Calvert  News & Commentary

Global Equity Markets Pull Back on Weak Economic Data in August

Despite a slow U.S. economic recovery, corporate strength continues and the long-term outlook for equities is positive

9/30/2010

Untitled Document

By Natalie Trunow, Chief Investment Officer, Equities, Calvert Asset Management Company, Inc.

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

During August, all major global equity indices reacted negatively to economic news that continued to confirm a slower pace of economic recovery than the markets and economists anticipated earlier in the year. The S&P 500 Index, Russell 1000 Index, Russell 2000 Index, MSCI EAFE and MSCI Emerging Markets Index returned -4.51%, -4.47%, -7.40%, -3.11%, and -1.72%, respectively.

Sector returns across the board were negative for the month, with the exception of Telecommunications and Utilities. The largest declines were in the Industrials, Financials, and Information Technology sectors, each of which dropped by about 7%.

Strong Earnings and Revenue Reports Continue

Corporate earnings reports continued to provide support for the market. The majority of reported company earnings and revenue were both positive and above Wall Street estimates. Pfizer, the world’s largest drug maker, News Corp., Kraft Foods, Humana, Alcoa, and Priceline, among others, beat analysts’ earnings estimates. To date, almost 78% of all S&P 500 companies that have reported earnings have beat analysts' estimates.

Strength in the corporate sector continues to boost corporate balance sheets and cash flow, providing further support for the merger and acquisition (M&A) activity that has been strong throughout the year. We continue to believe that this trend will be beneficial to U.S. small- and mid-cap companies as they often become acquisition targets. However, we also anticipate a somewhat more challenged earnings environment in the second half of the year.

Private Sector, Consumer Still Regrouping

Despite the rosy earnings and revenue numbers from U.S. companies, many of those same companies have been holding back on hiring and spending, contributing to the slower pace of economic recovery. The painful unemployment environment, which remains at 9.5% for July, continues to hamper the consumer and the housing markets. July private employment data came in lower than anticipated and government employment declined because of the drop in federal census jobs.

U.S. consumers are continuing to rebuild their balance sheets by taking out less debt, spending less, and saving more. These trends have pushed credit-card debt to its lowest levels since 2005. Constrained consumer spending was evident in slower-than-expected sales growth in the Retail sector. However, consumer confidence data reported at the end of August climbed more than was forecast, up from an eight-month low. We continue to expect that consumer spending will start to recover later this year. Inflation remains low with the Personal Consumption Expenditures Price Index, minus food and energy, rising at a 1.1% annual rate in the second quarter.

Fed Pledges Measures to Address Sluggish Recovery

The Commerce Department cut its estimate for U.S. economic growth (GDP) in the second quarter to an annual pace of 1.6% from an initially reported 2.4% pace. The sluggish pace of the economic recovery has also recently been confirmed by more-negative-than-expected data in employment, manufacturing, and housing. The news was particularly negative for housing, with sales of existing homes falling a record 27% in July as the positive impacts of the government tax incentives rolled off. That said, economic data also showed that service industries are starting to show some signs of improvement, expanding in July at a faster pace than forecast, while industrial production also rose 1% in July. The strength of the manufacturing sector gives us comfort that the economy as a whole, despite weak consumer and service sectors, is unlikely to fall back into the negative growth territory which could indicate the start of a double-dip recession.

At the Federal Reserve’s annual monetary symposium, Fed Chairman Ben Bernanke said the central bank “will do all that it can” to ensure a continuation of the economic recovery and said more securities purchases may be warranted if growth slows—especially if the outlook were to deteriorate significantly. Bernanke also said that the Fed could communicate that it will keep its benchmark rate low for a “longer period than is currently priced in the markets,” or lower the interest rate on banks’ deposits at the Fed to 0.10 percentage point or to zero from the current 0.25 percentage point rate.

China Navigates Soft Landing

Economic growth numbers out of China seem to indicate the Chinese government is seeing some success in engineering a soft landing and getting the growth rates down from the 11%-13% range of the past several years to a more manageable 9-10% level. Second-quarter GDP data showed that China surpassed Japan to become the world’s second-largest economy, so it is important that the cooling-down process continues to be gradual. A hard landing for an overheated Chinese economy would have strong negative implications for global economic growth. Last month, China produced the world’s largest-ever IPO when The Agricultural Bank of China went public, raising $22.1 billion on the offering.

Attractive Opportunities in the Equities Market

We believe that the sharp outperformance of bonds versus equities will reverse, with equities outperforming bonds over the next 6-18 months as the economy’s slow, but sustained, recovery continues. According to Cambridge, Massachusetts-based fund-tracker EPFR Global, global investors withdrew a net $7.1 billion from equity funds worldwide last week as of August 25 and put some $5.2 billion into bonds. A net $5.4 billion was redeemed from U.S. stock funds (inflows into emerging market stock funds were the lowest in 13 weeks). Developing-nation bond funds took in $1 billion, on course for a record-setting year, while U.S. bond funds drew $2.5 billion.

We are therefore optimistic that the recent equity market doldrums will result in attractive buying opportunities in equities. Currently, equities look more attractive relative to bonds than they have since 1993 (except for the market bottom in March of 2009), with 10-year Treasuries yielding 2.58% vs. the Dow Jones Industrial Average’s dividend yield of 2.89% and an attractive forward price/earnings multiple of 12.3.

As we have commented in the past, we don’t believe that negative GDP growth, which could constitute the start of a double dip, is likely. It is a bit puzzling, however, that a slow economic recovery off the bottom of the crisis—precipitated by large excesses in the global economic system—comes as a surprise to the markets. The current pull back in the markets is a healthy development, and will provide a better foundation upon which to build a more sustained market recovery in the long term. Our outlook continues to call for a slow, gradual pace to economic recovery and a generally positive environment for stock picking.

This commentary represents the opinions of its author as of 8/31/10 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.

The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Asset Management Company, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information.

Calvert Asset Management Company, Inc., 4550 Montgomery Avenue, Suite 1000N, Bethesda, MD 20814



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