First Quarter Market Commentary: Improving Economic Picture in the U.S. Continues to Fuel Equity Markets
By Natalie Trunow, Chief Investment Officer, Equities
Calvert Asset Management Company, Inc.
Despite some volatility in the first half of the quarter, equity markets ended the first quarter of 2010 back in positive territory. The Russell 1000 Index and the S&P 500 Index returned 5.70% and 5.39%, respectively, while the MSCI EAFE Index edged up just 0.98% and the MSCI Emerging Markets Index was up 2.34%. Small- and mid-cap indexes, as well as value and growth indexes, all posted healthy returns.
During the first half of the quarter, markets reacted negatively to signs that there was a lower probability of a V-shaped economic recovery, new financial regulation proposals from the Administration, and a potential economic slow-down in China. Concerns around high levels of U.S. and European debt, especially Greek sovereign debt, weaker consumer sentiment, and challenging unemployment worldwide fueled market volatility. Markets repaired those losses in the second half of the quarter and continued to rebound strongly as investors found confidence in the economic recovery with more positive economic data released later in the quarter, particularly around the consumer sector, as well as the Federal Reserve’s indication that the fed funds rate, currently targeted at 0% to 0.25%, would remain unchanged for the near term.
The Industrials, Financials, and Consumer Discretionary sectors were top performers in the S&P 500 during the period, returning 13.11%, 11.15%, and 10.47%, respectively, as investors interpreted the confirmation of low inflation, generally good earnings reports, and an indication of a steady fed funds rate policy as positive signs that the economy was on its road to recovery. The more defensive Telecommunications and Utilities sectors lagged, returning -4.32% and -3.53% respectively for the quarter.
The consumer continues to be constrained, although there have been steady improvements in year-over-year retail sales figures, especially for discount retail stores. New economic data released in March further indicated that consumer credit and spending increased more than forecast, sending the markets higher. While auto loans and retail sales showed healthy increases, spending on big ticket items has yet to recover. Consumers have been stepping up some of their delayed purchases, particularly in the IT sector, helping boost profits of software companies. Overall, consumers continued to save more and borrow less, with revolving consumer debt plunging by a record $13.1 billion in February. Consumer Confidence, however, was still largely weak with declines in February and flat numbers in March, as U.S. unemployment increased in 27 states and national unemployment remained at 9.7%.
The stubbornly high unemployment rate and the threat of a double dip in the housing market continue to present a challenge to the recovery of the consumer. U.S. mortgage delinquencies (excluding foreclosures) hit a record high of 9.8% in January, a 21% increase from a year ago. During February, new permits and housing starts data were negative, while the median cost of existing homes decreased to May, 2002 levels. We believe that a double dip in the housing market is still possible, with further downward pressure on home prices likely later in the year once mortgage debt purchases and the government tax credits for homebuyers expire and if the pace of foreclosures remains high, not to mention the fact that mortgage rates may start to inch higher. So far, foreclosures are expected to climb to 4.5 million in 2010 from 2.8 million in 2009. To battle the negative environment in the housing market, the Administration is proposing programs to help U.S. homeowners avoid foreclosure using funds from the $700 billion Troubled Asset Relief Program.
The Obama Administration has also actively been taking measures to stimulate job creation. President Obama signed into law a historic healthcare bill which will allow for tax credits to small businesses for offering health insurance. These tax credits are expected to help boost hiring by small businesses. In addition to providing incentives for increased bank lending to small businesses, the President also signed into law an $18 billion jobs bill which will give incentives to employers to hire unemployed workers through the end of 2010.
U.S. corporations continue to hoard cash and contain costs, a trend that has negatively impacted the jobless rate. Total cash on corporate balance sheets is approaching a trillion dollars and is at levels that are close to 50% higher than historical averages. Some strong companies that came out of the recession even stronger are looking to use their cash coffers for mergers and acquisitions, taking advantage of some of the attractively priced and distressed asset sales that are becoming available. As a result, we have seen a pick up in the M&A activity during the first quarter and believe that overall M&A activity worldwide is likely to pick up pace this year.
The U.S. dollar reacted positively to the more upbeat economic news in the U.S., rising against most major currencies during the quarter. The euro fell against major world currencies, as the turmoil surrounding the sovereign debt of Greece, Spain, and Portugal came into focus. In the Pacific Rim, China raised its bank reserve requirement twice in one month to cool its economy and avoid bursting of the multiple bubbles in that market.
Although the economic recovery may seem slow and painful—especially when it comes to unemployment—it is on track. Industrial production posted a small 0.1% rise in February after a 0.9% jump in January and a 0.7% jump in December, confirming that the manufacturing sector is still leading the recovery. We continue to believe that the consumer will be the next major factor necessary for a robust and extended economic recovery and that any meaningful uptick in consumer sentiment and spending in combination with ongoing recovery in the manufacturing sector could significantly improve the robustness of the economic upturn and further energize the markets. We believe that the consumer will start to return to more normal spending levels this year (although not the levels seen during the height of the housing bubble), as businesses run out of room to cut costs and start to hire new workers. It appears that the market may be anticipating a similar trend, with the Consumer Discretionary sector returning over 10% for the quarter.
A short-term concern is that once the strong contribution to GDP from inventory rebuilding subsides and the effects of the stimulus wane, GDP growth may slow. We believe that, while an important concern, this is unlikely to result in negative GDP growth that would lead to a double-dip recession in 2010.
This commentary represents the opinions of its author as of 4/6/10 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.