September 2012 Equity Market Review
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Investment Management, Inc.
Monetary easing measures launched by central banks around the globe and the Federal Reserve's third round of asset purchases (QE3) helped equity markets continue their rally in September. For the month, the Standard and Poor's (S&P) 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indices returned 2.58%, 2.57%, 3.28%, 2.99%, and 6.05%, respectively. Value stocks outperformed growth stocks during the month with the Russell 1000 Value Index returning 3.17% while the Russell 1000 Growth Index returned 1.96%.
Within the Russell 1000 Index, the top-performing sectors were Health Care, Telecommunication Services, and Materials, while Consumer Staples, Utilities, and Information Technology sectors lagged.
Global Easing Cycle Continues
The Federal Open Market Committee (FOMC) announced a third round of quantitative easing (QE3) during the month, making an open-ended commitment to purchase $40 billion of mortgage-backed securities each month until there are substantial improvements in the labor market. The FOMC maintained that the Fed's accommodative stance would remain in place even after the economic recovery showed signs of strength, while extending their zero-interest-rate pledge (ZIRP) to at least mid-2015.
Market participants responded favorably to the FOMC action, which came after an also well-received announcement by the European Central Bank (ECB) that it would launch an unlimited government bond-buying program to aid countries under severe fiscal stress, provided those countries meet certain budgetary and policy conditions. Importantly, the ECB stated that these purchases would not receive senior status relative to other creditors.
The Bank of Japan also announced an expansion of its asset purchase program during the month, further contributing to the global monetary easing cycle aimed at stimulating economic growth.
Gradual Economic Recovery Continues in U.S. but Global Slowdown Weighs on Manufacturing
Despite the recent QE3-induced burst of investor enthusiasm, the global economic slowdown, particularly the softer growth in China, continued to have a negative impact on the U.S. manufacturing sector. Data released during the month showed durable goods orders declined 13.2% in August, while industrial production also declined.Â Regional manufacturing data were mixed, but at the time of this writing the ISM National Manufacturing Index surprised to the upside in September, rising to 51.5, which indicates manufacturing activity expanded.
The ISM Non-Manufacturing Index rose to a three-month high in August, a welcome sign as the U.S. service sector represents a larger part of the economy than manufacturing. Consumer spending patterns remained promising and vehicle sales were strong. Retail sales (including autos and gasoline) rose 0.9% in August and consumer spending was up 0.5%, though this was driven more by higher prices than increased spending, with real spending up only 0.1%. U.S. consumer credit unexpectedly fell in July as the decline in credit-card borrowing more than offset modest increases in student and auto loans.
Inflation remained tame for the time being, but the drought in the Midwest earlier in the year may lead to a rise in food prices. Gas prices have also been rising.
U.S. second-quarter GDP growth was revised down from 1.7% to 1.3%. The Commerce Department attributed the downward revision to farm inventories being significantly lower than initially estimated due to the drought.
The overall unemployment picture continued to improve, but only slightly. Initial jobless claims fell to a two-month low at the end of the month and continuing claims have decreased for three consecutive weeks. As of the time of this writing, the unemployment rate had dropped to 7.8%, another encouraging sign for the labor market.
Consumer confidence, helped by strength in the housing market and improving equity markets, has also been showing signs of improvement.
U.S. Housing Market Continues to Show Improvement
U.S. housing market activity continued to pick up in September, spurred by record-low mortgage rates. The National Association of Home Builders Market Index rose to a six-year high in September while housing starts increased 2.3% in August from the prior month and were up an impressive 29% on a year-over-year basis, reflecting a pick-up in new home sales.
Sales of existing homes surged 7.8% in August and were the highest since May 2010. Existing home prices also continued to improve as housing inventories have been reduced significantly. This helped spur sales of new homes, which were up 28% in August on a year-over-year basis.
We continue to believe that the U.S. housing market and its impact on the consumer can support the U.S. economic recovery despite the softness in the U.S. manufacturing sector.
Recession in Eurozone Continues Despite Some Progress on Policy Front
Data continued to point to recession in the eurozone with Manufacturing PMI deep in contraction territory, consumer confidence at its lowest point since May 2009, and unemployment at a record high. Real GDP in the eurozone contracted 0.2% on a quarter-over-quarter basis and 0.5% year-over-year, while industrial production in the region was down 2.3% in July compared to the same period one year ago. Core European economies also continued to feel the impact of the region's sovereign debt crisis with France's Manufacturing PMI plunging to 42.6, the lowest level since April 2009.
Inflation in the eurozone increased more than forecast with the Consumer Price Index (CPI) up 2.7% in September, which may limit the ability of the ECB to introduce additional easing measures.
Yields on Spanish and Italian government bonds fell during the month as investors responded favorably to the ECB's open-ended commitment to purchase sovereign debt. Spain, Italy, and Portugal also had successful debt auctions during the month, though capital flight from the European periphery continued.
Greece's coalition government reached a deal on a new austerity package as the country awaits the decision by international creditors on whether the next tranche of Greek bailout aid will be released. Meanwhile, by the end of September the yield on Greek 10-year bonds had fallen to 17.5% from nearly 30% a few months ago.
On the policy front, the German Constitutional Court ruled in favor of the European Stability Mechanism (ESM), clearing the way for the bailout fund to be operational by mid-October. However, despite some positive developments, the eurozone's policy solutions continued to be fraught with challenges. The finance ministers of Germany, Finland, and the Netherlands issued a statement during the month questioning whether the ESM would be able to directly recapitalize banks on legacy loans, meaning Spain's banks would not be able to directly access that funding source. It also now appears that implementation of the proposed European Banking Union will likely take longer than initially planned.
Probability of Hard Landing for Chinese Economy Increases
In China, the probability of a hard landing continued to increase. This is a significant growth issue for the global economy and emerging markets, making the overall macroeconomic backdrop riskier for the next several quarters. China's HSBC Manufacturing PMI for August showed manufacturing activity contracted for the eleventh consecutive month while industrial production increased at the slowest rate since May 2009.
Foreign direct investment in China declined 1.4% in August from the same period one year ago while year-to-date industrial profits were down 3.1%. China's largest publicly traded steelmaker, Baoshan Iron & Steel, announced it was halting production at a major steel plant due to waning demand.
Chinese Premier Wen Jiabao announced during the month that the government had plenty of capacity to stimulate the economy via fiscal spending if downward pressure continued, while also noting that several stimulative measures enacted over the past few months should begin to have a positive impact on the Chinese economy.
We see continued challenges in the global macro backdrop, leaving equity markets vulnerable to negative news, especially given that most of the foreseeable positive catalysts have occurred and the markets have had a healthy run. Any negative news from Europe and/or China, or negative earnings announcements in the U.S., will likely trigger a risk aversion trade.
We continue to see equity markets as somewhat extended at the moment and overly reliant on policy measures for positive outcomes. We believe the probability of a near-term correction is higher now that there are few catalysts for improvements until the new earnings season kicks in. Once the presidential elections and fiscal cliff measures are decided, however, equity markets have the potential to continue to rally.
This commentary represents the opinions of the author as of 10/8/12 and may change based on market and other conditions. These 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.
Accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.
Calvert Investment Management, Inc., 4550 Montgomery Avenue, Bethesda, MD 20814