Commentary: July 2009 Market and Performance Update

Summary:

• Increased appetite for risk drove the rally in stocks and bonds 
• Economic data boosted hopes for an end to the recession
• Positive corporate earnings news instilled optimism
• Winners emerged from the credit crisis, displaying strong earnings

Market Overview

Global stock and bond markets extended their strong second quarter rally into July, 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 fueled hopes that the world’s biggest economy growth may turn positive in the second half of this year.

The Dow Jones Industrial Average gained 8.74% for the quarter, the S&P 500 Index rose 7.56%, and the NASDAQ Composite Index finished up 7.82%. 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 Bond Index gained 2.21%, led by strong returns for non-government sectors. The Chicago Board Options Exchange Volatility Index (VIX), a barometer of market volatility, dropped to its lowest level since September 2008 and ended at 25.92. However, it remained well above long-term averages. Dispersions 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 by encouraging economic news and better-than-expected corporate profits as second-quarter earnings results were announced.

Winners from the credit crisis appeared to emerge; strong earnings reports were released from Intel in the Information Technology sector and Goldman Sachs, JP Morgan, Barclays and HSBC in the Financials sector. Even Ford managed to turn a profit in the second quarter, as the automaker pulled away from its troubled rivals General Motors and Chrysler.

Small-cap stocks continued to outperform their large-cap brethren as investors favored them and the trend toward positioning portfolios for economic recovery continued. Value stocks outperformed their growth counterparts in both the large- and small-cap spaces. Energy was among the worst-performing sectors in July, held back by a modest decline in oil prices amid an increase in U.S. gasoline stockpiles. 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 per barrel reached in December 2008.

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 and emerging-market debt, posted some of the largest gains in July; this was also the case during 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 continued to be the best-performing sector in the overall bond markets for 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. CIT bonds and shares 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 favor some creditors others, and doubts remained around CIT’s ability to pay debts 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. While U.S. retail sales came in better than expected for June, most segments showed continued weakness. While the June employment report showed a bigger loss 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 euro zone’s largest economy had come out of its severest recession since World War II, citing stabilization 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 UK GDP was a big improvement on the 2.4% first-quarter drop, it was still a larger decline than what was forecast. UK house prices continued to rise on a monthly basis in June, and mortgage approvals also rose, fueling hopes for a sustained recovery in the real estate market. Inflation rate fell below the Bank of England’s (BoE) 2.0% target for the first time in nearly two years. The bank kept rates on hold at 0.5%, 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.

Portfolio Review

Equity markets experienced a dip but then continued to rebound sharply following the strong upward move during the second quarter. Earnings season kicked off with a majority of companies beating estimates, propelling markets higher. Economic data remained mixed. While the ISM services index contracted at its slowest pace in nine months, and the S&P Case Shiller Index of home prices registered a modest rise for the first time in three years, consumer confidence and durable goods orders both came in weaker than expected. Most importantly, the jobs picture showed signs of improvement, as the four-week average for jobless claims continued to moderate. The U.S. consumer should get past the recent crisis of confidence if housing firms up, markets gain traction and the jobs outlook improves. Investors have continued to shift further out on the risk spectrum, betting on a stronger-than-expected economic recovery.

The TED spread¹ continued to narrow, suggesting that credit is more readily available and providing the foundation for an economic recovery. Federal Reserve (Fed) Chairman Ben Bernanke has indicated that staving off job losses remains the Fed’s number one priority. He has suggested that interest rates will likely remain at historically low levels for some time.

In this environment, small-cap stocks and lower-quality assets continued to perform well; markets were led by interest-rate sensitive securities, early cyclicals and higher-beta sectors. The Russell 1000 Index was led to the upside by the Materials, Consumer Discretionary, Industrials and Information Technology sectors. Defensive sectors, particularly Utilities, Healthcare and Consumer Staples, trailed as investors shifted further out the quality spectrum. Better-than-expected earnings reports from Financials and bellwether Technology stocks heading into the middle of July led to a sharp rally for the second half of the month. Materials benefited the most from higher growth prospects out of China, followed by Consumer Discretionary stocks, which benefited from investors positioning for the back-to-school season. Technology stocks continued to fare well following better-than-anticipated earnings by its industry leaders, which benefited from not only cost cutting measures, but also modest growth in top line sales and revenue. This is being driven by system upgrades to extend technological efficiencies for the next cyclical upturn to help bolster the bottom line. Finally, Industrials rallied sharply, with improved outlooks announced by major Dow components such as Caterpillar. Cost-cutting measures helped to drive the bottom line, leading companies to beat weak estimates.

Global markets witnessed a robust rebound after posting a decline in June. Economic data presented a mixed bag of results, but incremental improvements have led to gains in investor confidence. Global fiscal stimulus appears to be taking effect, and better-than-expected company earnings, along with positive signals from the U.S. preliminary second-quarter gross domestic product report and the housing market, boosted the global market. Financials, Consumer Discretionary, Materials and Information Technology continued to lead the market, while Energy, Utilities and Consumer Staples lagged behind the benchmark. At the country level, emerging countries such as Poland, Indonesia, Turkey, and Korea did very well; Russia, Japan and some European countries including Finland, Russia and Portugal continued to lag the market. Emerging markets continued leading developed markets, but at a much smaller margin than during former months. Momentum in emerging countries continued its positive trend, despite the significant decline in Chinese exports.

For investment-grade fixed income, the majority of spread sectors outperformed Treasuries again in July. The investment-grade corporate sector posted positive returns, as corporate earnings surprised to the upside providing extra support. As a result, investment-grade corporate spreads continued to tighten on improving corporate performance and recovering economic conditions. Agency mortgage-backed securities (MBS) outperformed Treasuries but underperformed the overall index. Treasury yields remained relatively range bound during the month, which boded well for agency MBS. Mortgage spreads narrowed as demand from the U.S. government and money managers absorbed the constant stream of supply. Although fundamentals continued to deteriorate, it is important to keep in mind that the deterioration was expected and bond prices had already priced in such a scenario.

The high-yield market rally continued in July, registering its sixth-strongest return on record, as 59 of the 64 sectors in the index posted positive returns. In emerging-markets debt, rising commodity prices benefited emerging nations, and bonds rallied largely on increased risk appetite. The market easily absorbed new issuance on strong demand. Rating outlooks have improved at the sovereign level, as the Philippines received an upgrade to Ba3 by Moody’s. Interest rate cuts continued in some countries (Hungary and Brazil) and remained unchanged in others (Poland, Malaysia, and Colombia).

What Worked in Our Portfolios	What Didn’t Work in Our Portfolios
Exposure to Deep Value in Large Cap –Positive stock selection in Consumer Discretionary, Financials and Materials drove results	Poor Stock Selection in Large Cap – The Information Technology, Consumer Discretionary and Financials sectors suffered
Strong Stock Selection in International Developed – Financials in Africa and the Middle East, as well as Materials in Latin America, fared well.	Growth Factors in Small Cap – This area continued to struggle in July
Security Selection in Emerging Markets Equity – Positions in the Industrials, Consumer Discretionary and Information Technology added value	Securities Selection in International Developed – European Financials and Japan were weak
Underweight2 to CIT Group in High Yield – Without government support, CIT struggled to avoid bankruptcy	Allocation to Growth in Emerging Markets Equity – This area continued to face headwinds
Allocation to Brazil in Emerging Markets Debt –The Brazilian real has been one of the strongest-performing currencies against the dollar	Curve Steepening Position in Core Fixed Income –The yield curve flattened, detracting from performance
	Underweight3 to the Software/Services Sector for High Yield – First Data bonds rallied 21.5% after a new venture with Bank of America was announced
2 0.42% for the Fund versus 0.94% for the benchmark	3 0.33% versus 1.13% for the benchmark

Manager Positioning and Opportunities

Large-cap managers continue to focus on fundamentally sound, higher-quality names that should benefit from investors’ focus on companies with sustainable business models. The majority of our managers remain overweight technology, as they are finding cash flow rich companies with strong balance sheets, low debt and strong growth prospects at attractive valuations. The ability for these companies to grow their top lines through sales growth and pricing power should be a catalyst for strong earnings growth going forward especially in light of the recent inventory de-stocking that has occurred within the U.S. economy.

International developed equity managers currently maintain an overweight to telecom, consumer discretionary and information technology, the sectors that will benefit most from the continued economy recovery, and maintains an underweight to financials, energy and materials, the more cyclical sectors. Strategic allocations to the value and momentum alpha sources are also maintained, which have added value over the long term in global equity markets. Emerging-markets equity portfolio managers continue to have a strategic exposure to value and momentum factors, and fundamental bottom-up stock selection.

For investment-grade fixed income, spread sector allocations continue to focus on securitized sectors, as they represent the greatest fundamental relative value. The Fund’s significant overweight to non-agency MBS is expected to continue, as securities in these sectors are substantially over-collateralized and at the top of the capital structure.

High-yield managers have selectively increased their risk exposure in securities that they have the most conviction in, but overall, a more defensive posture is retained, with an allocation to bank loans and cash. They are actively looking for securities that are upgrade or acquisition candidates – two events that typically lead to outsized bond returns. Emerging-markets debt (EMD) managers are remaining overweight to higher-yielding credits, but they are gradually reducing exposure. EMD spread compression has been quite significant in the past few months, especially considering the amount of new issuance placed. The strength of the asset class has also been impressive, although there will come a time when such a strong rally can no longer be sustained, despite higher-yielding credit spreads at relatively wide levels.

Outlook

In SEI’s view, the global economic recession may still be with us, but 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 for stocks, high-yield bonds and commodities in particular. After an initial rally in March and April, the appreciation of assets that are perceived to be riskier has proceeded at a slower and more erratic pace.

A return to positive economic growth 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 setbacks in equities if 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 cash flows improve.

¹ The difference between the interest rate for Treasury bills and the rate for Eurodollar bills, the Ted spread is used as in indicator of credit risk.

 

Disclosures

This material is for educational purposes only and is not meant to be investment advice. The reader should consult with his/her financial advisor for more information.

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.

To determine if the Fund(s) are an appropriate investment for you, carefully consider the investment objectives, risk factors and charges and expenses before investing. This and other information can be found in the Fund's prospectus, which may be obtained by calling 1-800-DIAL-SEI. Read it carefully before investing.
SEI Investments Management Corporation (SIMC) is the adviser to the SEI Funds, which are distributed by SEI Investments Distribution Co (SIDCO). SIMC and SIDCO are wholly-owned subsidiaries of SEI Investments Company.

Diversification may not protect against market risk. Current and future portfolio holdings are subject to risks as well.  In addition to the normal risks associated with equity investing, international investments may involve risk of capital loss from unfavorable 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. REIT investments are subject to changes in economic conditions, credit risk and interest rate fluctuations. Bonds and bond funds will decrease in value as interest rates rise.

Index performance returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Past performance does not guarantee future results.

For those SEI Funds which employ the 'manager of managers' structure, SEI Investments Management Corporation has the ultimate responsibility for the investment performance of the Fund due to its responsibility to oversee the sub-advisers and recommend their hiring, termination and replacement.

• Not FDIC Insured 
• No Bank Guarantee
• May Lose Value