Quarterly Market Review
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First Quarter 2015
Global Backdrop Favored Non-U.S. Equities, U.S. Bonds
"Global divergence" remained the predominant theme in the world’s financial markets. Specifically, while the U.S. economy continued to demonstrate modest gains, other leading economies struggled with slow or stagnant growth. Against this backdrop, the Federal Reserve (the Fed) and the Bank of England remained the only leading central banks scaling back their stimulus programs and contemplating interest rate increases. Other central banks remained in aggressive-stimulus mode, including the European Central Bank (ECB), which finally launched its long-anticipated quantitative easing (QE) program.
In this environment, non-U.S. stocks rallied, as investors generally overlooked continued signs of global economic weakness and focused on central bank-driven optimism. U.S. stocks overcame a sharp bout of volatility triggered by slowing growth and earnings concerns to post modest gains, but they lagged their non-U.S. developed and emerging market counterparts.
Meanwhile, weak global growth, disparate central bank policies, a strong dollar, and low inflation led to solid performance in the U.S. bond market. The relatively higher yields available in the U.S. bond market versus other regions (particularly Europe, where QE pushed some yields into negative territory) continued to drive demand for U.S. securities. Returns among non-U.S. bonds were up in local currency terms, driven by slow growth, falling interest rates, and central bank stimulus measures.
U.S. Stocks: Rally Slowed as Volatility Accelerated
Strong stock gains in February helped offset declines in January and March, and the S&P 500® Index eked out a first-quarter return of 0.95%, the large-cap benchmark’s ninth-consecutive quarterly gain. But the first-quarter return marked a notable retreat from the nearly 5% gain in the fourth quarter of 2014, as familiar concerns about economic growth, commodity prices, corporate earnings, and Fed interest rate policy led to heightened volatility.
The quarter began on a weak note for U.S. stock investors. The government’s first report on fourth-quarter 2014 gross domestic product (GDP) showed growth slowed considerably from the third quarter. In addition, further weakness in oil prices and the U.S. dollar’s continued surge triggered concerns about corporate earnings. But those concerns subsided in February as oil prices stabilized and corporate earnings reports were surprisingly upbeat. Investor optimism resumed, and stock performance was robust, with the S&P 500 Index hitting new highs in February. Nevertheless, sentiment soured again in March, largely due to disappointing economic growth and weak corporate profits. The government revised fourth-quarter GDP downward, to 2.2% (annualized), which was less than half the U.S. growth rate in the third quarter. Meanwhile, growth outside the U.S. remained even weaker, and multinational corporate profits sank on continued U.S. dollar strength, which generated concerns about 2015 earnings forecasts. The Fed provided some relief, switching to a more "dovish" tone regarding the timing and pace of short-term interest rate hikes due to concerns about slowing growth and weak inflation.
Sector performance was mixed during the quarter. Six of the S&P 500 Index’s 10 industry sectors generated positive performance, and five of those sectors outperformed the index average. Sharp gains among health care providers and biotechnology companies helped the health care sector finish the quarter as the top performer, up 6.53%. The consumer discretionary sector gained 4.80%, as lower gasoline prices helped deliver a tailwind to consumer spending. Meanwhile, after leading the market in 2014, the utilities sector tumbled to last place among the sectors, declining -5.17% on fears of rising interest rates. Weak oil prices and a strong dollar weighed on the energy sector, which fell -2.85%.
Mid- and small-cap stocks, which are typically less influenced by currency and other international factors, generally outperformed large-cap stocks. Mid-cap stocks (Russell Midcap® Index) advanced 3.95% in the quarter, while small-cap stocks gained 4.32% (Russell 2000® Index). Growth stocks maintained an edge over value stocks across the board. Small-cap growth stocks (Russell 1000® Growth Index) were the first quarter’s top performers, up 6.63%, while large-cap value stocks (Russell 1000 Value Index) were the weakest, falling -0.72%.
Non-U.S. Stocks: Central Bank Stimulus Fueled Gains
Non-U.S. stocks rallied and outpaced U.S. stocks, as investors largely overlooked sluggish growth data, geopolitical concerns, and continued weakness among commodity prices to focus instead on supportive central bank policies. The relative strength of the U.S. dollar, which continued to gain ground versus most major currencies, reduced non-U.S. stock returns for U.S.-based investors.
In Europe, the ECB’s long-anticipated QE program helped revive Europe’s growth outlook and push stock prices higher. Certain data improved, including manufacturing and retail sales, but unemployment in the 19-member eurozone was 11.3% in February. In addition, deflation remained a concern, as consumer prices fell in March for a fourth-consecutive month. But the year-over-year inflation rate of -0.1% marked an improvement from -0.6% in January. Conditions in Greece remained a concern and a source of potential future volatility, as negotiations regarding the nation’s economic reform plans stalled. Overall, the combination of lower oil prices, a weaker euro, and the projected positive effects of QE prompted the ECB to raise its growth outlook for 2015 from 1.0% to 1.5%. Meanwhile, the U.K.’s economic prospects remained brighter, as the economy grew in 2014 at its fastest yearly pace since 2006. And in the first quarter, U.K. consumer sentiment reached a new post-financial-crisis high, even as inflation fell to 0%.
After slipping into recession in the third quarter of 2014, Japan returned to positive, albeit weak, growth in the fourth quarter of 2014. In addition, inflation continued to decline despite the government’s efforts to spark price gains. Despite the relatively weak economic backdrop, Japan’s stock market was among the strongest during the first quarter, buoyed by weaker oil prices, the government’s ongoing economic stimulus measures, and the Bank of Japan’s continued efforts to drive down the yen’s value, which was particularly beneficial to the nation’s exporters.
Emerging markets stocks generally advanced, but performance was mixed on a country-by-country basis amid ongoing concerns about slowing global growth, declining commodities prices, and the rallying U.S. dollar. Strong performance from China’s stock market largely offset weaker results from Latin America and drove the broad emerging markets benchmark higher. Despite lower growth forecasts and subdued economic data in China, Chinese stocks advanced on central bank easing and assurances from China’s leaders that the government can do more to stimulate growth.
Global Bonds: Macro Factors, Central Bank Actions Drove Yields Lower
Modest growth in the U.S. and weak or stagnant growth nearly everywhere else generally benefited the U.S. bond market. While the Fed continued to prepare the markets for an eventual tightening in U.S. monetary policy, other leading central banks initiated (as in the case of the ECB) or maintained (Bank of Japan, People’s Bank of China) aggressive stimulus programs to combat economic weakness. This dynamic helped strengthen the U.S. dollar relative to other world currencies. It also made U.S. Treasuries relatively more attractive than government bonds of other nations, where yields plunged on central bank easing. At the same time, inflation remained low, largely due to commodity price weakness, which also aided U.S. bonds, particularly those with longer maturities.
Against this backdrop of healthy demand for U.S. bonds and low inflation, the U.S. Treasury yield curve flattened as longer-maturity yields declined at a greater pace than short-maturity yields. Overall, longer duration (greater price sensitivity to interest rate changes) securities and strategies outperformed shorter duration.
All major sectors of the U.S. bond market generated positive performance. Among investment-grade sectors, corporate bonds and U.S. Treasuries were top performers, outpacing the broad investment-grade market average, while mortgage-backed securities (MBS) and agencies lagged the average. A turnaround in the energy sector helped high-yield corporate bonds rebound from last quarter’s decline to outperform all other major bond market sectors. Despite continued muted inflation, Treasury inflation-protected securities (TIPS) also rebounded from a negative fourth quarter, largely due to their longer duration and a modest rebound in breakeven rates (a measure of longer-term inflation expectations). Performance in the broad municipal bond (muni) market continued to follow the Treasury market higher, but at a more moderate pace. The still-low interest rate environment, higher federal tax rates, continued easing of credit concerns, and attractive valuations fueled investor demand for munis.
Meanwhile, global economic weakness and a lack of inflationary pressures put downward pressure on non-U.S. bond yields, leading to positive global bond returns in local currency terms. From a regional perspective, European bond markets delivered the best returns, led by peripheral markets such as Italy and Spain, while bond markets in the Asia/Pacific region generated more modest returns. Demand for yield helped non-government bonds outperform government securities.
For unhedged U.S. investors, a stronger U.S. dollar led to negative returns for non-U.S. bond markets. The U.S. dollar appreciated by more than 10% against the euro, 7% versus the Australian dollar, and 5% against the British pound during the quarter, and it was up slightly versus the Japanese yen.
The opinions expressed are those of American Century Investments (or the fund manager) and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.
For detailed descriptions of indices or investing terms referenced above, refer to our glossary.
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Source: Barclays Indices