July 2010 Market Update

Summary: 

• Global equity and fixed-income markets gained on robust corporate earnings and dissipating fears surrounding the European sovereign debt crisis. 
• “Stress test” results for European banks were largely benign, with only seven failures under the projected scenarios. 
• Economic data remained mixed, and central banks kept rates at record lows.

During July, investors were able to look past much of the weak global economic data and instead focus on positive corporate earnings releases. While a lack of consumer spending and a weak labor market continued to suggest slow growth for the U.S., economic indicators generally improved in Europe and the U.K. Inflation remained benign, with some market participants warning of a possible deflationary environment in the future, where prices would continue to decrease over time.

For the month, the Dow Jones Industrial Index gained 7.23%, while the S&P 500 Index rose 7.01% and the NASDAQ Composite Index returned 6.94%. The MSCI AC World Index ($) gained 8.14% for the month due to increased optimism about corporate profits and expansion in manufacturing. SEI believes that the global economy is still in the midst of recovery, although it will be a long, slow path due to government cost-cutting programs, high unemployment and reluctance to spend on the part of the consumer. The Barclays Capital Global Aggregate Bond Index ($) rose 3.40% for the month. Global high-yield bonds and investment-grade corporate bonds performed well on positive earnings news from a majority of global businesses.

Stocks

For much of July, investors’ appetite for risk returned as confidence increased surrounding global business prospects. As a result, cyclical sectors led for most of the month. Toward the end of the month, though, U.S. economic growth was weaker than expected, which led to more hesitance in the market even as equity prices still pushed higher. The Bank of England, the European Central Bank (ECB) and the U.S. Federal Reserve have continued to keep loose monetary policies in place and will likely do so for some time to come.

From a sector perspective, cyclical sectors such as Financials and Materials performed best. The Financials sector was driven by mostly positive results from the European bank stress tests (which were designed to forecast the effects of stunted or declining economic growth on bank solvency) and a finalization of U.S. financial reform legislation. Transparency around these events made it easier for investors to assess risks regarding financial institutions. Telecommunications had robust returns as well, as companies’ improved financial positions translated into positive second-quarter earnings news.

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 at around 34 but then fell to below 24 at the end of the month, as investor fears were calmed.

Bonds

Global fixed-income markets had a positive month, with solid gains in credit, high-yield bonds and emerging-market debt. High-yield and investment-grade bonds benefitted from optimism surrounding corporate profits, while emerging-market debt saw demand rise because these issuers are believed to have more stable finances than many of their developed-market counterparts. Government bond prices rose as well for much of the month due to global worries about a return to recessionary conditions.

Bond markets were volatile due to the potential for increased regulation and continued doubts about the sustainability of the global economic recovery. European bonds performed particularly well, as the bank stress tests and reduced fears about the sovereign debt crisis pushed prices up.

Economy

Economic data was mixed in July, showing economic growth worldwide but prolonged weakness in the housing and labor markets. Sales of existing U.S. homes posted a smaller decline than anticipated, but the construction of new houses for the month of June was at its lowest level since October 2009. Initial jobless claims stayed elevated, and the unemployment rate stayed at 9.5%. Manufacturing data suggested a slower pace, as durable goods orders fell for the second straight month in June. In addition, consumers remained wary, as retail spending also fell for the second consecutive month in June. Second-quarter gross domestic product for the U.S. was 2.4%, which was weaker than expected. The U.S. Federal Reserve commented on the high degree of uncertainty existing in the economic environment at the present time and pledged to keep interest rates at record-low levels.

Oil prices rose modestly, with WTI Cushing crude oil prices (a key indicator of movements in the oil market) ending at $78.95 per barrel. The U.S. dollar weakened on news of weaker-than-expected growth, ending the month at $1.57 per British pound and around $1.30 per euro. The dollar also weakened slightly against the Japanese currency, ending at around 86 yen.

Portfolio Review

A return to riskier assets helped broader markets, but results for SEI’s portfolios were mixed. SEI’s large-cap equity portfolios gained on strong stock selection in the Information Technology and Healthcare sectors. In small-cap equity, sector allocation boosted performance. In international equity, stock selection in Europe and Middle East ex-U.K. was weak, while stock selection in Japan, Pacific ex-Japan and the U.K. was helpful.

Renewed investor risk appetite in the fixed-income markets was largely positive for SEI’s fixed-income portfolios. In core fixed income, allocations to commercial mortgage-backed securities helped performance, as were allocations to corporate bonds and non-agency mortgage-backed securities. In high-yield bonds, collateralized loan obligations were helpful, as these securities tend to lag their underlying collateral in terms of performance when there are sharp changes in market direction. In emerging-market debt, both country allocation and security selection helped drive performance.

Contributors

• Value factors in Large Cap Equity – they helped quantitative models for the month 
• Selection in Small Cap Equity – particularly in Financials and Consumer Staples 
• Underweight to Healthcare and Utilities in International Equity – these more defensive sectors lagged the market 
• Overweight to Argentina in Emerging Markets Debt – these bonds rallied on an improvement in fundamentals and a commitment to servicing debt

Detractors 

• Underweight to Industrials in Large Cap Equity – the sector posted strong performance for the month 
• Energy in Small Cap Equity – selection in this sector was detrimental 
• Sector allocation in International Equity – primarily the underweight in Financials 
• Security selection in High Yield Bonds – especially in the Insurance sector

Manager Positioning and Opportunities

SEI’s portfolio managers remain focused on finding investment managers that provide diversified sources of excess return for our portfolios. For large-cap equity, our portfolios’ underlying investment managers have decreased exposure to Consumer Staples and now have overweights to the Technology and Consumer Discretionary sectors. In small-cap equity, managers remain underweight to Healthcare and Financials, while the largest overweight is in Information Technology. In non-U.S. equity, the managers remain overweight in emerging markets, which are still experiencing solid economic growth, and in Canada, which has less government debt and good economic prospects relative to other developed countries.

Our investment-grade fixed-income managers still see opportunities in non-agency mortgage-backed securities, and the overweight to agency mortgage-backed securities has been reduced to an underweight, as managers are finding better value in other sectors. High-yield managers have maintained an allocation to bank loans due to their more defensive positioning and event-driven opportunities. In emerging-markets debt, managers have increased exposure to higher-yielding sovereign debt and corporate debt while reducing cash positions.

Our View

In SEI’s view, the global economy should continue to improve, but concerns remain surrounding hefty amounts of government debt, expectations of tax increases and a lack of confidence on the part of consumers. Emerging markets have continued to grow despite more restrictive central-bank policies, and better economic activity in core countries in Europe, namely France and Germany, is encouraging. While doubts still linger about the U.S. economic recovery, SEI doesn’t believe that there will be a double-dip recession. Instead, growth is expected to be tepid as governments work to control costs and get deficits under control. The debt crisis in peripheral Europe seems to be looking better, which should result in a less fearful tone for investors.

We continue to hold a long-term positive view toward equities, and we believe large-company equity looks more attractive than small-company equity since these large companies in general have strong balance sheets and should be able to withstand uncertainties around taxation and new legislation. Opportunities in investment-grade and high-yield credit remain strong, but since spreads between non-government bonds and government bonds have narrowed, our managers are emphasizing security selection within the Funds. All in all, SEI’s outlook for growth is positive, although setbacks along the way are expected. In general, we continue to have a favorable outlook, seeing balanced opportunities in the fixed-income and equity markets from an asset allocation perspective.

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.

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. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments.

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