Calvert  News & Commentary

December 2011 Equity Market Commentary


Untitled Document

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

The eurozone's sovereign debt crisis continued to provide a negative backdrop for equity markets globally in December with the recent recovery in the U.S. equity markets reflecting the dichotomy of the U.S. economic reality versus most of the rest of the world. For the month, the Standard and Poor's 500, the Russell 1000, and the Russell 2000 Indices returned 1.02%, 0.84%, and 0.66%, respectively, whereas the MSCI EAFE and MSCI Emerging Markets Indices fell 0.94% and 1.20%, respectively. Value stocks outperformed growth stocks during the month with the Russell 1000 Value Index returning 2.02% while the Russell 1000 Growth Index returned -0.32%.

Within the Russell 1000 Index the generally more defensive telecommunications, utilities and healthcare were the top performing sectors for the month, while materials, information technology, and energy lagged.

Eurozone Sovereign Debt Crisis Continues

European economic data continues to show that the region is likely already in a recession. As mentioned in previous commentaries, expanding fiscal austerity measures will continue to weigh on economic activity in the eurozone, where the retail Purchasing Managers Index (PMI) and consumer spending data show significant declines, despite the slower pace of inflation.

Italy's new premiere, Mario Monti, introduced his austerity plan to lawmakers during the month, calling for €30 billion in spending cuts and tax hikes, and €10 billion in growth-boosting measures. He also noted that further reforms to Italy's rigid labor market were forthcoming. Still, data released during the month indicated Italy's GDP contracted 0.2% in the third quarter, signaling that the Italian economy may have entered a recession.

Investors remained unconvinced that the eurozone's problems can be solved through the policy measures presented to date and kept yields on Spanish, Italian, and Greek debt elevated throughout the month. Germany continued to oppose an expanded role for the European Central Bank (ECB) in capping sovereign debt yields with bond purchases. Meanwhile, France suffered a credit outlook downgrade by Fitch during the month, a development long anticipated by the markets. France's AAA credit rating remains at risk, with France's rating linked to the European Financial Stability Facility (EFSF) keeping its AAA rating as well.

The slow pace of global economic growth is dampening global inflation, allowing for global easing of monetary policies which, in turn, should help stimulate economic growth. A global easing cycle continued with Sweden, Russia, Denmark, and Norway easing their monetary policy during the month. The ECB also cut interest rates by 25 basis points to 100 basis points during the month. The euro fell to its lowest level against the U.S. dollar since January, with many analysts predicting that it will fall even more in 2012, which could provide a boost to European exports in the future.

The ECB lending program initiated during the month seemed to be successful and was received positively by markets. The ECB provided €489 billion in cheap three-year loans to European banks and lenders in the first tranche of "longer term refinancing operations," with additional funds to be made available at the end of February. However, the belief that banks would use the cheap financing to purchase sovereign bonds, thereby pushing sovereign yields down, did not seem to play out initially.

Growth Slows in Emerging Markets

Economic growth in China is slowing and the risk of a hard landing for its economy is increasing. This, combined with the potential risk of a significant negative event in Europe could serve as a further shock to investor confidence sometime in 2012. The Indian economy is also slowing.

U.S. Recovery Gains Momentum

Despite the negative international macroeconomic backdrop, the U.S. economy continues to gain positive momentum. The falling unemployment rate is boosting consumer confidence, which showed much better than expected readings during December. Retail sales indicated stronger, although not stellar, consumer spending. Gasoline prices are hitting new medium-term lows, which is also helping the consumer. Improvement in the household employment and temporary employment numbers were welcome positive signs, though the impressive decline in the unemployment rate from 9% to 8.6% in November was, unfortunately, primarily due to a drop in the labor force participation rate. Unemployment claims in the U.S. are also slowing. The initial jobless claims four-week moving average is now down to 375,000—the lowest level since June 2008. Continuing claims also dropped throughout most of the month. December payroll numbers are showing improvement which is certainly good for the consumer.

U.S. inflation continues to be low, exports and trade data are surprising on the upside, bank lending is improving, a weak U.S. dollar is supporting strong exports and the national PMI is firmly in an expansionary mode. The Federal Reserve's accommodative policy stance is also helping the U.S. economy. Most data now point to a likely higher than expected U.S. GDP in the fourth quarter.

The U.S. housing market, an important piece of the puzzle in the U.S. economic recovery, is likely to continue its bottoming-out process into 2012 with prices continuing to firm and likely to improve in some regions, starting a long-term upward trend, which means housing will no longer be a drag on the economy. Housing affordability in the U.S. is at an all-time high which, combined with a pickup in rents, helps provide support for housing pricing. Multi-family housing is already exhibiting robust recovery. Mortgage rates are at all-time lows; however, while the refinance share of mortgage activity reached a 2011 high during the month, financing for new borrowers is still hard to come by as banks' lending standards remain high.

Housing starts jumped more than expected in November, up 9.3% from the prior month, with robust increases in both single-family and multi-family starts, and building permits were up 5.7%, exceeding expectations. Pending and existing home sales also rose more than forecast in November. Similarly, new home sales increased 1.6% in November according to figures released by the Commerce Department during the month. This increase in housing activity—as measured by the S&P/Case-Shiller Composite Index (a broad measure of U.S. housing values of 20 cities)—falling more than forecast in October, while not pushing prices up at this point will continue to help form a bottom in housing prices.

Despite credit rating cuts for several of the largest U.S. banks (Bank of America, Goldman Sachs, Morgan Stanley, and Citigroup had their long-term credit ratings cut from A to A- by S&P while JPMorgan Chase was reduced from A+ to A), the group had a modest bounce during the month. Unlike their European counterparts, U.S. banks are recapitalized and have been increasing lending which is helping the economic recovery here. At the same time, regulatory pressure on the banking sector is unlikely to abate any time soon, which will continue to inhibit the financial sector's long-term profitability. During the month the Fed announced its intent to adopt the bank capital plans laid out in Basel III, an international regulatory framework for banks, which includes conducting annual stress tests.

While the U.S. economy seems to be doing well, the policy stalemate in Washington continues to be frustrating and disappointing for both its citizens and market participants. At the end of the month, Republicans finally agreed to a payroll tax break extension, albeit for two months instead of the full year, though that is still likely to happen.

Supply chain disruptions, particularly in the technology and auto industries, stemming from the floods in Thailand, are likely to have a similar impact on the global economy as the natural disasters in Japan did earlier this year, with both production and demand pushed out a quarter or two. This means that the floods probably slowed economic activity in the fourth quarter of this year but will likely have a positive effect in the first and second quarters of 2012.


U.S. equity markets continue to look undervalued and attractive owing primarily to the robustness and quality of the U.S. corporate sector. Corporate earnings in the U.S. are likely to continue to be strong in the near term, capital expenditure is improving and a solid manufacturing sector continues to support the economy. The U.S. consumer, a significant contributor to global economic activity, is showing signs of recovery, which, if continued, will help accelerate positive economic momentum.

U.S. bank lending is improving, however, big bank risks in Europe that have the potential to impact systemically important U.S. institutions could upset that trend. We continue to believe that it may take a significant negative event in Europe such as a failure or nationalization of a major bank(s) for investors to get their arms around the scope of a potential resulting "domino effect" on the U.S.'s systemically important institutions before a sustained recovery in U.S. financial stocks can take root. At that point, significant portfolio underweights in the financial sector, while beneficial over the past several quarters, will likely separate the "haves" from the "have-nots" in investment manager alpha land.

We expect market volatility to continue to exhibit significant spikes in 2012 which could afford investors significant investment opportunities given historically attractive valuation levels in U.S. equities.

The downside risks for 2012 are some of the same issues we discussed over the past several months–European recession and a potential hard landing in China. Fiscal drag globally and in the U.S. will be a negative for global economic growth. Easing moves in several countries, especially within emerging markets, should provide some support for global economic growth. The U.S. economy, while not immune to the eurozone's recession, seems to be gathering positive, self-sustained momentum. We expect these trends to continue well into 2012 with the U.S. likely outperforming other developed economies.

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

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