Focus on Equities for April 2013
By Natalie Trunow, Chief Investment Officer, Equities, Calvert Investment Management, Inc.
Trending in April
- Housing activity remained on the upswing
- Initial unemployment claims reached their lowest level since January 2008
- Chinese economy showed signs of softness
- European equities found support around likelihood of ECB key interest rate cut
- Housing likely to continue as a major driver of the U.S. economic recovery
- Few positive catalysts on the near-term horizon; short-term pullback in equities a distinct possibility
Continued improvements in the U.S. labor and housing markets, coupled with the continuation of easy monetary policy, helped most global equity markets extend their year-to-date gains in April. On the international stage, stabilization of the political situation in Italy and investor anticipation of monetary easing by the European Central Bank provided support for European equities, but slower economic growth in China weighed on emerging markets. For the month, the Standard and Poor's (S&P) 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indices returned 1.93%, 1.81%, -0.37%, 5.21%, and 0.75%, respectively. Growth stocks outperformed value stocks for the first time since November, though value stocks remained firmly ahead year-to-date. Within the Russell 1000 Index, the typically more defensive Telecommunication Services, Utilities, and Health Care sectors were the top-performers, while the Energy, Industrials, and Materials sectors lagged. This was not surprising as equity markets have posted considerable gains, with the S&P 500 up 14.32% year-to-date and, with earnings season winding down, few additional positive catalysts remain for further advancement in equities in the short-run.
U.S. Economic Data Recovery Continues Despite Sequestration
Despite fears that sequestration would significantly derail U.S. economic growth, macroeconomic data released during the month, while softer, continued to show signs of gradual economic recovery. Housing activity remained on the upswing with sales of new homes and homes under construction both advancing, while tightening supply continued to push up prices. The S&P/Case-Shiller 20-City Home Price Index was up more than 9% on a year-over-year basis.
The labor market continued to show signs of improvement as initial unemployment claims reached their lowest level since January 2008 and continuing claims remained in a downward trend. The unemployment rate fell to 7.5% after April's employment report showed more private-sector jobs added than forecast and significant upward revisions to job gains in the prior two months. Having said that, net job loss in the public sector provided an early sign that sequestration could become a greater drag on job growth as federal budget cuts are implemented throughout the year. We are encouraged to see, however, that the more productive private sector of the economy has been growing and adding jobs. This dynamic should help generate more jobs in the long run.
U.S. real GDP advanced 2.5% in the first quarter, with strong contributions from increases in consumer spending and residential (housing) investment. However, this growth rate fell short of expectations as a large trade deficit and drop in government spending, especially defense outlays, offset some of the growth. With weak global demand and further spending cuts from the sequester set to kick in, these sectors may continue to be a drag on U.S. economic growth.
The manufacturing sector showed signs of slowing during the month as regional manufacturing PMIs came in weaker than expected and the national Manufacturing PMI declined to 50.7 in April from 51.3 the prior month, but remained in expansion territory. Durable goods orders, excluding transportation, also fell for a second consecutive month. Fortunately, the U.S. consumer, propped by rising housing and equity market prices, as well as the improving employment picture, has been able to pick up some of the slack and drive economic growth.
Inflation Remains Low as QE Debate Continues
Inflation remained tame, allowing the Fed room to continue its bond buying program. While this provided a boost to investor sentiment, FOMC minutes released during the month highlighted the internal debate within the Fed about how and when to tighten monetary policy. We believe that current low inflation levels, coupled with the improving unemployment picture for the U.S., suggest the Fed will be compelled to end QE sooner rather than later.
Earnings Beat Expectations but Top-Line Growth Stalls
At the time of this writing about 80% of companies in the S&P 500 had reported earnings with 72% of companies in the S&P 500 beating their earnings expectations and aggregate earnings growth of 4% on a year-over-year basis. However, with poor corporate guidance and just 43% of companies beating revenue expectations, there is concern about the sustainability of earnings growth. Top-line growth was down 0.4%.
ECB Cuts Interest Rate in Face of Accelerating Recessionary Pressures
European countries continued to contend with struggling economies during the month as data pointed to an acceleration of recessionary pressures. Unemployment in the eurozone increased to a record high 12.1% while business and consumer confidence continued to plummet. Germany continued to show negative impacts from the region's recession as German exports declined significantly.
Despite negative macroeconomic data emanating from the region, market participants responded favorably to the political breakthrough in Italy as the country was finally able to form a government. European equities also found support in increasing expectations that the ECB would cut its key interest rate, with the widely anticipated move announced on May 2nd.
Slower Growth in China
The Chinese economy showed signs of softness with weaker economic data released during the month, weighing on investor sentiment and contributing to the relative underperformance of emerging market equities as well as the decline in commodity prices. China's official manufacturing PMI as well as the HSBC manufacturing PMI both declined in April while export growth came in below expectations. China's real GDP grew 7.7% in the first quarter, also below consensus forecast.
The U.S. economic recovery has remained tepid but consistent, and certainly ahead of most of the rest of the world. We believe the U.S. economy will be able to maintain the expansion even with 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 believe the biggest negative impact of the sequester is unfolding now, but should subside later in the year.
We expect housing to continue as a major driver of the recovery through its multiplier effect on the economy as a whole and on consumer spending.
We continue to believe that the market optimism from the past several months for a European recovery is a bit premature. The underlying economic fundamentals, not only in peripheral Europe, but also in core European economies, indicate pretty significant recessionary pressures all the way to the core. At the same time, policy steps in Europe are not as effective as in the U.S., so policy moves need to be taken with a grain of salt. As a result, we may see the underlying economic reality in Europe seep through into market performance.
As we anticipated, the earnings season is proving to be less than stellar thus far. With few positive catalysts on the near-term horizon, a short-term pull-back in equities remains a distinct possibility.
This commentary represents the opinions of the author as of 5/15/13 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. Calvert may have acted upon this research prior to or immediately following publication. In addition, 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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