First Quarter 2000 Market Review

In many respects this quarter was simply a carryover from the fourth quarter of last year, and many previous quarters, as well.   The story seems well told by now: stocks outperform bonds, growth outperforms value, and technology trounces all sectors.  While these trends began reversing dramatically in Mid-March, the quarter’s results remained high due to astounding returns for the first two and one-half months.  The attached table summarizes data for the quarter.

Equities Review

Technology continued to outperform other sectors with a return of 18.4% for the quarter.  The S&P 500 Index of large company stocks was able to generate only a meager gain of 2.3%. Meanwhile small company stocks continued their recent outperformance with the Russell 2000 index of small company U.S. stocks posting a 7.1% quarterly return.  Results for the average diversified U. S. stock fund, at 6.8%, were better than the S&P 500 Index which reflected funds’ generally higher exposure than the index to the technology sector and smaller company stocks. 

Value investors continued to be upstaged by their growth counterparts.  The average large value fund simply broke even for the quarter, while the average large growth fund returned 8.3%.  The return disparity was even more pronounced among smaller capitalized stocks with the small value sector returning 4.8% and the small growth sector returning a very strong 15.8%.

Against 19 currencies, the U.S. dollar strengthened 2.2%.  The dollar appreciation hindered unhedged U.S. dollar investors by decreasing overseas local currency returns.  Nevertheless, European stocks posted a respectable 7.9% return and bested other foreign markets.  Emerging markets returned 3.7%, while Pacific region stocks fell 1.4%. The drop in Asian stock markets reversed a four-quarter trend of outperformance relative to the European markets and dragged down the average for diversified international funds, which gained only 2.7%.

Fixed Income Review

U.S. bond markets generated relatively better returns than in previous quarters.  Further rate hikes by the Fed continued the trend of higher short-term rates, but longer-term rates appeared to have, at least temporally, halted their upward march over the past eighteen months.  As a result, short-term rates now yield more than long-term rates resulting in the seldom seen “inverted yield curve”.  It seems at this juncture that both the Fed and Caves & Associates are more concerned about inflation than the bond market. 

The discrepancy in interest rate movement was reflected in returns: the long-term government sector returned 5.3%, while the short-term government sector returned only 1.2%.  Meanwhile, a rise in corporate bond defaults lead to increased yield premiums for non-investment grade bonds and therefore to underperformance in the high yield market.  The average high yield fund lost 1.5% for the quarter.

Hurt by the appreciating dollar, international government bonds returned only 1.3% for the quarter, as measured by the Salomon Brothers index.  Nevertheless, many developing countries saw credit improvement in the face of higher commodity prices.  This improvement resulted in a 7.3% return for the average emerging markets bond fund.

* Mutual fund return data are from Morningstar.

**      Capitalization-weighted index of 500 very large U.S. companies.  The 500 are chosen to achieve a fair cross-section of U.S. industrial and service sectors.  Recent median capitalization of approximately $90 billion.

***      Lehman Brothers index of U.S. Treasury bond total returns (i.e., interest plus or minus change in price).  Bonds in index have intermediate maturity of about 4-7 years.  No mortgage-backed securities included.

d                 Lehman Brothers index of U.S. investment grade corporate bond total returns (i.e., interest plus or minus change in price). Bonds in index have intermediate maturity of about 4-7 years.

#      Index of small U.S. companies.  Recent median capitalization of approximately $800 million.  Somewhat overweighted toward financial stocks.

##      International stock index indicating return of large foreign companies of 20 major developed countries (Japan, UK, and Germany have the highest weightings).  Returns are converted to U.S. dollars.  No emerging market stocks are included.

###      Salomon Brothers index of total return of foreign government bonds issued by major developed foreign countries (Japan, Germany, France, and UK have the highest weightings).  Returns are converted to US dollars.

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