April 2010 Recap

Market volatility picked up in April as investors grew concerned about the indebtedness of several European countries, a major oil spill in the Gulf of Mexico, and Goldman Sachs’ legal mess. Despite the concerns, the S&P 500 managed to post a 1.58 percent gain for the month.

Corporate earnings reports helped offset some of the negative sentiment, with 77.9 percent of companies in the S&P 500 that have reported beating expectations. According to Bloomberg, earnings estimates for companies in the S&P 500 increased 10 percent on average in April, the largest monthly increase since at least 2006. Earnings have certainly benefited from low expectations and year-ago comparisons, but this era is rapidly coming to a close. On the bright side, positive earnings results and outlooks with little price movement allow the fundamentals underlying the market to catch up to the price action.

A bigger reason for domestic equities’ April performance was the Fed’s decision to keep its benchmark interest rate at a record low to help keep the economy from dipping back into a recession. The Fed continues to paint a “Goldilocks” scenario for the economy in which growth is not too hot and not too cold. Although there are signs of prices picking up in the production pipeline, consumer prices have been showing deflationary signs in recent months. In addition, it’s very unusual for the Fed to tighten until the unemployment rate goes down.

Small caps continued to outperform large caps during April. Smaller firms tend to thrive in low interest rate environments, which allow them to borrow cheaply to fuel their growth. Additionally, new net inflows into small cap funds may also be providing support to small cap stocks, with the four-week moving average inflows topping $701 million in April according to Lipper FMI data. Small caps began the year with outflows exceeding $144 million.

The best performing S&P 500 sector was Consumer Discretionary, which benefited from improving sales data and consumer confidence. Consumer Discretionary and Industrials, which has benefited from global economic improvement, are the top performing sectors year-to-date. Healthcare stocks were the worst performers in April as the sector’s earnings reports exposed the bottom-line effects of the new U.S. healthcare legislation.

Volatility, as measured by the VIX Index, perked up 25 percent. For a market that seemed overly complacent in recent months, the return of volatility can be interpreted as a healthy development. The uptick in volatility coincided with several negative events including fraud charges by the SEC against Goldman Sachs, continued Eurozone debt problems, financial regulation concerns, and tightening by numerous foreign central banks.

Problems in Greece, Spain, and Portugal sent investors fleeing to the safety of U.S. assets. As a result, Treasuries rallied and the dollar strengthened. Mortgages followed Treasury yields lower, with spreads more or less unchanged, as the market yawned in response to the Fed’s MBS-buying program coming to an end. Meanwhile, Commercial MBS gained despite widespread worries about rising commercial defaults and high-yield bonds add to a record run that began in late 2008.

Overall, investors continue to show desire to put cash that yields nothing to work, but they are hesitant to stick with riskier bets in the face of volatility. Investors have plenty of headwinds ahead including the removal of monetary and fiscal stimulus, interest rate uncertainty, weak housing market, national debt burdens, Chinese economic and policy questions, expiration of the Bush tax cuts, and the growth-restraining effects of the rapid rise in commodity prices.


Peter Lazaroff, Investment Analyst
Acropolis Investment Management
www.acrinv.com