MAY 2010

U.S. equities reversed trend and posted significant declines in May, with the Russell 3000 Index falling 7.9% during the month.  The returns for all market capitalizations were negative in May, with large cap (Russell 1000) falling 7.9%, mid cap (Russell Mid Cap) declining 7.4%, and small cap (Russell 2000) losing 7.6%.  Value stocks underperformed growth stocks within all market capitalizations, with a more pronounced gap among small cap stocks.  The Russell 3000 Growth Index dropped 7.6% versus a drop of 8.2% for the Russell 3000 Value Index.  Year-to-date, small cap stocks posted positive returns of 6.3% and substantially outperformed large cap stocks, which declined 0.9%.  Performance for the Russell indices in April and year-to-date is shown in the chart below.

The most noteworthy event in the equity markets during the month was the “flash crash” that occurred on Thursday, May 6.  The Dow Jones Industrial Average dropped precipitously between 2:42 p.m and 2:47 p.m., only to be followed by a rapid appreciation by 3:00 p.m.  While the exact cause of the “flash crash” is still debated, undoubtedly this was one of the most volatile trading days on record.  As highlighted in Securities and Exchange Commission Chair Mary Schapiro’s testimony before the Senate Banking Committee, “this extreme volatility in the markets suggests the occurrence of a very severe temporary liquidity failure, rather than the effect of any economic factor that might explain price discovery, indicating that the equity value of U.S. listed companies truly could drop and recover such a large amount in just a few minutes.”¹  Commodity Futures Trading Commission Chairman Gary Gensler testified to the Senate Banking Committee that a volume restriction “may have been ineffective and may have had an unintended market impact.”  Regardless of the cause, the SEC expects to implement additional procedures to limit trading in individual stocks that experience sharp declines in short periods of time.²

Within the S&P 500 Index, the energy, industrials, and materials sectors had the largest negative impact on performance during the month.  Commodity prices fell substantially in response to a stronger U.S. dollar and concerns about waning global demand for natural resources with slower potential industrial output.  The energy sector was the worst performing sector amid ongoing scrutiny of oil exploration and production companies following the oil rig disaster in the Gulf of Mexico.  Financials stocks were notably weak, as banks were negatively impacted by additional investigations into the marketing of collateralized debt obligations prior to the financial crisis.  The defensive characteristics of the telecommunications services, consumer staples, and utilities sectors were favored by investors during a negative equity market.  Telecommunications services stocks underperformed the broad market in the first four months of 2010, but positive news and analyst upgrades of Sprint Nextel provided a boost to the sector in May.³ 

¹ Schapiro, Mary L.  “Examining the Causes and Lessons of the May 6th Market Plunge.”  U.S. Securities and Exchange Commission.  20 May 2010.   http://sec.gov/news/testimony/2010/ts052010mls.htm

² Lynch, Sarah N.  “Gensler Blames the Math for ‘Flash Crash.’”  Wall Street Journal Online.  21 May 2010.

³ “World Markets Review.”  Capital Guardian Trust Company.  (May 2010).