Calvert  News & Commentary

Equity Market Sell-Off Accelerated in September


Untitled Document

Natalie Trunow, Head of Equities Natalie Trunow,
CIO, Equities

The broad-based sell-off in equity markets accelerated in September, ending a disappointing quarter for equity markets globally. All major equity indices were down for the month as concerns that the eurozone sovereign debt crisis would spark contagion and the prospect of a considerably slower global economic recovery weighed on investor sentiment. The Standard & Poor’s (S&P) 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indices returned -7.03%, -7.46%, -11.21%, -9.50%, and -14.56% for the month, respectively.

Within the Russell 1000 Index, all economic sectors were down for the month, led by declines in Materials, Energy, and Financials, while the more defensive Utilities, Consumer Staples, and Telecoms held up better. Utilities and Consumer Staples continue to be the top-performing sectors year-to-date, with Financials and Materials lagging considerably, down -23.64% and -21.80%, respectively, for the year. We believe that the U.S. Financial sector may have seen the worst of the sell-off and, while still exposed to further deterioration in the eurozone and the long-term negative impacts on earnings from a new regulatory regime, may experience a bounce in the remaining months of 2011.

Growth stocks held up slightly better than value names in September, with the Russell 1000 Growth Index declining 7.37% and the Russell 1000 Value Index dropping 7.56%. September was the fourth consecutive month in which growth outperformed value (due, to a large degree, to Financial sector underperformance), contributing to growth stocks’ performance lead for 2011 through the end of September.

Lack of Action Sufficient to Resolve Eurozone Crisis Weighs on Equity Markets

The apparent policy disarray in the eurozone continued to fuel the uncertainty around—and investor worries over—the eurozone sovereign debt crisis throughout September. During the month, the German Supreme Court ruled that German participation in E.U. bailouts was legal, but would require parliamentary approval going forward. The German Parliament also voted to approve the July 21 E.U. Debt Summit decision to expand the size of the European Financial Stability Fund’s (EFSF) lending capacity to 440 billion euros ($596 billion), which would allow Greece to receive its much-needed next tranche of bailout funds.

The Parliaments of Germany, Finland, and Austria, along with several other E.U. countries, also voted to approve the expanded EFSF, leaving just three European Union countries that still needed to ratify the changes as of the end of September–Malta, the Netherlands, and Slovakia. The Netherlands and Malta approved the expanded EFSF in early October. With Slovakia set to vote on October 11, the approval process is expected to be completed by mid-October. However, the Greek government’s announcement that it will miss its deficit target this year renewed concerns that funds could be withheld, leading to a possible default by Greece. Germany is bracing for a Greek default by taking steps to insulate its financial institutions from large losses on Greek bonds.

Throughout September, European bank stocks continued to be among those most adversely impacted by the eurozone debt crisis as the STOXX 600 Europe Banks Index approached 2008 financial crisis lows before rebounding at the end of the month. European banks are facing short-term funding problems. According to a report released during the month by the Institute of International Finance, in addition to longer-term funding stress, European banks are now also impacted by U.S. money market funds’ further reductions in their exposure to European banks. Leading central banks (in the E.U., U.S., England, Japan, and Switzerland) responded by agreeing to a coordinated effort to provide European banks with easy access to liquidity, a move similar to policies implemented during the 2008 financial crisis.

Despite these positive developments, the Organization of Economic Cooperation and Development slashed growth forecasts for several European countries and is now forecasting that the weighted average GDP of the three largest eurozone economies will fall 0.4% in the fourth quarter of this year. Meanwhile, the credit spread on Greek sovereign debt increased significantly throughout the month and at one point implied a 96% probability of default on the country’s debt. Credit default swap spreads for several European banks, including RBS and Lloyds, also spiked to all-time highs during the month (even above 2008 levels), though they receded towards the end of the month.

The concept of a common eurozone bond was discussed at a meeting of the Eurozone Finance Ministers during the month, but it is still far off any credible implementation path.

Fed Announces Operation Twist

In the U.S., the Federal Reserve's (Fed) September 21 announcement of stimulative monetary initiatives, while timely and appropriate, was accompanied by alarming statements about U.S. economic weakness, which further unsettled markets. The plan to sell $400 billion in short-term Treasuries while purchasing the same amount of longer-term Treasuries, a move that was dubbed "operation twist,” could provide a much- needed boost to investment, refinancing, and spending in the U.S by reducing long-term interest rates. Additionally, a letter from Fed chairman Ben Bernanke from mid-July (but released in September) cited Fed analysis that claimed U.S. financial companies’ exposure to the eurozone sovereign debt crisis is “manageable.”

U.S. Housing Data Bottoming Out

The U.S. housing sector continued to show signs of bottoming out, helped by historically low mortgage rates and home prices. Data released during the month indicated that existing home sales increased unexpectedly, jumping 7.7% in August to a five-month high. Home prices also increased by a higher-than-expected 0.8% in July. The pending home sales index, while dropping 1.2% in August compared to the prior month, was 13.1% higher than one year ago. August housing starts data, which were reported during September, declined 5% from the previous month, although building permits rose by 3.2% in August.

Unemployment Picture

President Obama gave his anticipated jobs speech to Congress early in the month, calling on Congress to pass a $447 billion jobs act.  His proposal included extending unemployment insurance benefits through 2012, streaming aid to state and local governments (including cash for hiring teachers), starting an infrastructure/transportation project spending bank, and instituting a temporary cut in payroll taxes for employers and employees. However, there was no mention of a corporate tax repatriation holiday despite the preceding speculation that the White House would include such a provision. Some economists estimate the proposed jobs plan could add one to two percentage points to real GDP growth in the U.S. and create more than one million jobs. This is in stark contrast to the previously proposed status quo fiscal policy, which economists estimated would actually be a net drag on the economy.

Data released during September showed job openings increased to 3.23 million in July from 3.11 million the prior month, marking the third straight month of increases. Still, employment numbers remain weak, with the most recent four-week moving average of initial jobless claims at 417,000. Additionally, payrolls fell in 30 U.S. states in August, according to data released by the Labor Department. Jobs data is likely to be a lagging indicator of economic activity and may not improve until other indicators are more firmly in positive territory.

Mixed Economic Data, but Double-Dip Unlikely

Economic data for the U.S. was mixed during the month, though a greater number of positive data points reinforced our view that a slow, painful recovery is more likely than a contraction/double-dip scenario. The Beige Book release early in the month indicated the economy continued to expand at a slow pace, with some regions showing weakening activity while consumer spending increased marginally, with the biggest boost coming from the auto sector. Data released in September also showed that retail sales stagnated in August as consumers were becoming more cautious about spending. The prior month’s increase was also revised down to 0.3% from 0.5%.

The U.S. Small Business Confidence Index fell to a 13-month low, declining for the sixth consecutive month. Moreover, the U.S. personal income report was not optimistic, showing a 0.1% decline in August, the first drop in nearly two years.

The U.S. consumer price index (CPI) increased 0.4% in August, greater than the 0.2% forecast, while core CPI increased 0.2%. On a year-over-year basis, the CPI increased 3.8% and core CPI increased 2%; both exceeded the consensus forecast among economists. A continued rise in inflation numbers will make significant further easing by the Fed less likely.

On a positive note, the Institute for Supply Management Index of Non-Manufacturing Businesses increased to 53.3 in August from 52.7 in July, while the U.S. trade balance improved to -$44.8 billion in July from -$51.6 billion in June, shrinking by 13.2%. Consumer credit also increased by $12 billion in July, the largest gain since April 2008; however, the increase was driven by a rise in non-revolving debt (largely student loans), while revolving debt (credit card purchases) decreased. More importantly, U.S. industrial production increased 0.2% in August, which seems to suggest that manufacturing is still able to support the economic recovery. Additionally, the Chicago PMI and ISM Manufacturing PMI were both better than expected in September and remained in expansionary territory.

Consumer confidence rose to 57.8 in September, up from the prior month, when it recorded its lowest level since November 2008. Real GDP growth for the second quarter was also revised up to 1.3% during September from the previous estimate of 1%.

China Likely to Avoid “Hard Landing”

In China, the release of August CPI data indicated that inflation eased somewhat to 6.2% year-over-year, down from 6.5% in August and in line with expectations. Despite the decrease, the threat of inflation still looms in emerging-market economies and may make it difficult for China and other emerging-market countries to implement more accommodative monetary policies in the near term.

Industrial production numbers in China were also positive, increasing 13.5% year-over-year for August. Manufacturing data was slightly contractionary but not at “hard landing” levels. Still, Fitch Ratings warned during the month that it could downgrade the credit rating for both China and Japan in the next few years because of debt loads and concerns about financial stability.


With marginally positive U.S. economic data and attractive equity valuations—the 12-month forward price/earnings ratio for the S&P 500 Index was at 10.61 as of the market close on September 30—as well as signs that China’s growth momentum has not stalled, we continue to believe that the market can see a healthy recovery in the next couple of months. We remain cautiously optimistic on U.S. economic growth, albeit less so on European and global growth.

We believe that the U.S. earnings season, which starts on October 11, is likely to provide positive earnings surprises and serve as a positive catalyst for the U.S. and possibly global equity markets, especially given current valuation levels.

Calvert Investment Management, Inc., 4550 Montgomery Avenue, Bethesda, MD 20814

#11608 (10/11)

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