European officials surprised the markets by addressing some of the required needs of banks in Spain along with a stimulus package for Europe as a whole. The EAFE (Europe, Australia and Far East) index rose over 7% while the EEM (Emerging Market Index) moved up almost 4% for the month. U.S. markets participated as well, bringing the S&P 500 close to double digit gains for the year.
While the details still need to be hashed out, officials at the European Summit made more progress than expected at the end of June. The agreements didn’t of course address all the problems that the Euro area is experiencing but they appear to have bought some additional time to work on these areas. Perhaps the biggest surprise was the willingness by the leaders to inject bailout funds directly into Spanish banks, rather than lending money to the Spanish government, which would drive up Spain’s debt load. In addition to addressing some of the banking issues the leaders also backed a €120 billion "growth pact" that will hopefully stimulate growth and create jobs. Funds will be allocated to small and medium-sized businesses and employment opportunities for the young and some new ‘project bonds’ will be launched for initiatives in energy, transport and broad-band infrastructure.
News out of Europe didn’t stop after the Summit though, as the European Central Bank announced on July 5th that it cut its rates and the Bank of England increased monetary easing by increasing the size of their asset purchases. On the same day we received some additional news outside of Europe from China who joined this ‘easing’ party with a second cut in interest rates within a month. The large number of headlines about Europe has somewhat drowned out news that China’s growth has been slowing considerably. It is good to see their officials address this issue, though it is likely we will see the continued slowing of their economy until the monetary easing measures take effect.
Back in the U.S. things are still more stable though some economic indicators show the economy may have shifted into a lower gear. Last month I referred to the very strong pace in the manufacturing sector but the month of June brought news that this sector experienced some slowing. The Institute for Supply Management's June manufacturing index showed the U.S. factory sector suffered its first contraction since July 2009. However, it appears that there may be support for manufacturing activity as U.S. auto sales continues to do well. Auto sales in June were strong and now have a trailing 12 month moving average at its highest level since November 2008. The non-manufacturing (services) sector also slowed but remains in positive territory.
As we look toward the end of the year, large concerns are looming unless Congress acts. A raft of spending cuts and tax hikes (including a significant capital gains tax hike) will become effective in January 2013. We believe it is reasonable to think that Congress can come together enough to not allow all the fiscal policies to expire at once, avoiding a significant drain on our economy which we can ill afford. However, it is likely the markets will experience volatility until the issue settles.
While it was good to see the major equity markets rebound for the month, we expect the markets to remain volatile for the for-seeable future. Given the sovereign debt issues and a slowing global economy, investors may be hesitant to add to equity holdings even though valuations are attractive. While corporations overall are in great shape with record profits and strong cash holdings, many investors are still cautious on investing in equities. Equity mutual fund outflows have tallied $43 billion year to date through May of 2012 while bond funds received inflows of $19 billion through the same period.
Here in the U.S. there is a danger that a down-shift in European and Developing countries demand for our goods and services could begin to show up in stagnant or lower U.S. corporate profits. Hopefully, corporations can continue to surprise us with better than expected earnings in the upcoming second quarter reporting season, but if not, this could add to the equity markets difficulty.
Similar to the equity markets, the international bond markets performed well for the month of June. The Morningstar Foreign Bond index rose over 4%, while the major bond index in the Barclays U.S. Aggregate bond index barely rose (.04%). It seems reasonable to believe that some of the international equity and bond market outperformance may not be able to continue in the near term as the excitement of the recent European summit dies down.
The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital... the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth in the economy. Former U.S. President John F. Kennedy