Commentary: February 2010 Market and Performance Update

Summary

• Global equity markets made modest gains, but fears of Greek government bond default remain
• Concerns increased that other peripheral European nations would also face possible downgrades and defaults for their government bonds 
• Economic news for the U.S. and U.K. remained mixed

Although the tone for February was cautious due to concerns about possible government bond defaults and mixed economic data, investors pushed equity markets higher on hopes of further economic recovery. Market activity for the month reflected our view that the global economy is on the path to recovery but still faces hurdles along the way.

In February, the Dow Jones Industrial Index returned 2.95%, while the S&P 500 Index returned 3.10% and the NASDAQ Composite Index returned 4.37%. The MSCI AC World Index ($) rose 1.27% amid an indecisive atmosphere, with investors moving between defensive assets and more cyclical assets from week to week. The Barclays Capital Global Aggregate Bond Index ($) was roughly flat, gaining just 0.07%. At the end of the month, there was a flight to quality away from the government bonds in peripheral Europe into the perceived safety of U.S. Treasuries and German government bonds.

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 month above 24 but fell to 19.50 at the end of the month, implying that negative sentiment, which was prevalent earlier in the month, had abated somewhat.  

Stocks

Market participants fled to more defensive assets due to anxiety 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. The European Union announced that it would work to provide assistance to Greece, but these plans were not yet laid out in full detail. In addition, it is unclear how markets will respond to the gradual removal of government stimulus packages put in place during the recession. As the global economy is still slow to recover, the U.S. and the U.K. have reiterated that policies will remain accommodative for some time to come.

Sector performance within the MSCI AC World Index showed that investors continued to focus on prospects for economic recovery, looking beyond the bleak outlook created by weak labor markets and concerns over possible government bond defaults. For the month, top performers were sectors that are more responsive to shifts in the broader markets, such as Materials, Information Technology and Industrials. More defensive sectors, such as Utilities and Telecommunications, lagged the market.

Bonds

Performance in the fixed-income markets was flat for February, and government bonds outperformed non-government bonds in general. 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.

Greek sovereign debt continued to be a concern, as several of its banks were downgraded by credit agencies and its government has been slow to implement spending cuts. Toward the end of the month, Germany announced that it may buy Greek government bonds through its state-owned lending group KfW, alleviating some concerns about whether the European Union will offer assistance but raising the question about what will happen if other European peripheral nations experience similar issues in the future. The ongoing debt crisis put added negative pressure on the euro.  

Economy

Economic data for the month was mixed, as caution remained regarding the sustainability of the recovery. The Bank of England decided to keep interest rates unchanged at 0.5%, and the European Central Bank also voted to keep interest rates at a record-low level of 1%. In the U.S., the federal funds rate was kept at its historically low range of zero to 25 basis points; however, the Federal Reserve increased the discount rate from 50 basis points to 75 basis points.

Winter weather was a hindrance to economic growth throughout the month. A plague of winter storms has been blamed for lower-than-expected retail sales in the U.K., as well as higher jobless claims in the U.S. However, bright spots could be found as well; U.K. consumer sentiment reached a four-month high, and loans for first-time home-buyers reached their highest levels in two years.

Oil prices rose for the month, with WTI Cushing crude oil prices ending at around $79.70 per barrel. The increase in prices was due in part to harsh winter weather.

The dollar continued its rally, ending the month at roughly $1.52 per British pound and $1.36 per euro. On the other hand, the dollar weakened against Japanese currency, ending at around 88 yen.

Portfolio Review

A more positive tone in the markets benefited SEI’s Funds. In large-cap equity, a majority of our core and growth managers outperformed due to strong stock selection as markets rose. In small-cap equity, overall stock selection in the Financials sector was beneficial to performance. In international equity, an overweight to Canada and underweights to Italy and Spain significantly helped performance.

An overweight to commercial mortgage-backed securities (CMBS) for core fixed income contributed positively to performance, as investors increased their risk appetites and felt more certain that the economic recovery would continue to take hold. In high-yield bonds, an allocation to collateralized loan obligations continued to be beneficial, as these investments benefited from improving company fundamentals and a favorable technical environment, where demand outpaced supply. In emerging-market debt, concerns about sovereign debt issued by Greece and peripheral Europe weighed on the asset class’s performance.

Contributors	Detractors
Growth and momentum factors in large-cap equity - these factors outperformed in response to an improvement in market sentiment	Weak stock selection in large-cap equity – especially in Information Technology
Sector allocations in international equity – particularly an overweight in Materials and underweight in Utilities	Stock selection in international equity – particularly in the U.K. and Switzerland
Overweight to non-agency mortgage-backed securities in core fixed income – demand and pricing continued to improve	Underweight to American International Group in high-yield bonds – positive news caused AIG’s bonds to soar
Security selection in high-yield bonds – specifically in the Banking sector	Colombian sovereign debt in emerging-market debt – inflation and the fiscal deficit continue to pose concerns

Manager Positioning and Opportunities

SEI’s portfolio managers remain focused on finding managers that provide consistent returns over time. For large-cap equity, our Funds’ underlying investment managers remained positioned in high-quality securities, as they believe these companies should continue to benefit as the recovery takes hold. In small-cap equity, managers are currently overweight to the Energy sector. In non-U.S. equity, managers are maintaining an overweight to Asia Pacific ex-Japan, which they believe will be a leader as the global markets emerge from recession. Our investment-grade fixed-income managers remain overweight to non-agency mortgage-backed securities and residential asset-backed securities. High-yield managers are gradually reducing their allocations to bank loans as better opportunities arise. In emerging-market debt, security selection will be a critical way to add value while steering away from event risk.

Our View

In SEI’s view, the global economy should continue to improve, led by emerging markets. Growth will likely remain sluggish in many parts of the world, as the outlook is uncertain for how the European recovery will progress. Several hindrances to growth in the near term include deleveraging by governments, companies and individuals, proposed regulations affecting financial firms and higher taxes in 2011. Inflation is not expected to be a concern since unemployment remains high, as does the capacity for industrial production in factories and machinery.

Substantially increased fiscal restraint and continued low inflation should keep bond yields from rising significantly and keep short-term interest rates low. We continue to see opportunities in credit, although the potential for appreciation is far less than it was last year. We expect interest rates to stay within a tight range for an extended period in the near term, but we anticipate that rates will increase as the recovery gains traction and governments expand issuance of their debt. In our view, high-yield bonds remain attractive as default rates continue to decrease, and there are still opportunities in emerging-market debt, as Latin American and Asian economies have good prospects for growth.

The key concern in our view is 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. While we see balanced opportunities in equities and fixed income, we remain cautious regarding the economic and market risks for the near term.

Global indexes and investing terminology

 

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 can be obtained by calling 1-800-DIAL-SEI. Read it carefully before investing.

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