Equity market review
During the first quarter, stocks remained under pressure due to continued evidence of a globally synchronized recession. The macroeconomic environment has been challenged by factors including severe employment weakness, massive decline in corporate inventories, growing signs of stress in the commercial real estate market and still-declining housing prices.
After a brief rally at the start of the new year, equity markets resumed their bear market slide, albeit with a few interruptions, for the next two months. By the end of February, the S&P 500® Index had pierced its lows formed on Nov. 21, 2008 and ultimately came to rest at a level first achieved in the summer of 1996. After reaching an intraday low of 667 on Mar. 6, a powerful rally of nearly 25% ensued. The rally saw the Index touch 833 on Mar. 26 before pulling back a bit to end the first quarter. The rally came in part from some clarity on the U.S. government’s strategy for addressing “toxic” loans at troubled banks as well as some preliminary evidence that the rate of decline in economic activity was easing somewhat.
The broad U.S equity market, as measured by the Russell 3000® Index, fell -10.80% for the first quarter while the large-cap oriented S&P 500® Index retraced -11.01%. March’s strong performance stemmed some of the sharp losses experienced earlier in 2009. As was the case in the last half of 2008, the losses in the first quarter came against a backdrop of tremendous volatility in daily index movements. In step with U.S. markets, international stocks fell during the quarter. The MSCI All Country World ex-U.S. Index (Net), representing both developed and emerging international markets, slumped -10.71% for the first quarter.
The performance divergence between growth and value stocks widened significantly during the quarter. Within the U.S. large capitalization arena, growth outperformed value by more than 12%. The large-cap oriented Russell 1000® Growth Index fell just -4.12% for the quarter while the Russell 1000® Value Index tumbled -16.77%. Stocks in the technology and materials and processing sectors boosted the Growth Index’s return while stocks in the financial services sector once again burdened the Value Index.
The U.S. small-cap oriented Russell 2000® Index tumbled -14.95% for the quarter, weighed down by slumping prices for stocks within the financial services sector. For the quarter, value stocks retraced deeper than growth stocks in the small-cap space.
Developed international stocks, as represented by the MSCI EAFE Index, fell -13.94% during the quarter. From a regional perspective, the commodity-oriented countries saw better returns; for example, Australian stocks were down just -1.58%. However, most major European countries fell harder than the overall index. Japan also fared poorly (-16.62%) in part due to the receding value of the yen versus the U.S. dollar. Emerging market stocks, as measured by the MSCI Emerging Markets Index, experienced a sharp rally in March and actually finished with a positive return for the quarter of 0.95%. Brazilian stocks experienced the most significant rally, with a notable 12.45% return for the first quarter. China finished the quarter with a positive return as well, up 1.33%.
Investments in the stocks of public real estate companies, including REITs, again experienced extreme volatility during the first quarter. The Dow Jones U.S. Select Real Estate Securities Index saw wide swings from day to day but ultimately saw much more downside pressure than upside. The Index fell -33.85% for the quarter and is down over 60% from a year ago.
Fixed-income market review
The first quarter was characterized by opposing forces — a very weak economic environment and unconventional, aggressive government intervention. Unfavorable economic data was underscored by the release of fourth quarter Gross Domestic Product (“GDP”) of -6.30% coupled with rising unemployment and declining consumer confidence. Indications were that the U.S. economy has yet to recover from the negative feedback loop which began with the decline in the housing market, leading to a distressed financial system and dampening economic activity. The U.S. government, in their continued efforts to counterbalance economic weakness and disrupt the negative feedback loop, unveiled further stimulus and bailout programs. The Federal Reserve (“Fed”) maintained its 0%–0.25% interest rate policy and announced plans to purchase up to $300 billion in U.S. Treasuries in an effort to keep borrowing costs low and inject further stimulus. Other new policies included the Fed’s announcement to purchase additional agency mortgage-backed securities, and government programs aimed at increasing investment into securitized debt obligations.
Despite the Fed’s plans to purchase U.S. Treasuries thereby increasing demand (and providing artificial downward pressure on yields), yields on U.S. Treasuries rose during the quarter, most notably on the long-end of the curve as investors became increasingly concerned over the elevating level of new Treasury issuance to fund new stimulus/bailout initiatives. Given the rise in yields, the U.S. Treasury sector was one of the worst performing segments of the bond market, posting a quarterly return of -1.32%. The sector’s performance was dragged down by the performance of long-maturity Treasuries. The 10-year and 30-year Treasuries generated quarterly returns of -2.68% and -13.45%, respectively. These negative returns come on the heels of a very strong return environment for U.S. Treasuries during 2008. The quarter ended with the 10-year note yield at 2.66% and the 30-year bond yield at 3.53%.
The broad U.S. bond market, as measured by the Barclays Capital Aggregate Bond Index, posted a very modest quarterly return of 0.12% despite wide dispersion among different sectors and maturities of the market. While the U.S. Treasury sector posted negative returns, many non-Treasury sectors rallied in response to government programs and investors’ renewed interest in attractive valuations.
Agency mortgage-backed securities (“MBS”) added positive value during the quarter with a return of 2.20%. Unprecedented government support through the MBS purchase program helped drive the performance of this sector. Performance of non-agency mortgages and commercial mortgage-backed securities continued to struggle. As a sector, corporate bonds posted a return of -1.93%, primarily due to the demise of the financial industry. Long-term financial bonds performed a dismal -19.61% for the quarter. However, some areas of the corporate market were positive, including utilities and industrials. Asset-backed securities (“ABS”) were one of the top performing sectors with the primary outperformers being credit cards and autos. The ABS rally was largely in response to the government’s Term Asset-Backed Securities Loan Facility program, which sought to restore liquidity to the consumer loan markets.
Several extended bond sectors performed very well during the quarter. Fixed-income strategies that utilized these extended sectors were benefited. High-yield bonds (below investment grade corporate bonds) posted a quarterly return of 6.61%. Bonds rated BB category were the best performers. High-yield bonds outpaced their investment grade counterparts and the broad domestic equity market during the period. Emerging market debt was another top performing sector, posting a quarterly return of 3.37%. Treasury Inflation Protected Securities (“TIPS”) returned 5.52% for the quarter. These securities, which provide investors a hedge against inflation, benefited from changes in future inflation expectations shifting higher.