A Strong December for Equity Markets
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Asset Management Company, Inc.
For the month of December, the S&P 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Market Indices returned 6.7%, 6.7%, 7.9%, 8.1%, and 7.2%, respectively. For the calendar year, despite significant gyrations during 2010, the Standard & Poor’s 500 Index rose 15.1% as the U.S. economy avoided a double-dip recession, growing an estimated 2.8%. During the year, corporate earnings beat estimates and consumers resumed spending. Most equity markets ended up in positive territory for the year. Higher-beta small cap and emerging market indices outperformed during the year with the Russell 2000 Index and the MSCI EM Index returning 26.9% and 19.2%, respectively. International markets lagged the U.S. with the MSCI EAFE returning 8.2% for the year.
The three top-performing sectors for the Russell 1000 Index for the month of December were Materials, Financials, and Energy while the Utilities, Consumer Staples, and Consumer Discretionary sectors lagged.
Gradual Economic Improvement Continues
The S&P 500 is now trading at 16.7 times reported profit, a relatively rich valuation given the uncertainties still in the global economic system. Advances in the stock market, continued gradual improvement in the economic environment, an expected boost in economic stimulus with the introduction of QE2, and incremental improvement in incomes despite high unemployment in the U.S. spurred improvements in consumer confidence. U.S. consumer confidence rose to a six-month high during the 2010 holiday season as consumers filled some of the pent-up demand that accumulated over the prior two years of recession. Consumer spending, as reported by the Commerce Department, is picking up faster than forecast, prompting businesses to order additional equipment to meet demand. The next step is likely to be investment in human capital and increased hiring.
Claims for jobless benefits dropped at the end of December to the lowest level in two years, showing the U.S. labor market may be taking a turn for the better as the economy accelerates into 2011. Applications for unemployment assistance decreased by 34,000 to 388,000 in the week ended December 25, breaking under the 400,000 level for the first time since July 2008, according to Labor Department figures. Other data showed businesses expanded in December at the fastest pace in two decades.
During the month, investors were optimistic about the extension of Bush-era income-tax cuts for two years, a reduction in the payroll tax in 2011, and the Federal Reserve’s plan to buy $600 billion of Treasury securities, while shrugging off the highly publicized insider-trading scandal engulfing company insiders in the Technology sector and their hedge fund clients.
Housing Market Still Challenged
The real estate market remained in negative territory, although it too may start to bottom out in the first half of 2011, especially the commercial real estate area. Housing continues in a double-dip state with housing prices depressed by a high inventory of foreclosed homes. Lower mortgage credit availability—despite lower mortgage rates—is dampening home prices while recession and unemployment have spurred a decline in borrower credit scores. The U.S. homeownership rate remains at a 10-year low. Pending home sales data, however, showed some improvement in November for the fourth time in five months.
In the U.S., the Banking sector continues to face the increasing costs of the faulty mortgage documentation debacle. Bank of America alone faces demands for almost $13 billion of refunds from mortgage investors. The bulk of claims are related to prime mortgages. Investors in mortgage-backed securities are demanding refunds from banks on loans based on faulty data about the property or borrower. By some estimates, the total cost of potential mortgage buy-backs to the industry is in the $50 billion to $100 billion range.
Overseas Concerns May Hamper Growth
European equity markets continued to suffer during December from the fear of contagion in the sovereign debt market. S&P downgraded Ireland’s sovereign debt by five levels to Aa2, while the sovereign debt of Portugal, Spain, and Italy remain under stress.
China’s continued policy of a weaker renminbi in support of the country's export sector, which comprises two-thirds of the country's economy, is hamstringing China’s efforts to suppress inflation. The markets have been cautious about rising Chinese inflation, which may impede growth in one of the leading global economies.
Meanwhile, tensions continued on the Korean peninsula as the U.S., Japan, and South Korea conducted live-fire artillery drills in the area.
Markets are anticipating better-than-forecast economic growth in the U.S. with some estimates now showing 3.5% GDP growth in 2011. We continue to be optimistic about improving prospects for the economic recovery in the U.S. and are pleased to see the U.S. consumer showing signs of recovery. This is a welcome change that can considerably improve prospects for higher top-line numbers in the corporate sector, allowing U.S. firms to maintain high levels of profitability even if they start hiring new workers. This should help reduce unemployment, although given the historically high levels today it may take quite a while.
Our outlook for equity markets continues to be positive long-term, although current valuations may prove optimistic and cause a sell-off in the short term. If the corporate earnings picture continues to be positive and top lines improve, valuations should come back to more attractive levels, especially if we see some pullback in the market after a considerable run up in December.
This commentary represents the opinions of its author as of 12/6/10 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