April 2012 Monthly Market Update
- Investor confidence deteriorated due to concerns about the eurozone and events in Spain.
- Global bonds outperformed all other asset classes, including equities, as risk appetite waned. Government bonds set the pace.
- Global equities struggled. Cyclical and riskier stocks lagged the most.
Investor confidence deteriorated in April due to concerns about the eurozone and events in Spain in particular. Risk appetite waned and the financial markets once again witnessed a flight-to-safety, whereby investors shunned assets perceived to be risky in favour of more defensive investments. Consequently global bonds outperformed global equities for the month and government debt was favoured 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 as being in recession, unemployment levels remained among the highest in the European Union and the growth outlook for the country is poor. 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, the credit rating agency, Standard & Poor’s (S&P), downgraded Spanish sovereign debt towards 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, including 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 2.7% in March (and was estimated to have fallen to 2.6% by the end of the April). The result of slowing growth was the feeling that eurozone austerity measures have been prioritised 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% was finalised by the end of the month).
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%, signalling 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 3.5% in March. However, some positives remained; for example, first quarter unemployment levels fell marginally to 8.3% and March retail sales increased by 3.3% (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 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 regards 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 centralised governments (like Portugal) than for larger, decentralised nations (such as Spain). Within the fixed income markets, emerging market 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 for the month, while higher quality, more defensive names performed better. Telecommunications, Consumer Staples and Healthcare were the only sectors within global equities to record positive returns for the month (in U.S. dollar terms) and Financials brought up the rear. Spanish and Italian equities bore the brunt of negative sentiment during the month and experienced large declines. Despite the announcement that the country had slipped back into recession during the month, U.K. equity performance remained fairly robust in April (despite ending the month in negative territory in local currency terms).
- The MSCI AC World Index, used to gauge global equity performance, fell by ($) 1.14% in April.
- The Barclays Global Aggregate Index, which represents global bond markets, rose by ($) 1.18% over the month.
- 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 during the month, but reached as high as 20.39 on 10th April.
- WTI Cushing crude oil prices, a key indicator of movements in the oil market moved from $103.02 a barrel at the end of March to $104.87 by 30th April.
- The euro weakened against most major currencies during the month 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.
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 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
- Austerity: Austerity refers to measures taken by a country’s government in an effort to reduce expenditures and a budget deficit.
- Credit rating: Credit ratings are an assessment of the risk of default of a company or country. The higher the credit quality (or rating), the lower the perceived risk of default. AAA rated are the highest; D rated are the lowest. Ratings below BBB are classified as non-investment grade, or junk, and are considered to be riskier.
- Peripheral eurozone countries: Peripheral eurozone countries are those countries in the eurozone with the smallest economies.
- Cyclical sectors or stocks: Cyclical sectors or stocks are those whose performance is closely tied to the economic environment and business cycle.
- High yield debt: High yield debt is rated below investment grade and is considered to be riskier.
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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.