Market Commentary – November 2009

Summary

• Gains in “riskier” assets continue alongside surge in Treasuries
• Dubai World’s request for delay on debt payments briefly roils markets at month end
• Gains in government bonds and “safe-haven” currencies suggest some unwinding of risk

Market Overview

The MSCI AC World Index ($) rose 4.11% in November amid continued global recovery optimism. However, gains were pared in the final days of the month amid fears that state-owned Dubai World may default on some of its roughly $60 billion in liabilities. The Barclays Capital Global Aggregate Index ($) of bond markets rose 2.55% over the month, amid gains in both government bonds and non-government fixed-income sectors that are considered to be riskier. Major government bonds surged around the globe at month end, as investors sought the perceived safety of these assets, while fear of contagion spreading from Dubai eroded much of the earlier gains for emerging-market bonds.

Dubai World, the Dubai state-owned investment company, announced on 25 November that it was seeking to delay payment on much of its debt, casting a brief pall over what had been generally upbeat investor sentiment heading into the year end. Following this news, yields on US Treasuries fell sharply. The yen also hit a 14-year high against the U.S. dollar, a further indication that investors were turning cautious after the strong rally in riskier assets that has taken place since mid-March.

Stocks

Economic data was generally supportive of global recovery hopes over the month of November. However, as had been the case in October, investors showed some caution with regards to some of the more optimistic recovery assumptions behind the rallies in equities, non-government bond markets and commodities over the past several months.

Sector performance within the MSCI AC World Index also sent mixed signals about investors’ recovery hopes. Among the sectors that are more sensitive to changes in the economic cycle (cyclical sectors), Materials raced ahead of all others with a near 10% gain, climbing in line with a surge in copper, gold and other metals. However, this extreme of positive sentiment was not echoed in the Energy sector, which underperformed the overall index as oil prices barely moved over the month. While the cyclical Industrials sector also outperformed the index, it was joined by the more defensive Healthcare sector among the top gainers. Other laggards in addition to Energy were both Consumer Discretionary and Consumer Staples. Financials brought up the rear, taking a hit at the end of the month on fears of contagion spreading from Dubai.

Still, in a sign of calmer nerves, the VIX index of implied volatility in the S&P 500 Index fell by roughly a fifth to just below 25 by month end.

Bonds

Performance in the fixed-income markets was evenly balanced between government and non-government sectors, with both making roughly equivalent gains. A lack of inflationary pressures and continued demand for higher yields were supportive of non-government bond sectors in November, while a desire to limit exposures to areas of perceived risk bolstered demand for the relative safety that government debt is seen to provide. 

A breakdown of debt auctions by the U.S. Treasury during the month suggested a high level of demand from foreign central banks, particularly for shorter-dated Treasuries, which contributed to the sharp decline in two-year Treasury yields seen over the month (yields move inversely to prices). This was interpreted by some analysts as suggesting a desire on the part of these central banks to buy dollars in order to limit gains in their own currencies against the U.S. currency.

Corporate bonds performed roughly in line with government bond markets around the globe in November, although high-yield bonds (those with poorer quality credit ratings) underperformed their better-quality peers in the rest of the corporate sector as investors started to show more discretion. A continuing rise in defaults in the commercial mortgage markets also caught up with commercial mortgage-backed securities (CMBS, made up of multiple smaller commercial property loans packaged into single securities), which were among the few areas in the fixed-income markets to experience a decline in November.

Emerging-market debt erased a lot of its strong gains from earlier in the month and ended up with a more modest return than the overall global bond markets, as investors wondered whether other emerging countries may face pressures similar to Dubai from an overabundance of debt.

Economy

Although weakness in labour markets continued around the globe, there were some signs of stabilisation in U.S. weekly jobless claims, while the pace of job losses in the U.K. also abated. Further signs of improvement also emerged in the U.S. and U.K. housing markets over the month. The eurozone reported an expansion of 0.4% in third-quarter gross domestic product, a marked improvement compared to a decline of 0.2% in the second quarter, but still slightly less than consensus estimates.

Oil prices were roughly flat over the month, with WTI Cushing crude oil prices ending at around $77 per barrel, despite gains in other commodity markets. A rebound in the dollar against some currencies during the month helped suppress oil prices (a higher dollar would tend to reduce demand for oil, which is denominated in dollars, by making it more expensive in other currency terms).

The dollar had a mixed performance against other major currencies in November, while the yen gained against them all. The dollar rose about half a percent against sterling to roughly $1.64, while declining approximately 2% to about $1.50 per euro. The U.S. currency fell about 5% to a 14-year low around 86 yen, with much of the decline coming in the wake of the Dubai news.

Summary

SEI believes there have been sufficient signs of improvement in the world economy in recent months to keep the recovery in the global financial markets on track, although the pace of gains is likely to be more tempered in the months ahead. In particular, we would expect to see a more balanced performance between high- and low-quality stocks, large versus small companies and developed versus emerging markets. Assets that are perceived to be riskiest could continue to perform reasonably well as economic activity revives and corporate profitability improves, but the magnitude of the outperformance should diminish.

Similarly, the dramatic narrowing that has already occurred in the spread between the yields on non-government and government debt probably limits the potential for further price gains in non-government sectors. Although corporate bonds and high-yield bonds are still attractive versus U.S. Treasuries (assets perceived to be the least risky), yields have fallen to levels that prevailed before the fall of Lehman Brothers. Emerging-market debt appears expensive, with yields having fallen close to the lows recorded at the previous peak in these markets.

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