Carlyle Group is said to have agreed to buy Brazilian healthcare company Grupo Qualicorp for $1.2 billion, NBTY for $3.8 billion (the biggest buyout this year) and Australia’s Healthscope for $1.7 billion. BP is said to be negotiating an $11 billion asset sale to Apache in order to line up funds for the $20 billion reserve fund for claims related to the spill in the Gulf of Mexico.
Despite these positive trends, inventory rebuilding in U.S. subsided as companies are anticipating weaker sales in the second half of the year. Small- business hiring has also slowed.
Goldman Sachs agreed to pay $550 million to settle an SEC suit, a much lower amount than generally anticipated by the market. The settlement states that the firm’s collateralized debt obligations documents linked to subprime mortgages were incomplete. Results of the settlement confirmed the general market perception that the SEC may not have had a strong case against the firm. Goldman stock rallied on the news.
Sovereign Debt Issues Remain
European sovereign debt issues continue to evolve. Hungary’s talks with the International Monetary Fund and European Union for support did not succeed and the country’s credit rating may be cut to junk at Standard & Poor’s. Moody’s Investors Service also warned that it may lower Iceland’s credit grade to junk and cut the outlook on Iceland’s Baa3 foreign currency debt to negative.
The European Union has been performing stress tests of European financial institutions, similar to the ones done on U.S. financial institutions a year ago. There continues to be uncertainty as to the outcomes of these tests. Potential sovereign debt defaults remain worrisome.
We are encouraged to see a rebound in the equity markets primarily in response to healthy corporate earnings reports in the U.S., and we are optimistic about the equity markets in general. Moderate but robust economic expansion, and realistic market expectations, should make for a healthy environment for stock picking in the coming months.
This commentary represents the opinions of its author as of 8/6/10 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.