Second Quarter 2007 Market Review

After mostly modest results in the first quarter, global equities markets moved substantially higher. U.S. and foreign developed stocks were up despite a modest correction in June. Emerging markets continued to move sharply higher, particularly Asian and Latin American markets, which registered double digit returns. Results for most bonds were disappointing if not unexpected; they ranged from slightly positive to slightly negative reflecting a variety of economic factors. 

Stocks

U.S. stocks rose steadily throughout April and May but stagnated in June. As in the recent past, the gains were primarily a result of healthy earnings gains, plentiful liquidity, and continued leveraged buyout activity. Large-capitalization indices outperformed mid- and small-cap indices in general. The Russell 1000 Index returned 5.9% during the quarter and the Russell 2000 Index returned 4.4%. Also, growth-biased indices outperformed their value-biased counterparts. This divergence was partly observed in the relative performance of various sectors. Industrials, materials, technology, and communications sectors provided strong gains while health care, financials, and particularly real estate lagged. Energy prices continued to escalate, with oil moving above $70 per barrel, which benefited the energy stocks. 

The MSCI EAFE Index of foreign developed markets returned 6.4% in U.S. dollars for the period, and the MSCI Emerging Markets Index returned 15.0%. In the developed markets, European countries paced the returns while the far eastern region was held back by Japan. However, within the emerging markets, the Far East, Asia, and Latin America regions dominated, while European developing countries lagged. China’s economy continued its astonishing growth, and its stocks rose more than 24% during the quarter. The U.S. dollar moved slightly lower relative to most currencies including the euro and British pound. In contrast, the yen continued to weaken versus the U.S. dollar and was down 4.6% for the quarter. Overall, the U.S. dollar lost about 1.7% during the quarter versus 19 currencies tracked by the J.P. Morgan Dollar Index, which aided foreign returns when converted to dollars. 

Fixed Income

The Fed held short-term interest rates constant, and investors reached an apparent consensus that the next Fed move is likely an increase. Reported U.S. inflation remained subdued, but the U.S. Treasury yield curve regained a positive slope for the first time in more than a year as long-term interest rates increased amid concerns about the U.S. real estate market and increasing defaults on sub-prime mortgages. Additionally, there is some evidence foreign central banks are reducing their U.S. Treasury purchases. The yield for ten-year Treasury bonds rose from 4.65% to a peak of 5.26% in mid-June. Because corporate yield spreads widened somewhat during the period, investment grade bonds suffered negative returns on average and under performed like-duration Treasuries. The Lehman Aggregate Index declined 0.5% for the quarter. Conversely, due to their yield advantage and continued low defaults, high-yield bonds provided a slightly positive return. 

Foreign bond yields also rose throughout the period. Rising yields and the falling yen combined to send most global bond funds into negative territory. The Lehman Global Aggregate Index lost 0.9% for the quarter.