NEW YORK (TheStreet) -- Volatility in the stock market continued last week. After large swings to start the holiday-shortened week, it seemed the market might perhaps just hold steady. Unfortunately a couple of major concerns on Fridayagain sent the market reeling.
In our view the primary cause of the continued market weakness is concern that the European sovereign debt problems will morph into another global economic downturn -- with the problems in Hungary and the U.S. employment data fanning those fears on Friday.
Hungary is the latest European country to haunt the markets. On Friday a spokesman for the prime minister of Hungary spooked the markets by saying that "there is nobody apart from the previous government who still says the budget deficit of 3.8% of gross domestic product can be reached." The 3.8% level was the target set by the International Monetary Fund.
As a refresher, Hungary had an early sovereign debt problem during the financial crisis. In 2008 Hungary was forced to ask for help from the IMF and European Union when it could no longer access the capital markets. As part of a rescue package from the IMF, Hungary implemented austerity measures to meet the deficit targets.
Hungary is another situation that on its own holds little danger for the world economy:
Hungary accounts for roughly 0.3% of global GDP;
According to Bank for International Settlements data, the cross-border banking exposure toHungary is relatively small at $158 billion versus $303 billion for Greece as an example; and
Hungary has its own currency (forint) and is not part of the Euro currency union.
To take the bear case of the argument, the cross-border banking exposure of $158 billion to Hungary is primarily continental European banks (92%) with very little U.S. or U.K. exposure. In the end it is really neither Hungary nor Greece that the market is really worried about, it is fear of potential contagion from a collapse of the European banking system, which could derail the global economic recovery.
Further complicating the week was a middling jobs report in the United States. While on the surface an employment report showing a gain of 431,000 jobs and a decline in an unemployment rate to 9.7% would seem reason for celebration, the details provided less reason for optimism than might initially meet the eye.
The job gains were overwhelmingly census workers, with only 41,000 new private sector jobs versus consensus estimates of 180,000 prior to the report. These census workers will be laid off in the second half of the year, so they can't provide the sustainable employment boost needed.
Though on the whole one must consider it a disappointment, the report was not without a few rays of light. Both average hourly earnings and average weekly hours increased, which should support income growth. In addition, manufacturing jobs have continued to gain, adding 29,000 in May. Temporary help services, a leading indicator of future job gains, also added 31,000 jobs.
While the employment report was disappointing, other important U.S. economic data last week were more supportive. The ISM Manufacturing Index in May posted a very healthy reading of 59.7, which is well above the neutral level of 50. The May ISM Non-Manufacturing Composite was reported at 55.4, which remains consistent with moderate GDP growth.
Sell in May?
After the dismal stock market returns in May, the old market adage "sell in May and go away" has seemed like it would have been the correct strategy in retrospect. But what does the future hold after May is over?
In looking at
losses of more than 5% in May since 1938, there have been eight episodes prior to this year. Interestingly, in seven of eight instances stocks subsequently rebounded for the remainder of the year.
While this type of historical analysis should be taken with a grain of salt and should not be used to project future returns, it does lay to rest the concern that a difficult May automatically portends a poor remainder of the year. It does however illustrate that extreme downward market movements tend to revert back toward the mean over time, which would be a positive indicator of future returns.
PNC Investment Strategy Recommendation
The bottom line is that we expect the global and U.S. economic recovery to continue, despite the occasional concerns to the contrary. The big picture is that the majority of the globe's economies are on the mend and that should eventually overwhelm the current worries in Europe.
PNC still expects second-quarter GDP to be in the range of 2.5-3.0%. Downside risks certainly remain, and we continue to monitor the situation closely.
We believe that stocks provide an attractive risk vs. reward for investors with a sufficient investmentholding period and ability to withstand the market volatility. The relative performance of stocks to bonds and cash should remain attractive when viewed over a reasonable investment period.PNC currently recommends:
a baseline allocation in our asset allocations in terms of stocks versus bonds and cash, but
a tactical allocation to leveraged loans within the bond allocation in order to reduce interest-rate risk within portfolios. This allocation is an expression of our baseline view that the recovery should continue, which will likely necessitate higher short-term interest rates at the very least.
Our current recommended allocation attempts to balance the relative attractiveness of stocks and other risk assets, given the improvement we expect in the global economy, with the downside risks to our forecast.
Volatility may remain the watchword for the foreseeable future as the market struggles to digest concerns emanating from the eurozone and a variety of other issues.
Bill Stone is the Chief Investment Strategist for PNC Wealth Management and PNC Institutional Investments with over $100 billion in assets under management. He is a member of PNC's Investment Policy Committee and is responsible for defining the asset allocations and portfolio strategies used throughout the organization to advise individual and institutional investors. Stone is a cum laude and honor's program graduate of the University of Dayton with a bachelor's degree in finance. He earned a master's of business administration from the Katz Graduate School of Business at the University of Pittsburgh. In addition, he holds the Chartered Financial Analyst? designation and is a Chartered Market Technician. Stone has been quoted in many publications including The Wall Street Journal, Financial Times, Barron's, Fortune, Forbes and USA Today. He is regularly interviewed by Associated Press and Reuters. He is also regularly interviewed on CNBC and Fox Business for his market insights.