Equity Markets Down in May on Macroeconomic Issues
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Asset Management Company, Inc.
May was a down month for equities as an impressive earnings season ended and economic activity waned, prompting investors to refocus on macroeconomic issues. With the European sovereign debt crisis intensifying, risk aversion among investors picked up, driving Treasury yields down and the U.S. dollar up. The Standard & Poor’s 500, Russell 1000, and Russell 2000 Indices returned -1.13%, -1.07%, and -1.87% in May, respectively. The top-performing sectors for the month were the generally defensive Health Care, Consumer Staples, and Utilities sectors, while the more cyclical Energy and Financials sectors lagged. The MSCI Emerging Markets Index and the international developed market MSCI EAFE Index returned -2.58% and -2.81%, respectively, as the strength of the U.S. dollar compounded local market losses.
Value stocks slightly outperformed growth names, with the Russell 1000 Value Index returning -1.06% while the Russell 1000 Growth Index fell 1.09% for the month.
We are now in an environment where positive company news generally won’t appear until the next earnings season, so markets are more focused on the global macro picture, which continues to be less positive. The resulting sell-off in equities is consistent with our outlook for markets and may continue through June and into July.
Defensive Sectors in Favor
The market’s rotation towards more-defensive sectors was prompted by the impending completion of the Federal Reserve’s (Fed’s) stimulative QE2 program in June and a sell-off in commodities markets. Completion of the QE2 program can be seen effectively as a tightening, which can be a negative for the stock market if the economic recovery and great improvements in the earnings cycle are not self-sustaining—which we don’t think is the case. If bank lending and mortgage lending stabilize and business borrowing and consumer spending continue to recover, the removal of QE2 may not be as much of an issue but will result in a potentially slower, more gradual recovery than the markets are anticipating.
The sell-off in commodities markets was partially due to the demand destruction effects of high prices for oil and increases in margin requirements for commodities traders. The upcoming end of QE2 is also credited with having a negative impact on commodity prices. Prices for crude oil, gold, silver, and other commodities fell in May as traders sold out of speculative positions. Brent crude, gold, and silver fell 15.9%, 5.3%, and 31.1%, respectively, over the first two weeks of May, but each recovered some of that lost ground over the closing weeks of the month. Brent crude finished down 6.6% and gold was off 1.3% for the month. Silver seemed most stung by events, off over 21% for the month.
Economic Data is Mixed
Lower commodity prices are a positive for global economic growth in the near term, although the long-term, secular upward trend in commodity prices may persist. If this break in commodity prices continues, it should reduce risks to top-line inflation, lifting a drag on economic growth and providing additional stability to the Fed’s accommodative stance. Core inflation rose 1% year-over-year in April, while top-line inflation grew 2.25%, offsetting gains in personal income. Consumers are constrained by high food and energy prices, making the overall recovery less buoyant. While consumer spending and home sales data reported during the month were disappointing, consumer sentiment was positive.
The April unemployment data released early in May saw the unemployment rate rise due to an increase in the number of people seeking jobs. However, payroll employment figures increased, which gives us confidence that the overall health of the job market is on the mend.
Europe’s sovereign debt crisis continues to draw the market’s attention as Greece’s economy contracted in the fourth quarter of 2010, Fitch downgraded the country’s debt rating to B+, and many expect the country to ultimately default on its debt obligations. Lack of agreement within Greece on budget reform makes the release of additional funds from the European Union less likely. While Portugal received approval for a three-year, $3.86 billion International Monetary Fund bailout loan in May, fear of contagion in Europe’s peripheral economies in the event of one of the countries defaulting or restructuring its debt is high.
The recent weakness in the equity markets is justified given the softer macroeconomic environment globally, continued sovereign risk concerns in Europe, a slowdown in China, negative impacts from the global supply-chain disruptions caused by events in Japan, and a lack of positive catalysts in the short term. However, we expect that the economic recovery will pick up pace in the second half of the year and that this market downturn will provide attractive entry points in the equity markets. Our view is that, after expected seasonal weakness during the summer, equity markets should regain their footing and produce attractive returns again this year if consumer and job recovery continues.
This commentary represents the opinions of its author as of 6/10/11 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 Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information.
Calvert Investment Management, Inc., 4550 Montgomery Avenue, Bethesda, MD 20814