Quarterly Market Review
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Second Quarter 2015
Stocks Shifted to Neutral, Bonds to Reverse
Uncertainty and volatility gripped the global financial markets, putting the brakes on stock market performance and driving down bond market returns. Most notable, Greece’s long-standing debt crisis finally reached a tipping point. Late in the quarter, bailout negotiations between Greece and the European Union broke down, culminating in a shutdown of Greece’s banking system and the June 30 default of the nation’s $1.7 billion payment to the International Monetary Fund (IMF). Greece’s financial crisis triggered losses throughout the global financial markets, highlighting the fragile nature of the global economy.
The U.S. continued to demonstrate better relative economic growth than many other countries, where aggressive central bank quantitative easing (QE) remained in play. Modest U.S. economic gains led to continued speculation as to when the Federal Reserve (the Fed) would begin removing the remaining component of its stimulus program—near-zero short-term interest rates. Expectations for the Fed to hike rates later in the year pushed Treasury yields higher. Meanwhile, early signs the European Central Bank's (ECB) QE program was working prompted a significant sell-off among European bonds, which also triggered losses in the U.S. and other bond markets. Additionally, optimism surrounding the ECB’s QE caused the euro to rally versus the U.S. dollar.
In this environment, broad U.S. and non-U.S. stock benchmarks held onto fractional gains for the quarter. Global bond markets struggled, and most major bond market benchmarks posted negative second-quarter total returns.
U.S. Stocks: June Downturn Stalled Quarterly Performance
Healthy stock market gains in April and May gave way to plunging performance in June, leaving the S&P 500® Index barely in the black for the second quarter. With a total return of 0.28% for the April-June period, the U.S. large-cap stock benchmark eked out its 10th-consecutive quarterly gain.
Investor optimism generally prevailed during April and May, largely due to better-than-expected first-quarter corporate earnings results and tempered expectations for Fed interest rate hikes. U.S. economic data were mixed, with housing and labor market improvements offset by some relatively soft gross domestic product (GDP), inflation, and manufacturing readings. This uninspiring mix of data led to increased speculation that the Fed would hold off raising interest rates until later in the year, which helped support stock gains in April and May.
Investor sentiment shifted sharply in June, as European and domestic factors unnerved U.S. stock investors. Greece’s worsening financial crisis captured headlines, and a late-month shutdown of the nation’s banking system and ultimate default on its IMF payment sent stocks tumbling. Meanwhile, signs the U.S. economy was gathering steam prompted a fresh round of rate-hike speculation, with September emerging as the consensus frontrunner for the Fed’s first short-term rate hike since June 2006. Specifically, housing, consumer spending, and consumer confidence data closed out the second quarter on an upbeat note.
Sector performance was mixed during the quarter. Five of the S&P 500 Index’s 10 industry sectors generated positive performance, and four of those sectors outpaced the index average. Once again, the health care sector was the top performer, gaining 2.84% on robust mergers-and-acquisitions activity and favorable drug launches. The consumer discretionary sector also remained strong, up 1.92% on improving spending trends. Meanwhile, the utilities sector remained the weakest, tumbling -5.80% on fears of rising interest rates. Although the U.S. dollar retreated during the second quarter, its relative strength over longer time periods continued to weigh on the industrials sector, which fell -2.23%.
Style performance also was mixed. Small-cap stocks, which are typically less influenced by global factors, generally outperformed mid- and large-cap stocks. Growth stocks maintained an edge over value stocks across the capitalization spectrum. Small-cap growth stocks (Russell 2000® Growth Index) were the quarter’s top performers, up 1.98%, while mid-cap value stocks (Russell Midcap® Index) were the weakest, falling -1.97%.
Non-U.S. Stocks: Greece’s Debt Woes Rattled Markets
Similar to U.S. stocks, non-U.S. stocks generally plunged in June, leaving the broad developed and emerging market benchmarks with fractional gains (in U.S. dollar terms) for the second quarter. In a reversal from recent quarters, the U.S. dollar declined in value versus the euro and pound, which helped boost non-U.S. developed market stock returns for U.S.-based investors. Local currency returns throughout Europe were generally negative.
The ECB’s QE program, which the central bank launched during the first quarter, showed some early signs of success, as economic growth data and forecasts out of the eurozone generally improved. The region’s manufacturing purchasing managers’ index reached a four-year high in June, while relatively low energy prices and interest rates continued to provide a boost to consumer spending and sentiment. Meanwhile, stabilization in the oil markets provided some relief from long-standing fears of deflation. Job creation remained a key challenge for the 19-member eurozone, which had an unemployment rate of 11.1% in May, down slightly from 11.3% in February. Economic growth in the U.K. remained brighter, as unemployment remained at a seven-year low and wages grew at their fastest pace in four years.
Despite the positive signs on the economic front, Europe couldn’t escape the negative influences from Greece. Optimism regarding a potential bailout deal with the ECB faded as June progressed, and on the last day of the quarter the debt-plagued nation defaulted on its nearly $2 billion payment to the IMF, sending shockwaves throughout the stock markets in Europe and the rest of the world.
Japan’s stock market remained a global bright spot, avoiding much of the Greece-induced downturn. Stronger-than-expected first-quarter GDP growth and a boost in wages, combined with the Bank of Japan’s ongoing stimulus efforts and a weaker yen, helped push stock returns higher.
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: U.S. Rate-Hike Speculation, European Sell-off Drove Yields Higher
U.S. economic data released during the second quarter were mixed, suggesting the economy was improving from its first-quarter slump. Better economic data and its potential inflationary implications, combined with investor speculation surrounding Fed rate hikes, drove longer-maturity Treasury yields to their first quarterly increase since the fourth quarter of 2013. Meanwhile, a sharp sell-off among European bonds, the debt crisis in Greece, and questions about Greece’s future in the eurozone after landing in arrears with the IMF weighed on U.S. (and global) fixed-income returns.
Against this backdrop, the U.S. Treasury yield curve steepened as longer-maturity yields increased at a greater pace than short-maturity yields, which remained influenced by the Fed’s short-term interest rate policy and robust demand. Overall, the second-quarter environment favored shorter duration securities and strategies and lower-quality/high-yield bonds.
All sectors of the U.S. investment-grade bond market declined, with corporate bonds posting the weakest results (-3.16%, according to Barclays) and lagging the Barclays U.S. Aggregate Bond Index return (-1.68%). Accelerated issuance of corporate bonds, an increase in shareholder-friendly corporate actions (mergers and acquisitions, share buybacks), and modest spread widening (an increase in the yield differential between corporate bonds and U.S. Treasuries of similar maturity) weighed on the sector. Other investment-grade bond sectors generally outpaced the market average. High-yield corporate bonds outperformed all investment-grade sectors, benefiting from yield demand and the inherently shorter duration of high-yield bonds.
Municipal bonds (munis) also declined but generally outperformed Treasuries, a typical outcome when rising rates are tied to improving economic conditions, which tend to boost muni credit strength. Munis outperformed despite Moody’s credit rating downgrade of city of Chicago bonds and Puerto Rico’s escalating public debt crisis—events that seemed more reflective of special circumstances than of broad muni market issues.
Yields on sovereign non-U.S. bonds also increased, led by Europe. In the first quarter, eurozone yields plunged to record lows after the ECB launched QE. A sense that yields fell too far too fast, along with signs the QE program was sparking economic gains and inflation, prompted the second-quarter sell-off, while the mounting debt crisis in Greece further encouraged investors to exit bonds. Regionally, Japan bond markets delivered the best returns (in local currency terms), while European bond markets were among the weakest. Non-government securities generally outperformed government bonds.
For unhedged U.S. investors, a weaker U.S. dollar lifted returns for non-U.S. bond markets. The U.S. dollar declined by nearly 4% against the euro and by more than 6% against the British pound, and it was up nearly 2% versus the Japanese yen.
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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