Knowledge Centre Archive
First Quarter 2012 Market Update
- Investor confidence received a boost from continued central bank support in the U.S. and eurozone.
- Equity markets gained, with risky assets among the strongest performers. Bond market performance was held back by waning demand for government debt.
Equities rallied throughout the quarter, outperforming global bonds. Investor sentiment was generally positive and market volatility remained calm. Consequently, assets that are perceived to be riskier were favoured. In particular, measures by the European Central Bank (ECB) to support the banking system and progress towards resolving Greece’s sovereign debt troubles fuelled a hopeful outlook.
In January the U.S. Federal Reserve (Fed) indicated that the country’s current low interest rates would continue until the end of 2014. This was longer than the markets had expected (the Fed had previously stated that interest rates would remain at near-zero until mid-2013) and so the news was received positively.
Ratification of the second bailout package for Greece took place in the middle of the quarter. The deal, which was agreed in 2011, provides €130 billion for Greece from the European Union and the International Monetary Fund. This helped to ensure that Greece was able to avoid defaulting on its debt payment of €14.5 billion on the 20 of March. However, the terms of the bailout were severe. One of the key conditions of the deal is that private sector Greek government bondholders need to agree to take a loss on what is owed to them. This is to be achieved through a bond swap, also known as debt restructuring. The replacement debt would be worth less than the original and would also pay interest at a lesser rate, equating to a 53% loss on a holder’s initial investment. News of the agreement buoyed the markets.
Other activity in Europe also served to improve optimism during the quarter. The ECB introduced three-year loans - known as long-term refinancing operations (LTROs) - in January, with the intention of helping to ease short-term money-supply pressures on the region’s banks. This provision was welcomed by the markets at the start of the year and continued to have a positive impact in February and March as additional funding filtered through to banks.
Global bond markets as a whole rose marginally in the quarter, masking a large disparity between asset types. Government bonds generally fell out of favour as investors left “safe haven” debt to embrace risk. Fixed income assets that are perceived to be riskier therefore performed strongly in the period. High yield debt did particularly well, followed by emerging market debt. As demand for government bonds slowed, yields (which move inversely to prices) generally rose. Investor concern about the debt crisis in the eurozone lessened during the period and, as a result, the government debt of most peripheral eurozone countries outperformed that of core eurozone countries. Spain was a notable outlier. Spanish 10-year government bond yields ended the quarter higher than the 10-year benchmark yield of Italy, signalling renewed concerns over the Spain’s finances (the country slipped back into a recession and unemployment remains among the highest in the region) and upcoming financial reforms which led to a violent public demonstration against the proposed measures at the end of March).
Central bank support and more positive investor sentiment drove a positive quarter for the equity markets. Volatility declined and correlations fell sharply such that stocks no longer all moved together. Valuations in the equity markets ended the quarter more in line with company fundamentals. In this environment, investors favoured riskier assets. In the equity markets, cyclical sectors performed well. Information Technology, Financials and Consumer Discretionary recorded the highest returns for the quarter, while more defensive sectors lagged. Small company stocks outperformed mid-size and large companies for the period, and emerging market equities beat developed markets.
- The MSCI AC World Index, used to gauge global equity performance, gained ($) 11.88% in the first quarter of 2012.
- The Barclays Capital Global Aggregate Index, which represents global bond markets, rose by ($) 0.87% over the period.
- 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”, fell from 23.40 to 15.50 during the quarter.
- WTI Cushing crude oil prices, a key indicator of movements in the oil market moved from $98.83 a barrel at the end of December to $103.02 by 30 March and reached a high of $109.49 in mid-February.
- The Japanese yen weakened against most currencies during the quarter, as did the U.S. dollar, which fell against the euro and sterling, but gained against the Japanese yen. The Swiss franc strengthened, while sterling and the euro were mixed for the period. The U.S. dollar ended March at $1.59 against sterling, $1.33 versus the euro and at 82.29 yen.
We are neutral on equities versus bonds. Although we believe equities are likely to experience a period of pullback and consolidation in the months ahead, we do not expect a severe reversal like the one experienced last year. SEI believes that U.S. economic expansion is finally on firmer ground. The improvement in the financial position of U.S. households and the recovery in employment should give investors confidence that U.S. economic expansion will be sustained.
We favour U.S. versus international equities. The U.S. certainly looks like the best house in a bad neighbourhood. Although the eurozone has made some progress in dealing with its periphery debt crisis, it will continue to face periods of stress. Growth in the strongest countries is likely to trail the U.S., while the problem debtors continue to face austerity-induced economic decline. Eurozone exporters may benefit if the euro declines as we expect. Emerging markets will likely continue to grow at a faster clip than the U.S. but, China, India and Brazil all have issues that lessen their near-term attractiveness.
We favour high yield debt versus investment grade fixed income. The financial health of high yield debt issuers suggests that this asset class should continue to outperform treasuries and investment grade bonds.
Glossary of Financial Terms
High yield debt: High yield debt is rated below investment grade and is considered to be riskier.
Peripheral eurozone countries: Peripheral eurozone countries are those countries in the eurozone with the smallest economies.
Core eurozone countries: Core eurozone countries are those countries in the eurozone with the largest economies.
Fundamentals: Fundamentals refers to data that can be used to assess a country or company's financial health such as amount of debt, level of profitability, cash-flow, inventory size etc.
Cyclical sectors or stocks: Cyclical sectors or stocks are those whose performance is closely tied to the economic environment and business cycle.
Austerity: Austerity refers to measures taken by a country’s government in an effort to reduce expenditures and a budget deficit.
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SEI sources data directly from the following vendors: Factset, MSCI Barra, Russell, TOPIX, FTSE, Barclays Capital and BofA Merrill Lynch. Where appropriate, returns in base currencies are converted to the relevant currency using WM Reuters 4pm Spot rates.