Market Update
April 2010
First Quarter 2010 Market Update
Summary:
- Global equity markets rose as manufacturing helped drive economic growth.
- Concerns lessened about possible sovereign debt default in Greece as European Union (EU) leaders agreed on a bailout plan.
- Labour markets and consumer spending remained weak.
At the end of the first quarter, investors were generally less concerned about possible government bond defaults as European nations decided on a plan of action to assist Greece if necessary. Central banks in both developed and emerging markets began to tighten monetary policy in order to curb inflation. China’s central bank raised bank reserve requirements twice, and India raised its interest rates after inflation reached a 16-month high. In the U.S., the Federal Reserve (Fed) raised its discount rate (the rate charged to banks that borrow from the central bank).
The MSCI AC World Index ($) rose 3.23% for the quarter, as optimism prevailed about the global recovery. However, it is SEI’s view that global economic growth will continue to be sluggish, as governments and central banks carefully remove policies put in place during the recession. The Barclays Capital Global Aggregate Bond Index ($) was roughly flat, returning -0.27% for the quarter. Corporate bonds continued to see strong gains due to better-than-expected earnings reports and improving profits from cost-cutting programs.
Stocks
Market participants worried that the debt crisis in Greece and other European nations might stall euro-zone economic recovery and put pressure on the still-nascent U.K. recovery. European leaders announced they would work with the International Monetary Fund to provide assistance to Greece, which eased fears early in the quarter that sovereign debt troubles would spread to other European nations. The global economy is gradually improving, but the U.S. and the U.K. central banks have reiterated that policies will remain accommodative for some time to come.
Sector performance within the MSCI AC World Index reflected investors’ willingness to look beyond weak labour markets and concerns over possible government bond defaults and focus on global economic recovery instead. For the quarter, top performers were sectors that are more responsive to shifts in the broader markets, such as Information Technology, Industrials and Materials. More defensive sectors, such as Utilities and Telecommunications, lagged the broader market.
The Chicago Board Options Exchange Volatility Index (VIX), a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” began the quarter above 21 but then fell to a little over 17 at the end of the month, as a calmer tone prevailed in the market.
Bonds
Performance in the fixed-income markets was mostly flat for the quarter, and non-government bonds (which are perceived to be riskier) generally outperformed government bonds. Earlier in the quarter, investors looked for safe havens, such as shorter-maturity German bunds and U.S. Treasuries, as speculation about defaults in other countries continued to make headlines. However, towards the end of the quarter, positive news about corporate earnings and increases in manufacturing pushed demand for corporate bonds higher.
Greek sovereign debt sparked investor concern, as several of its banks were downgraded by credit-rating agencies and its government has been slow to implement spending cuts. Although the European Union developed a plan to assist Greece as necessary with its financial difficulties, it has raised the question about what will happen if other European peripheral nations experience similar issues. The ongoing debt crisis has put added negative pressure on the euro.
Economy
Economic data continued to be mixed throughout the quarter, but there was marked improvement in European business confidence and growth in manufacturing and services. The Bank of England, the European Central Bank and the Fed all kept interest rates at record-low levels. However, the Fed increased the discount rate from 50 basis points to 75 basis points (100 basis points equals 1 percentage point).
We believe the economy is steadily rebounding, but hurdles remain ahead. A mixture of encouraging and gloomy headlines confirmed this view. In January, European industrial output had its biggest increase in 20 years, but construction output fell to its lowest level in over a year. A composite index of euro-zone purchasing managers (a measure of manufacturing activity) rose, but industrial orders declined unexpectedly. It continued to be a benign environment for inflation, as the core inflation measure for the euro-zone declined to a record low due to weakness in labour markets and consumer spending.
Oil prices rose for the quarter, with WTI Cushing crude oil prices (a key indicator of movements in the oil market) ending at around $83.76 per barrel. The increase in prices was due in part to harsh winter weather in February, but the gain could also be attributed to gradual improvements in the global economy.
The U.S. dollar continued its rally, ending the quarter at $1.52 per British pound and $1.35 per euro. The dollar was also slightly stronger versus the Japanese currency, ending at around 93 yen.
Our View
In SEI’s view, the global economy should continue to improve, but growth will not be uniform across all regions. Emerging markets are the clear leaders so far. The outlook remains uncertain for how the European recovery will progress, as uncertainty around how to handle problems with Greek sovereign debt revealed weaknesses in the structure of the euro-zone. Developed countries face a delicate balancing act. There is growing pressure on high-deficit nations to rein in government spending, but it is necessary to maintain sufficient fiscal support in order to prevent a relapse into recession.
We continue to hold a positive view toward equities, although year-to-date performance has been choppy. Fixed-income markets are being pulled in different directions. Developed-market sovereign debt has been hurt by deficit concerns, but helped by the slow recovery and generally low inflation. Emerging-market debt has been relatively strong, as investors continue to re-evaluate the relative riskiness of the asset class. Opportunities in investment-grade (bonds with relatively better credit quality) and high-yield (rated below investment grade and perceived to be riskier) credit also remains strong, reflecting robust corporate financial positions and expectations of continued economic expansion.
The key concern, in our view, continues to be the exit from governmental stimulus packages. A big increase in government spending was certainly the correct response as private-sector demand fell away in the latter part of 2008 and early 2009, but it may reduce economic growth potential over the long term, as stock prices usually fall during times when government spending rises substantially. We still believe that the key central banks—the Fed, the Bank of England and the European Central Bank—will be slow to remove economic stimuli. While we continue to see balanced opportunities in equities and fixed income, we remain cautious regarding the economic and market risks for the near term.
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SEI sources data directly from the following vendors: Factset, MSCI Barra, Russell, TOPIX, FTSE, Barclays Capital and Merrill Lynch. Where appropriate, returns in base currencies are converted to the relevant currency using WM Reuters 4pm Spot rates.