Fourth Quarter 2004 Market Review

Despite some deterrents, the U.S. economy continued to grow during the fourth quarter.  Similarly, U.S. equity markets, after having stalled in anticipation of the U.S. presidential election, rallied strongly following the Bush victory and an orderly election.  Overseas, local currency returns were excellent and were enhanced by the dollar’s fall for U.S. investors. Meanwhile, interest rates were flat to slightly higher in the U.S. and lower in most other developed markets, producing positive results for bonds for the quarter. The table on the other side of this page summarizes data for the quarter (reviewed below) and full year.

Equities Review

Despite the generally positive economic backdrop, the equity markets had been locked into somewhat of a trading range throughout most of 2004, but broke out immediately following the presidential election.  The S&P 500 index’s 9.2% surge in the 4th quarter accounted for the lion’s share of the index’s 10.9% full year return.  Stylistically, large-cap value outperformed large-cap growth by about 1.2 percentage points.  Smaller-company stocks were among the best performing assets of the quarter: the Russell 2000 jumped 14.1% and the S&P Small Cap Index rose 13.0%.  Despite these valuation and capitalization biases, returns were consistently strong across a variety of investment categories.  This breadth of performance also coincided with an improvement in corporate profitability.  About two-thirds of the companies in the Russell 3000 Index that reported earnings during the fourth quarter beat consensus expectations. From a sector standpoint, the fourth quarter saw a reversal of market leadership. Technology funds – the worst performing sector during the first nine months of the year – gained 16.0%, which made them the market leader in the last three months. In contrast, natural resources funds, which generated impressive gains the first three quarters, gained just 4.8% in the fourth as oil prices subsided.

Fixed Income Review

In the U.S., interest rates increased about 50 basis points (bps) for shorter maturity instruments (thanks to two short-term rate hikes by the Federal Reserve) but did not change materially for longer-maturity bonds during the fourth quarter due to the lack of significant inflationary pressure and the measured policy responses of the Fed.  The Lehman Aggregate Index returned just under 1% for the quarter.  High yield bonds continued to surge: the Lehman High Yield Index gained another 4.5%.  The good performance of credits, particularly high yield corporate bonds, continued to be a result of slower default rates in the wake of economic and balance sheet improvements.  

Non-U.S. bonds performed extremely well during the quarter.  While interest rates declined between 25 and 50 basis points in most developed markets (except for Japan where rates did not change), most of the quarter’s performance could be attributed to the decline of the USD.   
 

Fourth Quarter and Latest Twelve Months

Table of Stock and Bond Returns

Period Return to 12/31/04*  
Fourth 
Quarter

Twelve Months
Year to Date

  
U.S. Stocks
S&P Index** 9.2% 10.9%  
Average Diversified U.S. Equity Mutual Fund 11.0% 12.3%  
Russell 2000 # 14.1% 18.3%  
Sector Mutual Funds
Technology 16.0% 3.8%  
Health 7.7% 9.4%  
Communications 17.7% 22.4%  
Financial 9.9% 13.7%  
Real Estate 15.8% 31.9%  
Natural Resources 4.8% 28.4%  
Foreign Stocks
MSCI Europe, Australia & Far East (EAFE) ## 15.3% 20.3%  
Average Diversified Foreign Equity Mutual Fund 14.2% 18.7%  
Regional/Specialty Mutual Funds
Europe 15.1% 20.9%  
Diversified Pacific/Asia 13.1% 17.1%  
Diversified Emerging Markets 16.8% 23.8%  
U.S. Bonds
Lehman Brothers Intermediate Gov't Bond Index*** .2% 2.3%  
Lehman Brothers Intermediate Credit Index ð .8% 4.1%  
Intermediate Municipal Bond Mutual Funds (National) .7% 2.8%  
High Yield Bond Mutual Funds 4.4% 9.9%  
Foreign Bonds
Citigroup Non-U.S. World Gov't Bond Index ### 10.6% 12.1%  
* 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 $46 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.
ð 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 $861 million.
## 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.
### Citigroup 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 U.S. dollars.

 

 

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