Second Quarter 2009 Market Review

Financial markets provided welcome positive returns following six consecutive negative quarters. The S&P 500 Index rose 15.9% and the Barclays’ Capital U.S. Aggregate Bond Index returned 1.8% for the quarter. Investors felt confident enough about the financial system and the global economy to move money back into riskier bonds and stocks. Lower quality securities led the rally amid investors’ increased appetite for riskier assets. International stocks and bonds also had a very good quarter reflecting the global nature of increasing investor confidence as well as currency gains for U.S. investors.

Equities Review

The rebound in equities that began on March 10th continued for the majority of the second quarter as investors found silver linings in a variety of economic reports. However, the rally met some resistance late in the period amid renewed concerns about the potential economic recovery. Investors did not exhibit a meaningful preference for either growth or value stocks during the quarter, as both investment styles experienced sizeable gains across all market capitalizations. However, consistent with investors’ increased interest in riskier assets, small-cap stocks outperformed large-cap stocks; the Russell 2000 and Russell 1000 Indexes returned 20.7% and 16.5%, respectively. Investors’ preference for riskier assets was also evident in the substantial performance advantage that lower-quality stocks had over higher-quality stocks during the quarter. Within the Russell 3000 Index, stocks with a Standard & Poor’s quality ranking of C gained 26.4% for the period while stocks with a quality ranking of A returned only 8.8%. The risk taking/quality theme was also exhibited at the sector level. Within the Russell 3000 Index, higher beta sectors such as financials, industrials, and technology gained 29.0%, 20.8%, and 20.4%, respectively. In contrast, the more defensive sectors such as consumer staples, healthcare, and utilities gained 10.3%, 10.4%, and 11.4%, respectively.

International stocks returns also varied notably along the risk spectrum. Emerging markets stocks, helped in part by strength within the commodities sectors, led the way, with the MSCI Emerging Markets Index surging 34.7% for the quarter. Developed country stocks, as represented by the MSCI EAFE Index, rose a lower 25.4%. Small-caps outperformed large-caps, as the MSCI EAFE Small-Cap Index gained 34.3% while the MSCI EAFE Large-Cap Index returned 25.0%. The dollar weakened, declining 5.5% versus 19 currencies tracked by the J.P. Morgan Dollar Index. This further demonstration of the reversal of previous quarters’ flight to quality boosted foreign returns for the unhedged U.S. investor. 

Fixed Income Review

Quality (or the lack thereof) was also the primary driver of performance within the fixed income markets. Again, investors poured back into riskier bonds, and spreads between the highest- and lowest quality bonds narrowed considerably during the period. The Barclays Capital Aggregate U.S. Treasury Index and the Barclays Capital U.S. Corporate High Yield Index returned -3.0% and 23.1%, respectively. In addition, the yield curve steepened substantially during the quarter as intermediate- and long-term interest rates increased while shorter-term rates declined modestly. High quality foreign bonds outperformed their domestic counterparts, aided by currency profits on U.S. Dollar weakening. The Barclays Capital Global Aggregate ex U.S. Bond Index gained 7.1% for the quarter.