Quarterly Market Review
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Third Quarter 2015
Volatility, Uncertainty Sank Stocks, Buoyed Bonds
Widespread concerns about global growth triggered sharp financial market volatility during the third quarter. China was the catalyst for the turmoil. An abrupt currency devaluation from China’s central bank in August, followed by a sharp downturn in China’s equity market, fueled fears that the world’s second-largest economy was cooling at a greater pace than its government originally reported. Slowing demand from China helped drive already-low commodity prices even lower, which contributed to investors’ concerns and further fueled the sell-off among global stocks. These factors also contributed to the Federal Reserve's (the Fed's) decision in September to delay its first short-term rate hike since 2006.
In this environment, broad U.S. and non-U.S. stock benchmarks plunged as investors exited equities and other risk assets in favor of safer ground. In the U.S., major stock benchmarks posted their worst quarterly losses in four years. But despite the decline, the U.S. stock market still fared better than others, particularly emerging markets, where economic, commodity, and currency woes triggered even steeper declines.
The factors that triggered equity market losses led to global bond market gains. Amid an increase in volatility and global economic uncertainty, global bond yields fell, and most major bond market benchmarks gained.
U.S. Stocks: Global Factors Trumped Domestic Economic Influences
U.S. stocks broke a 10-quarter winning streak as the S&P 500® Index dove into negative territory during the third quarter. Healthy stock market gains in July gave way to steep declines in August and September, leaving the broad U.S. stock market benchmark with a total return of -6.44% for the quarter. The decline pushed the S&P 500 Index well into the red for the year-to-date period, too.
After ending the second quarter on a negative note, primarily triggered by Greece’s debt default, U.S. stocks held up relatively well early in the third quarter. Several factors, including modest U.S. economic gains, generally positive U.S. corporate earnings reports, and an agreement between Greece and its creditors, helped restore investor optimism. But the upbeat tone shifted dramatically in mid- August, when trouble that had been brewing in China for several months reached a boiling point, sending stocks spiraling downward. China’s government unexpectedly devalued the nation’s currency, claiming the action was an attempt to let market forces determine the exchange rate. But investors believed it was an attempt by the government to prop up the nation’s struggling industrials sector. This prompted greater scrutiny of other recent data out of China, leading investors to conclude the economy was weaker than expected. Meanwhile, China’s stock market plunged, adding to the volatile global backdrop and the widespread stock market sell-off. China’s economic problems also weighed on commodities. Slumping demand from China pushed prices sharply lower.
China and the commodities markets weren’t the only sources of uncertainty for U.S. stocks. The Fed’s strategy surrounding short-term interest rates also unnerved investors. Entering the third quarter, most investors expected the Fed would finally lift the federal funds rate target off its near-zero level (where it’s been since 2008) in September. Improving economic data released during the quarter seemed to support that assumption. But the global market turmoil that erupted in August put the market’s rate-hike expectations in question. At its September policy meeting, the Fed tabled the rate hike, citing the global economic slowdown and its risks to the U.S. economy as reasons to hold rates steady. Instead of cheering the Fed’s decision, investors interpreted the delay as confirmation of the global economy’s weakness, which put additional pressure on U.S. stocks.
Against this backdrop, sector performance was mostly negative. Nine of the S&P 500 Index’s 10 sectors declined. Only the defensive utilities sector was positive, gaining 5.37%. Consumer staples, also a defensive play, declined -0.20%. The consumer discretionary and information technology sectors also outperformed the S&P 500, but with declines of -2.54% and -3.71%, respectively. The energy and materials sectors were the worst performers, plunging -17.41% and -16.90%, respectively, due to turmoil in the commodities markets.
Among the major equity market styles, large-cap stocks generally outperformed mid- and small-cap stocks. Growth stocks maintained an edge over value stocks in the large-and mid-cap universes, but they lagged value stocks in the small-cap segment. Large-cap growth stocks (Russell 1000 Growth Index) were the quarter’s top performers, down -5.29%, while small-cap growth stocks (Russell 2000® Growth Index) were the weakest, falling -13.06%.
Non-U.S. Stocks: China’s Slowdown, Weak Economies Overwhelmed Markets
Non-U.S. stocks generally suffered steeper declines than their U.S. counterparts, as weaker economic fundamentals exacerbated the effects of global market unrest. The quarter’s "risk-off" sentiment affected emerging markets stocks the most, and developing markets sharply underperformed developed market benchmarks. Compared with a broad mix of currencies, the U.S. dollar advanced modestly, which slightly reduced overall non-U.S. stock returns for U.S.-based investors.
In Europe, the positive effects on investor sentiment of ongoing quantitative easing (QE) and Greece’s debt bailout deal were short-lived. Greece reached a deal with its creditors early in the third quarter, and fears of an impending Greece exit from the eurozone faded. This news, combined with ongoing stimulus from the European Central Bank (ECB) and modestly improving European economic data, made for an optimistic start to the third quarter. But that tone faded beginning in August, as China’s economic and market turmoil sparked widespread market jitters. After several consecutive quarters of economic gains fueled by the ECB’s QE, Europe succumbed to pressures from China. Economic activity slowed, and stock prices plunged. Economic growth in the U.K. also slowed, though stronger than the eurozone, but U.K. stocks suffered the same third-quarter fate as their counterparts on the Continent.
Stocks in Japan also faced domestic and global pressures. Data released during the third quarter showed Japan’s fragile economy contracted during the second quarter, despite ongoing stimulus efforts from the Bank of Japan. By quarter-end, Japan’s government cut its economic assessment, highlighting external risks posed by China and a possible U.S. interest rate hike.
Emerging markets suffered the most from the turmoil in China and experienced the brunt of the global stock market sell-off. Contagion fears, ongoing currency pressures stemming from a strong U.S. dollar, and concerns about the effects of China’s slowdown on already-weak commodity prices weighed on economies throughout the emerging markets and pushed down stock prices significantly.
Emerging markets stocks generally advanced, but performance was mixed on a country-by-country basis. Concerns surrounding slow growth in the U.S. and China, commodity price volatility, a relatively strong U.S. dollar, and a looming Fed tightening cycle pressured broad emerging markets benchmarks. There were pockets of solid performance in Asia, particularly in China for much of the quarter, where various stimulus measures, including rate cuts, reforms, and liquidity efforts aimed at stabilizing the decelerating economy, fueled stock market gains. But the China market reversed course late in the quarter, giving back some of its big gains.
Global Bonds: Flight to Quality Favored Government Bonds
Compared with the rest of the world, the U.S. economy held up relatively well throughout the turbulent third quarter and the year-to-date period, highlighting the continuing "global divergence" theme. Nevertheless, the Fed remained focused on the global landscape and its potential risks to the U.S. economy in its decision to leave monetary policy unchanged. Additionally, current inflation remained subdued and longer-term inflation expectations declined, lending further support to the Fed’s decision to keep short-term rates at their near-zero level. Investors generally viewed the Fed’s delay as a warning sign for the global economy, which sent U.S. Treasury yields tumbling.
Against a backdrop of global economic uncertainty and financial market volatility, the U.S. Treasury market benefited from its perceived "safe-haven" status. Accordingly, the U.S. Treasury yield curve fell and flattened, with longer-maturity yields decreasing at a greater pace than short-maturity yields. Investor risk aversion remained prevalent, which led to relative outperformance for higher-quality securities. In addition, longer duration securities and strategies outperformed as the yield curve flattened.
Sector performance within the U.S. investment-grade bond market was mixed during the third quarter. Treasuries and mortgage-backed securities (MBS) outperformed the broad U.S. investment-grade bond market, while corporate bonds, agencies, and Treasury inflation-protected securities (TIPS) lagged, according to Barclays. Although investment-grade corporates generally delivered positive returns, they underperformed as spreads widened (an increase in the yield difference between corporate bonds and Treasuries of similar maturity) due to the global economic slowdown, investor risk-aversion, and an increase in corporate actions that favored shareholders over bondholders. Spread widening was more severe in the high-yield corporate bond sector, where returns turned sharply negative on risk-off trading. Meanwhile, municipal bonds (munis) generally advanced, benefiting from the flight to quality, improving credit trends and favorable supply/demand forces.
The quarter’s surge in market volatility, combined with slower global economic growth and low inflation, also drove yields on sovereign non-U.S. bonds lower. European bond markets were the best performers, led by the U.K. and peripheral markets such as Spain and Italy. Bond market returns in the Asia/Pacific region were muted but still positive, while emerging markets bond returns were mixed. Similar to trends in the U.S., the flight to quality helped government bonds outperform non-government securities.
The U.S. dollar was mixed but mostly stronger against major foreign currencies, reducing non-U.S. bond market returns for unhedged U.S. investors. The U.S. dollar was down fractionally against the euro and declined by 2% versus the Japanese yen, but it rallied 4% against the British pound, 7% versus the Canadian dollar, and 9% compared with the Australian dollar.
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For detailed descriptions of indices or investing terms referenced above, refer to our glossary.
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Source: Barclays Indices