Stocks started November off with a bang as midterm elections in the U.S. resulted in the Republicans taking the House of Representatives and the Federal Reserve announced another round of quantitative easing.  But global risk appetite waned as the month wore on.

U.S. economic data showed some encouraging signs.  The economy grew faster in the third quarter than previously thought: by 2.5% at an annual rate, against an initial estimate of 2%.  Meanwhile, U.S. jobless claims declined to the lowest level since July 2008 and October retail sales climbed more than forecast, which suggests consumers may play a bigger role in the recovery.  However, the Fed’s gloomy assessment of the labor market (predicted 9% unemployment by the end of 2011) overshadowed the incremental improvements in economic data.

Outside of the U.S., Chinese officials raised the possibility of an interest rate hike to curb inflation and cool their economy.  This shook global markets, but not as much so as the continuing sovereign debt issues in the Eurozone.

Ireland’s government asked the European Union and IMF for a bailout of about €85 billion ($115 billion) to prop up its struggling banks.  But the rescue package failed to reassure investors and spreads of Irish, Portuguese, and Spanish government debt over German bonds grew even wider.  After Greece in May and Ireland in November, Portugal looks to be next in line.  The bigger concern, however, would be if Spain catches the bug.  Spain’s economy is much bigger than those of Greece, Ireland, and Portugal combined.

Domestic stocks outperformed international and emerging market stocks.  The MSCI EAFE Index dropped 4.77%, with large losses in Spain (-13.51%), Italy (-10.53%), and Portugal (-9.86%).  The MSCI Emerging Market Index fell 2.63%, dragged down by China (-5.33%), Brazil (-4.20%), and India (-2.52%). 

In the U.S., the S&P 500 was basically flat in November on a total return basis. Smaller companies had nice monthly gains, with the S&P 400 Mid Cap and Russell 2000 Small Cap indexes returned 2.97% and 3.47%, respectively.  Mid and Small Cap stocks have significantly outperformed Large Cap stocks year-to-date.  Growth stocks widened their year-long lead over value stocks.  Value stocks trailed significantly in November due to poor performance in Utilities, Telecoms, and Financials.

The top performing S&P 500 sectors in November were Energy (5.49%), Consumer Discretionary (2.66%), Materials (1.12%), and Industrials (1.11%).  These four sectors also lead all sectors in year-to-date returns. Investors bid up Energy and Material shares in anticipation that increasing demand for commodities in emerging markets will increase demand for these companies’ products and services.  Meanwhile, Consumer Discretionary and Industrial shares gained on improving economic data and prospects that the Fed’s monetary policy will prevent the economy from falling into another recession.

Bond yields rose in November despite the Fed announcing plans to buy $600 billion in Treasury debt.  This may come as a surprise, but the market had already priced a second round of quantitative easing into interest rates.  In other words, investors bought the rumor in July and sold the news in November.

Another reason for rising yields is that interest rates rise with inflation expectations.  It’s fair to assume that investors are more worried about inflation given the Fed’s continuation of extremely accommodative monetary policy. 

For updated performance tables click here.

Peter Lazaroff, Investment Analyst

www.acrinv.com