November 2012 Equity Market Review
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Investment Management, Inc.
With the U.S. presidential election decided on November 6, market participants refocused intently on the potential—and quite negative—implications of the impending fiscal cliff. A lack of positive near-term catalysts, exacerbated by the continued political gridlock in Washington, a less-than-stellar earnings season in the U.S., the negative economic impact of Hurricane Sandy, and recession in the eurozone, further dampened investor sentiment in November. Despite the resulting uncertainties in the macroeconomic landscape, a rally by equities to close the month helped most major equity market indices finish November in positive territory. For the month, the Standard and Poor’s (S&P) 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indices returned 0.58%, 0.79%, 0.53%, 2.43%, and 1.28%, respectively. Growth stocks outperformed value stocks with the Russell 1000 Growth Index returning 1.67% while the Russell 1000 Value Index dropped 0.04%.
Within the Russell 1000 Index, Consumer Discretionary, Industrials, and Consumer Staples were the top-performing sectors for the month, while Utilities, Energy, and Telecommunication Services sectors lagged. The Consumer Discretionary sector is now leading the charge for the year-to-date period through November, with an impressive 23.86% return, followed by the Financials sector, which is up 21.63%. With the housing and equity markets doing better this year, the Consumer Discretionary sector may continue to lead for some time while Financials may cede some of their leadership position given the challenges in their earnings profile.
Investors and Companies Focus on U.S. Fiscal
The fiscal cliff was a major source of concern for investors during the month. Despite initial positive rhetoric from policymakers, Democrats and Republicans appeared to be far apart in negotiations on entitlement reforms and increased tax revenue.
With the Bush-era 15% top tax rate on dividends set to expire at the end of year and dividends reverting to being taxed as ordinary income, dividend tax policy is likely to be an ongoing point of discussion during fiscal cliff negotiations. A significant number of companies have already responded by issuing large special dividends prior to the end of the year, while some firms, including Wal-Mart, have shifted the timing of dividend payouts from January to December. U.S. companies have also been lobbying Congress to limit the dividend tax rate hike, urging policymakers to at least keep it in line with the capital gains tax rate, noting that a higher tax rate on dividends relative to capital gains penalizes dividend-paying companies compared to growth-oriented companies that don’t regularly issue dividends.
Gradual Economic Recovery in the U.S. Continues, Weighed Down by Hurricane Sandy and Fiscal Cliff
After already being weakened by the global economic slowdown, the U.S. manufacturing sector, particularly in the Northeast, received an additional blow from Hurricane Sandy. As of the time of this writing, the release of the November ISM National Manufacturing Index indicated manufacturing activity in the U.S. shrank for the first time in three months. However, despite the devastation caused by “super-storm” Sandy, other U.S. macro data were slightly more positive in November.
Construction spending increased for a sixth straight month, driven by strong gains in private residential construction, and domestic vehicle sales also continued to post strong gains. Orders of both durable goods and capital goods increased more than forecast in October, while the U.S. trade deficit unexpectedly narrowed in September. Exports reached a record high as demand from emerging markets more than offset weakness in Europe. Unfortunately, we believe that the impact of the storm on economic activity will rear its ugly head in the months to come. According to New York Federal Reserve President William Dudley, the negative impact of Hurricane Sandy on fourth quarter GDP could be between 0.25 and 0.5 percentage points, though the positive multiplier effect of reconstruction could wind up lifting GDP in 2013.
The ISM Non-Manufacturing Index fell in October, but remained firmly in expansion territory while the employment component increased to a seven-month high. With the jobs market also on the mend, the consumer sector should get even more support, though jobless claims are likely to remain elevated and volatile in the near term in the wake of Hurricane Sandy.
The initially estimated 2% annualized GDP growth rate in the third quarter was revised higher to 2.7%, supported by the better-than-expected trade data and upward revisions to inventories. However, the increase in personal consumption was revised down from 2% to 1.4%.
Inflation remained tame and consumer confidence continued to improve with the Conference Board Consumer Confidence Index rising to its highest level since 2008. Consumer credit increased more than forecast in September, led by increases in borrowing for college tuition and automobiles, though other data released during the month showed real consumer spending declined in October with the Commerce Department estimating the storm reduced pay at an annual rate of $18.2 billion. We expect the upcoming holiday season to provide a boost to the Retail sector.
U.S. Housing Market Recovery Continues to Gain Traction
The decision by the U.S. Federal Reserve to purchase $40 billion of mortgage-backed securities each month in an effort to lower long-term interest rates seemed to be working, and the most recent Federal Open Market Committee (FOMC) minutes indicated members expect to continue asset purchases into next year.
With mortgage rates at record lows, the Mortgage Bankers Association (MBA) purchase index rose to its highest level this year while other housing data continued to show home prices rising. Pending home sales also surged in October, suggesting sales of existing homes should continue to increase in the coming months.
Double-Dip Recession in Eurozone
The eurozone continued to provide a negative backdrop for equity markets in November with unemployment in the euro region at a record high and manufacturing PMI mired deep in contraction territory. Eurozone GDP contracted at a seasonally annualized rate of 0.1% in the third quarter on a quarter-over-quarter basis and 0.6% on a year-over-year basis, officially pushing the euro area into a recession for the second time in four years. Core European economies also continued to be negatively impacted by the region’s economic troubles. Industrial production declined sharply in both France and Germany, while consumer spending in those countries has also been weakening.
There was some progress on the policy front during the month as Greece reached a deal with its international creditors that will allow for the release of the next tranche of bailout funds while reducing Greece’s debt burden to 124% of GDP by 2020. The package of measures was approved by Germany’s parliament, removing one potential obstacle that could have inhibited the deal’s implementation.
China’s Economy Stabilizing
Data released in November suggested China’s economic slowdown may be stabilizing as the growth-boosting measures enacted by the Chinese government seemed to be having the desired effect without stoking inflation fears. China’s Consumer Price Index (CPI) came in at 1.7% in October and the Producer Price Index also came in lower than forecast at -2.8%.
China’s official manufacturing PMI rose to a seven-month high in November while the HSBC China Manufacturing PMI indicated an expansion in manufacturing activity for the first time in 13 months. Profits earned by Chinese industrial companies increased 20.5% in October compared to the same period one year ago, which pushed year-to-date profits into positive territory (on a year-over-year basis) for the first time this year. Although economic growth appeared to be stabilizing, the Chinese economy is not out of the woods yet. China’s transition from an export-driven economy to a more consumer-driven economy will likely face significant challenges.
We are looking for continued uncertainty surrounding the resolution of the fiscal cliff at year end. We remain hopeful that reason will prevail and policymakers will be able to reach a compromise. However, we think that the opportunity for disappointment is significant with the deadline for a deal approaching. At the moment, there seems to be little focus in the marketplace on the potential negative impact that the dysfunctional U.S. political process around fiscal cliff and budget ceiling negotiations could have on the outlook for the credit rating of the United States and resulting actions by credit rating agencies.
If the payroll tax breaks are not extended into 2013, which is a likely scenario, and spending cuts are affected automatically, the negative impact of the fiscal cliff on U.S. GDP in 2013 could be as much as 1 to 1.5 percentage points. We believe, however, that if the housing market continues to recover and gather momentum the way it has been this year, a positive multiplier effect could be felt throughout the U.S. economy as consumer confidence and spending improve. We continue to think that the housing market can provide a substantial positive impact for the U.S. economy in the next 12 to 18 months and, quite likely, beyond. This should, to a degree, offset the negative impacts of the fiscal cliff.
This commentary represents the opinions of the author as of 12/19/12 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information.
Accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.
Calvert Investment Management, Inc., 4550 Montgomery Avenue, Bethesda, MD 20814