Eurozone Concerns Generate Domestic Market Volatility
Posted by Eric Anderson on October 17, 2011
Fear in the eurozone over the spreading European debt crisis came back into the forefront during the third quarter, and equities across the globe experienced a heavy and relentless wave of selling pressure. With the experience of the 2008 financial crisis and economic recession still relatively fresh in the minds of investors, the growing sovereign debt concerns and liquidity issues of several large global financial institutions gave traders and investors a reason to want to run and not walk for the exit doors. As a consequence, market volatility spiked to elevated levels, and there were numerous days in August that saw stocks declining or advancing by more than 4% in a single trading session. The weakest equity results were experienced by the small capitalization companies and international equities, with the Russell 2000 losing 21.9%, while the MSCI EAFE retreated by 18.9%. The larger capitalization indexes were hit with slightly less force, as the S&P 500 declined by 13.9%, while the NASDAQ slipped 12.7%, and the Dow Jones Industrial Average lost 11.5%.
As a result, beginning on July 21, 2011, the rally that got underway in August 2010 came to an abrupt halt, and each of the equities indexes that we track in our monthly and quarterly MMU gave up all of their year-to-date gains. As a result, for the first nine months of the year the best result came from the Dow Jones Industrial Average which was off only 3.9%, while the NASDAQ and S&P 500 were quite close at -8.3% and -8.7% respectively. The MSCI EAFE index and the Russell 2000 delivered returns that were almost twice as negative at -14.6% and -17% respectively.
Only three of the ten S& P 500 sectors — Consumer Staples, Health Care, and Utilities — have delivered positive returns through the third quarter. Their common attribute is that their businesses are generally more defensive in nature. In addition to the three sectors with positive absolute year-to-date performance, three other sectors turned in positive relative performance, as the Consumer Discretionary, Telecommunications, and Technology sectors all declined less than had the S& P 500 so far in 2011. On the other hand, four of the more economically sensitive sectors have, not surprisingly, underperformed the S&P 500’s 8.7% decline. Specifically, Energy declined by 11.4%, and Industrials dropped by 14.7%, with Materials slipping by 21.7%, while the Financial sector went back to behaving like it did back in 2008, dropping 25.1% during the first three quarters of 2011.
Global GDP growth in this recovery is being held back by a variety of forces, with weak housing activity in the U.S. a noteworthy issue since housing and its related supporting industries are normally a strong driver of economic growth and job creation. GDP in Europe is slowing to the sub 1% level, and the high savings rates in the eurozone do not allow for the same level of consumer activity that is the case in the U.S. Specifically, in the U.S. the saving rate of personal disposable income is around 5% (up from very low levels several years ago) versus 13.6% in Europe and 17% in Germany.
After the horrendous experience of the credit crisis in 2008 and 2009, corporate America has made a concerted effort to shore up their balance sheets. This has been accomplished by raising equity capital as well as by paying down debt and accumulating cash reserves, so as to not be dependent on and at the mercy of the credit markets should they again seize up and become dysfunctional. In fact the Federal Reserve estimated that at June 30, 2011 cash hoards of U.S. nonfinancial corporations are at an all time high, $2.05 trillion dollars. The largest percentage of this total is held by technology companies, with an estimated $388 billion, and Apple Computer has close to 20% of this amount with its $76+ billion of reserves. Some of this cash is held in foreign subsidiaries of U.S. corporations and thus can not be brought back into the U.S. unless additional U.S. federal income taxes are paid, which many companies are loathe to do since they have already paid income taxes to the local country where the foreign subsidiary is located. There is talk in the Congress of passing some sort of tax plan that would encourage companies to repatriate some of this stranded capital back to the U.S. as a way to spur investment and job creation. With the unemployment level stuck at a stubbornly high level of 9.1%, the U.S. economy has only regenerated 20% of the 8.8 million jobs lost during the credit crisis. Just to keep up with population growth, the U.S. needs to add at least 150,000 jobs monthly. Small businesses that are the engine of U.S. job creation have not had the confidence to hire this cycle as they have coming out of prior recessions.