Knowledge Center Archive
April 2012 Market and Performance Update
- Investor confidence deteriorated due to concerns about the eurozone.
- Global bonds outperformed all other asset classes as risk appetite waned.
Global equities struggled, with cyclical and riskier stocks lagging the most.
Investor confidence deteriorated in April due to eurozone concerns and problems in Spain. Risk appetite waned and the financial markets witnessed a flight to safety, whereby investors shunned assets perceived to be risky in favor of more defensive investments. Consequently, global bonds outperformed global equities and government debt was favored over all other asset classes.
Investors once again focused on the eurozone in April, this time with Spain in the spotlight. The Spanish economy was confirmed to be in recession, unemployment levels remained among the highest in the European Union and the country was saddled with a poor growth outlook. The Spanish government had previously revealed its intention to push through austerity measures in an effort to reduce the country’s spending by €27 billion. There were public demonstrations (which turned violent) against these harsh financial reforms at the end of March, and more were planned for early May. Investors subsequently became increasingly worried that Spain may follow in the footsteps of other struggling eurozone nations and be forced to request a financial bailout. As a result of growing concerns about the country’s finances, credit rating agency Standard & Poor’s (S&P), downgraded Spanish sovereign debt toward the end of April. This downgrade also impacted S&P’s view of the country’s banks, many of which may need to rely on government support in the future. On the final day of the month, S&P took negative actions against 16 Spanish banks, downgrading 11 of them. This included Banco Santander, one of the largest banks in the eurozone.
For the eurozone as a whole, economic data released during April painted a gloomy picture. Unemployment levels for the region reached a record high of 10.80% in February, retail sales fell by 0.10% (when compared with January sales) and manufacturing output continued to decline. The Markit Eurozone Manufacturing Purchasing Managers’ Index (PMI) fell from 49.00 in February to 47.70 in March (any number below 50.00 indicates contraction). However, inflation remained stable at 2.70% in March (and was estimated to have fallen to 2.60% by the end of the April). The result of slowing growth was the feeling that eurozone austerity measures have been prioritized over economic expansion. This sentiment was reflected in national politics during April, including in the lead up to the French and Greek elections and through the collapse of the Dutch government in the wake of failed budget cut talks (although a budget deal for 2013 to help reduce the deficit by 3.00% was finalized by the end of the month).
In the U.S., the economy showed modest signs of life after the first estimate of gross domestic product came in at 2.2%. This was below the consensus number of 2.5% and the fourth quarter read of 3.0%. The Federal Open Market Committee met and held interest rates steady. Federal Reserve Chairman Ben Bernanke provided a modest upgrade to the economic picture while continuing to voice concerns about slow growth within the labor market and the housing sector. Investors eagerly anticipated the release of April’s nonfarm payroll data, hoping that would halt a developing slowdown within the labor market. Unfortunately, it did not move the needle in either direction, and indicated only modest growth. Retail sales were stronger than expected, and showed that consumers are finding ways to cope with higher gas prices. However, housing and manufacturing data were weaker.
News was mixed for the U.K. in April. Estimated first-quarter gross domestic product readings from the Office for National Statistics showed that growth in the U.K. contracted by 2.00%, signaling that the U.K. economy returned to recession. Further bad news showed that the recent trend of falling inflation had halted, as the U.K. Consumer Price Index rose to 3.50% in March. However, some positives remained; for example, first-quarter unemployment levels fell marginally to 8.30% and March retail sales increased by 3.30% (when compared with March 2011). Growth in the U.K. manufacturing sector was also solid, which was reflected in the Markit/Chartered Institute of Purchasing & Supply UK Manufacturing PMI reaching its highest levels in ten months, rising to 52.10 in March from 51.50 in February (any number above 50.00 signifies expansion).
The flight to safety witnessed during the month resulted in increased demand for government bonds, which are perceived to be safer investments compared with other fixed-income instruments. Government bond yields (which move inversely to prices) generally fell in April, although Spain was a notable exception. Spanish government bond yields continued to rise due to worries over the state of the country’s economy and the S&P downgrades. With regard to other peripheral eurozone counties, the government debt of Portugal held up well during the month, reflecting the belief that financial austerity is possibly more credible for smaller, more centralized governments (like Portugal) than for larger, decentralized nations (such as Spain). Within the fixed-income markets, emerging markets debt bucked the risk-off trend and demand continued to be high in April. The asset class managed to distance itself from generally downbeat global news and benefited from pockets of optimism, such as the announcement that the Chinese government intends to increase the amount that foreigners can invest in their economy and S&P’s upgrade of Uruguayan government debt.
Global equity markets struggled in April. Riskier, more cyclical sectors experienced the largest declines, while higher quality, more defensive names performed better. Telecommunications, Consumer Staples and Health Care were the only sectors within global equities to record positive returns (in U.S. dollar terms), and Financials brought up the rear. Spanish and Italian equities bore the brunt of negative sentiment and experienced large declines. Despite the announcement that the country had slipped back into recession, U.K. equity performance remained fairly robust in April (despite ending the month in negative territory in local currency terms).
- The Dow Jones Industrial Average index gained 0.16%.
- The S&P 500 Index declined 0.63%.
- The NASDAQ Composite Index returned -1.42%.
- The MSCI AC World Index, used to gauge global equity performance, fell by 1.14%.
- The Barclays Global Aggregate Index, which represents global bond markets, rose by 1.18%.
- The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” moved from 15.50 to 17.15, but reached as high as 20.39 on April 10.
- WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $103.02 per barrel at the end of March to $104.87 by April 30.
- The euro weakened against most major currencies and the Japanese yen strengthened. The U.S. dollar ended April at $1.62 against sterling, $1.32 versus the euro and at 79.85 yen.
The equity rally seen during the first quarter failed to extend through April, and SEI’s equity portfolios felt the impact of growing investor unease. In large-cap equity, stock selection within Consumer Discretionary and Energy detracted, but solid stock picking within Industrials and Telecommunications helped results. In small-cap equity, an overweight to Information Technology (IT) detracted from performance, as the sector responded poorly to quarterly earnings reports. In international equity, an underweight to Financials and strong stock selection within Energy was more than offset by weak selection in Materials and Industrials.
SEI’s fixed-income portfolios benefited from the fact that all segments of the fixed-income markets posted positive total returns, helped in part by falling Treasury yields. In core fixed income, an allocation to non-agency mortgage-backed securities (MBS) was a modest positive, as pricing in certain sub-sectors continued to improve. An underweight to the underperforming Utilities sector enhanced returns in high-yield bonds. Security selection within the sector was also positive. In emerging markets debt, an underweight to Hungary hurt as bonds rallied on news regarding European Union/International Monetary Fund assistance, while security selection in Ukraine dragged performance down, mostly from external debt.
- Industrials and Telecommunications in Large-Cap Equity – stock selection within these sectors benefited performance
- Consumer Discretionary Picks in Small-Cap Equity – durables and apparel posted gains within this sector
- Emerging Markets Holdings in International Equity – emerging markets outperformed their developed peers
- Security Selection in High-Yield Debt – an allocation to municipal tobacco bonds added to returns
- Stock Selection in Large-Cap Equity – picks in Consumer Discretionary and Energy detracted from results
- Underweight to Real Estate within Financials in Small-Cap Equity – real-estate securities performed well during the month
- Selection in Materials and Industrials in International Equity – this offset solid stock picking within the Energy sector
- Local Currency Exposure in Emerging Markets Debt – exchange rates declined in Brazil and Mexico over global growth concerns
Manager Positioning and Opportunities
SEI’s portfolio managers aim to provide diversified sources of excess return for portfolios through solid investment-manager selection and portfolio construction. In large-cap equity, managers have maintained a slight growth bias and overweights to IT and Consumer Discretionary, as they believe an attractive opportunity set is still present in these areas. Large-cap managers think the U.S. economy is in for an extended period of low growth, but not an outright recession. In small-cap equity, managers remain cautiously constructive on the market environment and have retained a slightly pro-cyclical positioning. This is expressed through overweight positions to IT and Industrials, and underweight positions in areas such as Utilities, Consumer Staples and Telecommunications. International equity managers have maintained a strategic overweight to emerging markets, as they still see this area as the future source of global growth. Given the debt worries that still exist in Europe, managers feel an underweight to the region is prudent and will rely on shrewd stock selection to gain exposure.
In investment-grade fixed income, an overweight to non-agency MBS is expected to continue, as securities in this sector are attractively priced relative to conservative assumptions. High-yield debt managers remain underweight to the Energy and Utilities sectors. Low natural gas prices have also led them to underweight coal producers, as generating companies are switching to natural gas. Emerging markets debt managers still like corporate and local currency debt, but continued to pull back their local currency exposures given the strong start to the year, the still uncertain global growth environment and relative value considerations versus dollar debt. Corporate debt also offers value, although managers have emphasized higher quality as of late and have reduced overall exposure, particularly from the high-yield sector.
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 favor U.S. versus international equities. Although the eurozone has made some progress in dealing with its 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 favor 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 Treasurys and investment-grade bonds.
1 Source: BloombergGlossary
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