Market Commentary: July 2009

Summary:

• Assets perceived to be riskier continue to drive the rally in stocks and bonds
• Economic data generally boost hopes for an end to recession
• Positive corporate earnings news also instills optimism
• Some winners emerged from the credit crisis, showing through in strong earnings

Market Overview

Global stock and bond markets extended their strong second quarter rally into July, and continued to be driven higher by strong demand for assets considered to be riskier such as smaller companies and corporate bonds. Generally positive U.S. economic data and earnings news fuelled hopes that growth may turn positive in the second half of the year in the world’s biggest economy.

The MSCI AC World Index ($) rose 8.80% in July, with Financials and other sectors that are sensitive to economic cycles generally leading the way. The Barclays Capital Global Aggregate Index ($) of bond markets gained 2.21%, led by strong returns for non-government sectors. The VIX Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” dropped to its lowest levels since September 2008 and ended the month at 25.92. However, it remained well above long-term averages and gaps between the best and worst performing stocks over the month also continued to be very large by historic standards.

Stocks

After a brief bout of profit taking in the final weeks of June, investors turned optimistic again, spurred on by some encouraging economic news and generally better-than-forecast corporate profits as second-quarter earnings reports continued to roll in.

Winners from the credit crisis appeared to emerge, showing through in strong earnings from the likes of Intel in IT and Goldman Sachs, JPMorgan, Barclays and HSBC in banking. Even Ford managed to turn a profit in the second quarter, as the U.S. car maker pulled away from its troubled rivals GM and Chrysler.

Positive performance was concentrated in the Materials, Financials, Industrials and Consumer Discretionary sectors of the MSCI AC World Index over the month, with the more defensive areas of Utilities, Healthcare, Consumer Staples and Telecommunications all lagging the 8.80% return of the index. Energy was also among the worst performing sectors in July, held back by a modest decline in oil prices amid an increase in U.S. stockpiles of gasoline and poor earnings from France’s Total and Italy’s Eni. WTI Cushing crude oil prices fell 0.63% in July to finish the month at $69.45 per barrel. Still, that was more than double the low of near $30.00 reached in December last year.
The MSCI AC World Value Index ($) outperformed the MSCI AC World Growth Index over the quarter as recovery hopes continued to grow, with respective gains of 9.39% and 8.21%. Because value stocks (those with cheap valuations) are perceived to be more vulnerable to losses, they have tended to sell off more during down markets compared to growth stocks, and also have historically tended to lead when markets rebounded during a recovery.

Bonds

Bond investors showed a still-growing appetite to take on additional risk for the sake of higher yields. Sectors that are perceived to be riskier, such as commercial mortgage-backed securities (CMBS), high-yield bonds (those with poorer credit-quality ratings) and emerging-market debt posted some of the largest gains in July, as had been the case for the second quarter.

Despite a continued deterioration in the commercial real estate market, growing appetite for risk helped CMBS sustain its impressive second quarter gains and continue to be the best performing sector in the overall bond markets in July. High yield bonds came in a close second, followed by corporate bonds in general and the Financials sector in particular.

The bonds of troubled U.S. lender CIT, which failed to get additional financial support from the government and lurched closer to bankruptcy, fell to around half of their face value mid-month. However, the bonds and shares of CIT, a major lender to small and mid-sized U.S. businesses, rebounded by month end as the company was able to secure temporary funding from creditors. Still, the terms of the short-term loan were seen to put other CIT creditors and shareholders at a disadvantage, and doubts remained around CIT’s ability to pay debts maturing later in the year.

Economy

In the U.S., the June purchasing managers index for the services sector contracted at its slowest pace in nine months, marking the third month that it decelerated. However, consumer confidence in the world’s largest economy came in below expectations. U.S. retail sales came in better than expected for June, though most segments showed continued weakness. While the June U.S. employment report showed a bigger loss of jobs than anticipated, weekly jobless claims fell to their lowest since January during the course of July.

The German government said there was a good chance that the eurozone’s largest economy had come out of its severest recession since World War II, citing a stabilisation in overall activity. German gross domestic product (GDP) was broadly flat in the second quarter, and may even have expanded slightly, the government predicted. These forecasts were reinforced by the Ifo Institute’s business sentiment index, which rose for the fourth straight month to its highest level since last October, outstripping forecasts.

While a 0.8% decline in second-quarter U.K. GDP was a big improvement on the 2.4% first-quarter drop, it was still bigger than forecast. U.K. house prices continued to rise on a monthly basis in June, and mortgage approvals also rose, fuelling hopes for a sustained recovery in the property market. The U.K. consumer price index (CPI), which is a measure of the country’s inflation rate, fell below the Bank of England’s (BoE) 2.0% target for the first time in nearly two years. The BoE kept rates on hold at 0.5% at its July meeting, as expected, but failed to expand its bond buying program as most analysts had forecast.

In the currency markets, mounting recovery hopes meant that the dollar continued to lose its appeal as a “safe haven” in times of global turmoil. It fell a little over 1% against sterling and the euro to end the month at $1.69 and $1.42, respectively, while declining nearly 2% to about 95 yen.

Summary 

The global economic recession may still be with us, but in SEI’s view it has eased considerably in recent months. The reduction in economic and financial stress appears to have led to normalization in investors’ risk appetites, resulting in sharp recoveries in stocks, high-yield bonds and commodities in particular. After an initial rally in March and April, the appreciation of such assets that are perceived to be riskier has proceeded at a slower and more erratic pace.

A return to positive growth in the economy is, in our view, a necessary condition for additional appreciation in these assets. In the near term, we continue to see risks that there may be a setback in equities on the grounds that the forecasted economic upturn promises to be a sluggish one. In addition, equity valuations do not appear extraordinarily depressed following the steep March-to-April rally.

We remain optimistic regarding the corporate bond markets. Although high-yield corporate bonds have appreciated strongly, yield spreads (the difference between the higher yields available in this sector compared to equivalent government bonds) remain attractive. We expect non-government bonds to continue to outperform government debt if economic growth turns positive and corporate cashflows improve. 

Important Information:

Past performance is not a guarantee of future performance.

Investment in the range of SEI’s Funds is intended as a long-term investment. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. Additionally, this investment may not be suitable for everyone. If you should have any doubt whether it is suitable for you, you should obtain expert advice.

No offer of any security is made hereby. Recipients of this information who intend to apply for shares in any SEI Fund are reminded that any such application may be made solely on the basis of the information contained in the Prospectus. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

If the investment is withdrawn in the early years it may not return the full amount invested. In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavourable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Products of companies in which technology funds invest may be subject to severe competition and rapid obsolescence. SEI Funds may use derivative instruments such as futures, forwards, options, swaps, contracts for differences, credit derivatives, caps, floors and currency forward contracts. These instruments may be used for hedging purposes and/or investment purposes.

While considerable care has been taken to ensure the information contained within this document is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.

This information is approved, issued, and distributed by SEI Investments (Europe) Limited, 4th Floor, Time & Life Building, 1 Bruton Street, London W1J 6TL which is authorised and regulated by the Financial Services Authority. Please refer to our latest Full Prospectus (which includes information in relation to the use of derivatives and the risks associated with the use of derivative instruments), Simplified Prospectus and latest Annual or Interim Short Reports for more information on our funds.. This information can be obtained by contacting your Financial Advisor or using the contact details shown above.

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.