First Quarter 2013 Equity Market Review
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Investment Management, Inc.
The U.S. equity market recorded strong gains in the first quarter of 2013, benefiting from a relief rally to start the year as market participants responded favorably to the last-minute short-term fiscal cliff deal. Improving data in the U.S. labor and housing markets and continued accommodative monetary policy by the Federal Reserve boosted investor sentiment throughout the quarter, which helped both the Dow Jones Industrial Average and Standard and Poor's (S&P) 500 Index reach record highs. However, recessionary pressures in the eurozone and concerns about slower growth in China weighed more on international equity markets and contributed to their weaker performance relative to U.S. markets as the underlying economic reality in Europe began to seep through into investor sentiment and market performance. For the quarter, the S&P 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indices returned 10.61%, 10.96%, 12.39%, 5.23%, and -1.57%, respectively.
Value stocks outperformed growth stocks during the first quarter with the Russell 1000 Value Index returning 12.31% while the Russell 1000 Growth Index returned 9.54%. Within the Russell 1000 Index, Health Care, Consumer Staples, and Utilities were the top-performing sectors in the quarter, while the Materials, Information Technology, and Telecommunication Services sectors lagged.
Temporary Fiscal Cliff Deal and Improving U.S. Economic Data Contribute to First Quarter Rally
Following the U.S. fiscal cliff deal reached at the end of last year that prevented a series of tax increases and spending cuts from simultaneously taking effect with the new year, Congress approved a temporary extension of the debt ceiling in January, which also contributed to the initial relief rally. However, political dysfunction returned to the forefront during the first quarter as U.S. policymakers were unable to reach a deal to avoid sequestration, prompting $85 billion in automatic spending cuts to take effect. Despite renewed fiscal policy headwinds, investors looked past the federal budget sequester and focused on the gradually improving economic conditions in the U.S.
The U.S. housing market continued to recover in the first quarter with building permits and housing starts increasing significantly, while the inventory of homes for sale declined further, helping push up home values.
The labor market also continued to show signs of healing during the quarter as unemployment claims maintained their downward trend and the unemployment rate declined to 7.6%, though this was driven by a sharp drop in labor force participation.
Consumer spending data increased modestly, while vehicle sales remained strong, and the ISM National Manufacturing PMI pointed to an expansion in manufacturing activity.
The corporate earnings season finished with 67% of S&P 500 companies beating earnings expectations and 65% topping revenue forecasts for the fourth quarter of 2012.
The U.S. economy grew at a 0.1% annual rate in the fourth quarter of 2012, compared to the initially reported 0.1% downturn. The marginal advance in economic output was attributed to 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. The upward revision was driven largely by better trade data than was first estimated as energy-related exports rose to a record high while oil imports continued to decline.
Fed Maintains Accommodative Monetary Policy as Global Monetary Easing Cycle Continues
Inflation remained tame, allowing the Fed to maintain its accommodative stance. With that said, FOMC minutes released during the quarter highlighted the growing debate inside the Fed about the appropriate time to scale back the most recent round of quantitative easing. The eventuality of this scale-back triggered considerable discussion in the media around the impact of rising interest rates.
Meanwhile, Japan launched a massive easing campaign aimed at fighting deflation, which helped produce a significant run in Japanese equities.
Europe Struggles While Political Turmoil Resurfaces
European countries, including core European economies, continued to struggle with recessionary pressures during the first quarter. France reduced its 2013 growth outlook by half and the U.K. had its AAA credit rating cut by Moody's, while the U.K., Germany, Spain, and Belgium reported their economies shrank in the fourth quarter.
Political turmoil threatened to reignite the region's sovereign debt crisis as Italian voters supported parties promising to scale back austerity measures, and the country was unable to form a government. The Standard & Poor's rating agency warned during the quarter that Spain, Italy, Portugal, and France might have difficulty carrying through necessary reforms with their populations likely to oppose further austerity measures.
Economic and financial crisis was averted in Cyprus as the country's policymakers were able to reach a deal with eurozone finance ministers and international creditors for a â‚¬10 billion bailout. While the last-minute deal prevented an imminent default of the country's major banks, it also renewed concerns about the region's ability to resolve its sovereign debt crisis.
European Recession Hurts Emerging Markets but China's Economy Shows Signs of Stabilizing
Unfortunately, recessionary pressures in Europe are also likely to continue impacting emerging market economies. However, data released during the quarter showed signs of China's economy stabilizing. China's real GDP rose 7.9% in the fourth quarter while Chinese exports have seen better growth than expected. Foreign Direct Investment (FDI) also increased for the first time in nine months and both measures of Manufacturing PMI increased in March. Despite these positive developments, a study published by the U.S. Federal Reserve during the quarter suggested China's economic growth could slow significantly over the coming years due to an aging population and declining productivity.
Equity markets started 2013 having gained a tremendous amount of ground since the depths of the financial crisis. A recovering U.S. housing market, declining unemployment, record-high exports, and encouraging year-end manufacturing data fueled by an attractive U.S. dollar exchange rate have all helped boost U.S. equity market sentiment. However, with the possibility of a less-than-stellar upcoming earnings season, and few positive catalysts on the near-term horizon, a short-term pull-back in equities remains a distinct possibility.
We believe the U.S. economy will be able to maintain some expansion despite the sequester. Despite having a short-term negative impact on economic growth, actions that reduce spending and improve budget strength for the U.S. over the long term are necessary. We expect housing to continue as a major driver of the recovery with the recovering U.S. housing market now providing a positive impact on economic growth and consumer confidence as well as contributing to employment in housing-related sectors, as opposed to being a drag on the economy.Â
Despite the U.K. losing its AAA rating, there seems to be little marketplace focus on how the dysfunctional U.S. political process could negatively impact the credit rating of U.S. government debt. Any discussion of a downgrade by a credit-rating agency could once again upset investor sentiment and ignite market volatility. Overall, however, the United States remains in the driver's seat of the global economy for the time being, with the rest of the world benefiting from continued U.S. economic growth, however tepid.
We continue to believe that the consensus forecast from the past several months for a European recovery was a bit premature. Â Because the economic recessionary pressures in the region are so pronounced and so strong (especially in peripheral Europe)—with Cyprus one example, however small—over time the potential default issue may continue to resurface, and markets could be reawakened to that reality.
Overall, we believe 2013 could be another good year for U.S. equities as investors look past the political dysfunction in Washington and move more money into stocks as they become more comfortable with risk. Value stocks generally performed better than growth companies in the second half of 2012, and we believe that this trend may persist in 2013 as risk aversion continues to subside. We also think that small-cap equities are poised to post better returns than large-caps, driven by healthy earnings and top-line results as well as global M&A activity. Finally, environmental, social, and governance (ESG) issues could become more prominent factors in individual stock performance in 2013 as the flow of information becomes more seamless and consumers become more aware of the impacts of ESG factors. As a result of these broad equity market trends, active equity managers should regain their ability to help investors benefit in 2013. 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 commentary represents the opinions of the author as of 4/11/13 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.
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