Quarterly Market Review
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Fourth Quarter 2015
Eventful Quarter Capped Volatile Year
Following a disappointing third quarter for stock investors, the fourth quarter began on an optimistic note. Investors briefly abandoned their concerns about weakening global growth, as economic data in China appeared to stabilize and leading central banks maintained their accommodative programs. But familiar fears slowly resurfaced, including slowing growth in China, mounting geopolitical risks, and plunging commodities prices. These factors put the brakes on a robust early-quarter rally among global stocks. At the same time, U.S. Treasury yields edged higher on expectations for the Federal Reserve (the Fed) to begin "normalizing" short-term interest rates with its first rate hike in more than nine years.
In this environment, broad U.S. and non-U.S. stock benchmarks rebounded from their third-quarter losses, largely due to strong performance in October. In the U.S., the S&P 500® Index fourth-quarter rebound capped off a volatile year in which the broad benchmark generated a total return of only 1.38% for the 12 months ended December 31, 2015—the index’s worst annual return since 2008. Non-U.S. benchmarks were generally negative for the one-year period (in U.S. dollars)
Global bond yields were mixed during the quarter, generally tracking the ongoing global economic and interest rate policy divergence. For example, bond yields rose in the U.S. and U.K., which remained the strongest economies among developed countries. In addition, the Fed separated itself from other central banks by raising short-term interest rates in December. Meanwhile, yields were flat to slightly lower in Europe and Japan, reflecting the weak economic environment and increasingly accommodative central bank policies.
U.S. Stocks: October Optimism Fueled Fourth-Quarter Gain
After breaking a 10-quarter winning streak in the third quarter, the S&P 500 Index returned to positive territory during the fourth quarter. The upbeat performance was largely due to renewed investor optimism in October, which sent stocks soaring to an 8.44% gain for the month. Optimism gradually faded, though, and the S&P 500 finished the fourth quarter with a total return of 7.04%, enough to push the broad U.S. stock benchmark’s total return back into positive territory for the year.
U.S. stocks started the fourth quarter strong, buoyed by a central bank-led "risk-on" rally. Following the sharp stock market sell-off in the third quarter, central banks in Europe, Japan, and China reiterated their commitments to economic stimulus programs, and the Fed delayed its widely anticipated September rate hike. These factors, along with the release of data suggesting China's economy was stabilizing, helped jump-start investor optimism and trigger a strong rally in October. Although the Fed kept its interest rate policy unchanged, it hinted it could start normalizing rates in December, sparking improved investor confidence in U.S. economic growth.
Stock performance slowed considerably in November and turned negative in December, as global growth worries resurfaced, oil prices hit new lows, and the policies of leading central banks continued to diverge. A fresh round of weak economic data in China, combined with back-to-back double-digit monthly declines in oil prices, dampened stock market returns and the outlook for global growth. Central banks in Europe, Japan, and China responded to the weakening economic backdrop with additional stimulus measures. Meanwhile, the Fed finally raised its short-term interest rate target by 25 basis point (1 basis point equals 0.25%). Although the Fed’s action was a much-anticipated and largely symbolic move toward interest rate normalization, it highlighted the broad discrepancies between central bank policy in the U.S., where the Fed is now tightening, and elsewhere, where central banks continue to ease aggressively.
Despite the quarter's volatility and the turmoil in the commodities markets, sector performance was positive during the quarter. All of the S&P 500 Index’s 10 industry sectors advanced, and six sectors outpaced the index average. Outperforming sectors included materials (+9.70%), health care (+9.22%), information technology (+9.16%), industrials (+8.00%), consumer staples (+7.64%), and telecommunications services (+7.61%). Oil price weakness led to subdued performance in the energy sector, the quarter’s weakest with a return of 0.20%, while rising interest rates held back returns in the utilities sector, which gained 1.07%.
Large-cap stocks generally outperformed mid- and small-cap stocks, while growth stocks maintained an edge over value stocks across the board. Large-cap growth stocks were the quarter’s top performers, while small-cap value stocks were the weakest.
Non-U.S. Stocks: Central Bank Stimulus Sparked Rebound
Similar to their U.S. counterparts, non-U.S. stocks generally rebounded during the fourth quarter. Most of the quarter’s gains came during an October rally, as fears about China’s economic slowdown, which had prompted the third-quarter sell-off, subsided and leading central banks reaffirmed their commitments to aggressive stimulus plans. As the quarter progressed, however, concerns about China’s economy and weak global growth resurfaced. This, along with worries about terrorism, weakening commodities markets (particularly oil), and a likely interest rate hike from the Fed (which ultimately occurred on December 16, as expected), weighed on global stock returns. 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, ongoing quantitative easing (QE) from the European Central Bank (ECB) sparked modest economic gains, including improvements in the manufacturing and services sectors, consumer spending, and the labor market. These gains, combined with the prospect for additional stimulus from the ECB, supported stock market returns early in the quarter. In December, the ECB announced additional stimulus measures in response to a weakening economic backdrop. But these measures were not as robust as investors had hoped they would be, particularly in light of renewed concerns about slowing growth in China and still-falling oil prices. As a result, European stocks declined (in local currency terms) in the final month of the quarter.
Despite mixed economic data released in Japan, the nation’s stock market was among the world’s top performers for the quarter. In December, an upward revision to third-quarter GDP (gross domestic product), which is a measure of the total economic output in goods and services for an economy) meant Japan did not slip into an official recession, as originally feared upon release of the initial third-quarter GDP report. Additionally, the Bank of Japan maintained its asset-purchase program and implemented additional stimulus measures designed to fuel economic growth.
Emerging markets, which were up fractionally, significantly trailed all other markets for the second consecutive quarter. Contagion fears, ongoing currency pressures, and concerns about the effects of China’s economic slowdown on already-weak commodities prices weighed on stocks in developing markets.
Global Bonds: Yields Rose in U.S., Were Flat to Lower Elsewhere
Despite a backdrop of mixed U.S. economic data and muted inflation, U.S. Treasury yields headed upward during the fourth quarter. After the Fed tabled its much-anticipated September rate hike on concerns about the health of the global economy, investors assumed the central bank would begin to normalize short-term interest rates at its December monetary policy meeting. This expectation drove Treasury yields higher, particularly among shorter-maturity securities, which are the most sensitive to Fed policy. On December 16, the Fed finally ended its unprecedented near-zero interest rate policy, which had been in place since 2008, and implemented its first rate hike in more than nine years. The Fed's 25-basis point increase in the federal funds rate target pushed the range for the overnight lending rate from 0.00%-0.25% to 0.25%-0.50%.
Against this backdrop, the U.S. Treasury yield curve flattened, with shorter-maturity yields rising at a greater pace than longer-maturity yields. For example, the yield on the two-year Treasury note increased 42 basis points, while the yields on the 10-year Treasury note and 30-year Treasury bond increased 23 basis points and 17 basis points, respectively, according to Bloomberg.
Most sectors within the taxable U.S. investment-grade bond market declined during the quarter. Mortgage-backed securities (MBS) outperformed the broad U.S. investment-grade bond market, and corporate bonds performed in line with the market. Treasury bonds, Treasury inflation-protected securities (TIPS), government agency securities, and commercial mortgage-backed securities (CMBS) lagged, according to Barclays. Continued turmoil in the commodities markets weighed on high-yield corporate bonds, particularly in the energy and metals and mining industries, and overall returns for the corporate high-yield sector plunged on liquidity concerns. Meanwhile, municipal bonds (munis) were standout performers, as the tax advantages and perceived "safe-haven" status of the asset class appealed to investors. Favorable supply/ demand dynamics also supported muni market gains.
Outside the U.S., European bond markets were among the best performers, led by Spain and Italy, while the U.K. market underperformed. Bond market returns in the Asia/Pacific region were mixed but positive overall, led by Japan. Decelerating economic activity in many regions weighed on non-government securities, which underperformed government bonds during the quarter.
The U.S. dollar continued to strengthen against most major foreign currencies, leading to negative returns for unhedged non-U.S. bonds for U.S. investors. The U.S. dollar was largely unchanged against the Japanese yen and declined -3.7% against the Australian dollar, but it rallied 2.6% against the British pound, 2.8% against the euro, and 3.5% against the Canadian dollar.
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Source: Barclays Indices