May Market Commentary: Investors See Slower Deterioration in Economic Data as the Green Shoots of Recovery
By Natalie Trunow, Senior Vice President, Head of Equities
Calvert Asset Management Company, Inc.
| Natalie Trunow, |
Head of Equities
For the month of May, U.S. equity markets rallied on reports of slower deterioration in economic data, which encouraged investors eager for signs of recovery and propelled the S&P 500 Index up 5.6%. During the month, the reported job figures showed that the unemployment rate rose to 8.9%, and the economy lost an additional 539,000 jobs, a much lower than anticipated number and well below April’s 663,000 loss.
Although new temporary jobs accounted for a large part of the difference between expectations and the reported number, markets reacted strongly to this, as well as to other less dire economic indicators. During the month, housing price declines also appeared less severe, as the U.S. Treasury’s efforts to depress mortgage rates through purchases of Treasuries and agency paper saw some success. The Index of Leading Indicators, while still negative, showed some marginal improvements spurred both by the market rally and by improvement in consumer sentiment. Equity markets continued to rally into the end of May, despite some valuation measures reaching fair value levels for broad indexes like the S&P 500.
Eighteen months into the recession, equity markets have reacted to the signs of perceived “green shoots” in the economy throughout May in anticipation of economic recovery. Riskier, higher beta stocks continued to rally off the March 9th lows, with the riskiest names in the Russell 1000 Index (highest beta quintile) outperforming their lower-risk counterparts by 94% through the end of May. The flight-to-quality trade paused during the month, Treasury yields rose, and the price of gold fell.
In early May, the government announced the results of the “stress tests” designed to assess the funding needed by the nation’s 19 largest banks in the event of further economic deterioration. The results indicated that ten of the nation’s 19 largest banks will need to raise $74.6 billion in new assets over the next six months, while some 1,000 additional banks are estimated to fail in the next two to three years. These disconcerting findings, along with worries about the “swine flu” virus and the geopolitical problems in Pakistan and North Korea, were unable to halt May’s market run. During the month, Financials was the best performing sector in the Russell 1000 Index, returning 11.5%.
Both Treasury-Eurodollar (TED) spreads and London Interbank Offered Rates (LIBOR) continued to fall, reaching pre-crisis, long-term lows indicating normalization in bank-to-bank and short-term lending. Carry trade has posted a comeback.
In the automotive sector, General Motors’ filing for chapter 11 was expected to create additional drag on the economy’s recovery, an impact that has been widely anticipated and seemed priced into the market during May. The U.S. government committed a total of $50 billion to GM’s turnaround, while Chrysler was being sold to Fiat.
On a regional basis, emerging markets, which declined the most in 2008, posted impressive rebounds so far in 2009 and in May, rising approximately 40% and over 15%, respectively. This type of rebound was observed across higher-risk investments, in general.
Over the past few months, companies have been aggressively cutting costs and slashing inventories, which should make for healthier margins and better productivity once economic recovery takes hold. While top line revenues are still disappointing, coming in below expectations, last quarter’s reported earnings were better than expected due to aggressive cost cutting. Any improvement in the top line should be a big positive for leaner companies in the future when any pick up in the economic activity will disproportionately improve earnings.
Having said that, the market seems to be forecasting a sharper, v-shaped recovery with the Russell 1000 Index rallying over 35% since the March 9th low through the end of May. Judging by fundamentals, this impressive rally seems to have come too far too soon, however, and may be due for a pause. We are still placing a higher probability on a slower-paced recovery.
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