January 2013 Equity Market Review
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Investment Management, Inc.
Equity markets benefited from a relief rally in January as market participants responded favorably to the last-minute short-term fiscal cliff deal that prevented a series of tax increases and spending cuts from simultaneously taking effect with the new year. Improving data in the U.S. labor and housing markets also boosted investor sentiment during the month, but, with the eurozone mired in recession and a looming budget battle in the U.S., potential headwinds remain. Despite these concerns, all major global equity indices were in positive territory to start 2013. For the month, the Standard and Poor's (S&P) 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indices returned 5.18%, 5.42%, 6.26%, 5.27%, and 1.38%, respectively. Value stocks significantly outperformed growth stocks during the month, and within the Russell 1000 Index, Energy, Health Care, and Financials were the top-performing sectors, while the Information Technology, Telecommunication Services, and Materials sectors lagged.
Temporary Fiscal Cliff Deal and Improving U.S. Economic Data Contribute to Rally
Following the U.S. fiscal cliff deal reached at the end of last year, Congress approved a temporary extension of the debt ceiling in January, which also contributed to the relief rally during the month. However, policy measures did not address the concerns of major credit rating agencies, which maintained that the U.S. will need to take additional steps in order to address the country's budget deficit.
Economic data continued to show signs of gradual improvement in the U.S. labor market with initial jobless claims falling to a five-year low during the month. However, the unemployment rate edged up to 7.9% in January despite moderate gains in private payrolls and a sharp upward revision to the number of jobs added in the prior two months.
The housing market also continued to recover with housing starts surging and the S&P/Case-Shiller 20-City Composite Home Price Index showing the largest year-over-year increase in home prices since 2006.
Fourth quarter GDP unexpectedly contracted at an annual rate of 0.1%, the first time the U.S. economy shrank in more than three years. The drop in economic output was driven by a significant decline in government spending, which more than offset strong gains in residential investment and capital expenditures and a 2.2% increase in consumer spending.
Strong Start to Corporate Earnings Season in U.S.
Earnings season was off to a solid start with approximately 67% of companies in the S&P 500 that reported their financial results as of the time of this writing beating both earnings and revenues expectations.
Global Monetary Easing Cycle Continues, While Europe Struggles and China's Economy Shows Signs of Stabilizing
The global easing cycle continued as the Fed affirmed its existing level of asset purchases at the January FOMC meeting, while Japan launched a massive easing campaign aimed at fighting deflation.
European countries continued to struggle with recessionary pressures. The U.K., Germany, Spain, and Belgium reported their economies shrank in the fourth quarter, while the eurozone manufacturing PMI remained in contraction territory.
At the same time, China's economy continued to show signs of stabilizing, with real GDP rising 7.9% in the fourth quarter and export growth of 14% in December significantly exceeding expectations.
Overall, we believe 2013 may unfold as a year of inflection points and reversals, with the U.S. equity market again delivering positive returns despite the political dysfunction in the nation's capital. However, with the federal budget sequester set to take effect on March 1, political gridlock in the U.S. could once again be a source of headline risk over the next month. We remain hopeful, however, that policymakers will be able to reach a compromise without significantly upsetting investor sentiment.
As risk aversion subsides and investors are less willing to accept tiny—or negative—inflation-adjusted yields from Treasuries, we may finally see the performance spreads between equities and fixed-income securities reverse from their historically low levels and return to longer-term historical averages. From a relative valuation point of view, stocks are now very attractive relative to bonds.
Unlike the situation in the previous four years, however, we believe that positive asset flows may accompany attractive equity returns as retail and institutional investors gain confidence in the U.S. market recovery. This would reverse a multi-year trend of outflows from equity funds. With risk aversion still relatively high among investors, these new flows may be reallocations from other asset classes rather than from investors' cash positions. In fact, if we see an inflection point in the fixed-income markets where bond returns turn negative, investors may be less willing to reallocate cash to risky assets. Even if this scenario occurs, we still think equities may attract incremental flows.
We see several other trends potentially reversing in 2013 as the global macroeconomic picture becomes less treacherous. The value discipline may outperform in 2013 (as it generally did in 2012), reversing a much longer term, multi-year cycle of underperformance. We also believe that small-cap stocks are poised to move higher and may outperform large caps in 2013. Additionally, we may see the "risk-on, risk-off" investor sentiment of the past few years grow into a more steady "risk-on" approach by the end of 2013 or early 2014. These trends can provide a perfect environment for yet another reversal—in the performance of active equity portfolio managers.
ESG Factors to Gain Attention
Another aspect of the equity investing climate that we expect to start to reverse in 2013 is the general lack of attention to environmental, social, and governance (ESG) factors and how they will impact company valuations. The most obvious driver for this transition is the new four-year mandate for the Obama administration in the United States, which should give the president the political capital to drive for significant growth in green jobs and alternative energy. In addition, there have been many relatively small advances in government regulations relating to ESG over the last few years that haven't yet made a big impression on investors. However, we expect to see the aggregation of these incremental advances in ESG regulation beginning to have a larger positive effect in 2013 and beyond.
More importantly, U.S. consumers are more aware of and educated about ESG matters and how they impact themselves and the economy. This is positive for both the U.S. economy as a whole and for companies that are poised to benefit from the push toward improvements in ESG factors—as well as for portfolio managers who can identify those trends and benefit from them.
This commentary represents the opinions of the author as of 2/15/13 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