Second Quarter 2010 Market Review

Rising economic uncertainty caused a substantial pullback among global equities and other risk-based assets. Market volatility spiked in May as improving corporate profits and strong manufacturing data were not enough to offset investors’ fears about the sovereign debt crisis in peripheral countries of Europe and the viability of the Euro as a currency. Partly offsetting losses on stocks, U.S. and emerging market bonds provided solid returns for the quarter, but developed foreign bonds fell.

Equity Review

All domestic equity styles posted losses for the second quarter. Consistent with expected stock performance coming out of a recession, U.S. small-cap stocks outperformed U.S. large-cap stocks. The Russell 2000 (small cap) and Russell 1000 (large cap) indexes returned -9.9% and -11.4%, respectively. Economically sensitive sectors such as materials, financials, and energy were among the worst performers, falling -14.8%, -12.9% and -12.6%, respectively. Sectors less dependent on economic conditions such as utilities, telecommunication services, and consumer staples held up the best, falling -3.8%, -5.1%, and -8.5% respectively, for the quarter. The VIX Index, a barometer for assessing market volatility, increased from 17.59 at the start of the quarter to 48.2 on May 21st.

International stocks substantially underperformed their domestic counterparts. European stocks were especially weak, with the MSCI Europe Index falling -15.2% for the quarter. Emerging market stocks generally held up better than developed countries’ stocks as investors preferred the relative strength of emerging countries’ balance sheets and GDP growth prospects. For the quarter, the MSCI Emerging Markets Index declined -8.4% while the MSCI EAFE Index of developed markets fell -14.0%. Similar to the domestic equity results, small-cap international stocks outpaced large-cap stocks. The dollar strengthened 3.1% versus 19 currencies tracked by the J.P.Morgan Dollar Index during the period; rose 10.5% versus the 6 major currencies (Euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc) tracked by the U.S. Dollar Index; but declined -2.3% versus 25 emerging market currencies tracked by the MSCI EM Currency (USD) Index. For the quarter, currency losses by unhedged U.S. investors cut into foreign returns in the 6 major stock markets, but currency gains helped emerging markets record the lower losses reported above. 

Fixed Income Review

U.S. fixed income returns were generally positive but mixed during the quarter. U.S. Treasuries and U.S. Treasury Inflation Protected Securities outperformed high-yield bonds and mortgage-backed securities. In a reversal from recent quarters, high quality was a key driver of relative performance as illustrated by the 4.7% and -0.1% returns generated by the Barclays Capital (Barcap) Aggregate U.S. Treasury Index and the Barcap U.S. Corporate High Yield Index, respectively. The broad market, as represented by the Barcap U.S. Aggregate Bond Index, returned 3.5% for the quarter. During the period, the U.S. Treasury yield curve remained fairly steep but also declined somewhat all along the curve, especially long-term rates. Accordingly, longer-term bonds significantly outperformed shorter-term bonds on both a yield and total return basis. Foreign bonds generally underperformed their domestic counterparts; the Barcap Global Aggregate ex U.S. Index fell -2.4% for the quarter. However, results varied considerably between issuers due to the differing movements of the dollar relative to developed versus emerging markets. Thus, developed foreign bonds were in the red, but emerging market bonds had positive total returns.