CAPTRUST Chief Investment Officer
Bond market movements defined the second quarter investment landscape and concurrently set the backdrop for 2013’s finish.
In the second quarter, U.S. interest rates did something they don’t do very often; they went higher. Bond prices, which move inversely with rates, have enjoyed an over 30-year bull market as U.S. 10-year Treasury yields compressed from a monthly high of 15.3 percent in September of 1981 to a paltry 1.5 percent in June 2012. However, following two consecutive months of bond market selling, investors are forced to contemplate rates’ future path. Federal Reserve commentary regarding its latest iteration of quantitative easing — or Treasury and mortgage bond open-market purchases — drove most of the selling as investors anticipated the program’s denouement as economic data improves.
The Barclays Capital U.S. Aggregate Bond Index, a broad fixed income market proxy, was down over 2 percent through the end of June and is in danger of turning in its first negative year in the past thirteen. The quarter also witnessed the largest weekly migration out of bond mutual funds since 2008, adding to selling pressure. Bond market volatility rippled into other asset classes, especially historically interest-rate-sensitive and income-producing assets. Public real estate, master limited partnerships, dividend-focused equities, and preferred stocks all fell intra-quarter in sympathy with bonds.
Outside of the U.S., emerging markets continued to experience investor outflows, with several countries experiencing a one-two punch of falling currencies and weaker asset prices across both stock and bond markets during last quarter. Brazilian stocks fell over 17 percent translated back to dollars; energy-dependent Russian stocks fell over 8 percent, and China fell 6 percent on banking sector and manufacturing concerns.
The calm enveloping Europe carried on in the second quarter, with asset prices relatively tame in the second quarter, partially aided by a stronger euro versus the dollar. The European Central Bank reduced its benchmark interest rate in May for the first time in 10 months and signaled it was open to more actions should conditions warrant. While unemployment rates remain persistently higher than desired, signs of manufacturing stability could bode well for future economic activity. Central bank activity also remains center stage in Japan, where monetary authorities continue to fight nagging deflation with aggressive intervention that has weakened the yen and driven equities considerably higher.
Several catalysts will drive capital markets in coming weeks. All eyes remain on global central bank activity, primarily on the United States with important meetings at the end of July and September. Ahead of those meetings, investors will parse Chairman Bernanke’s mid-July routine congressional testimony. The U.K. introduces a new central bank head in July, and Germany hosts key elections in late September that will help shape the European balance of power. Policymakers are anxious to move away from seemingly perpetual central bank aid, but economic growth has not been robust enough to justify a clean exit. Investors will likely once again take their clues from bond market developments in what will be an exciting conclusion to 2013.
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