Financial Markets Review and Outlook Fourth Quarter 2011
Managers Investment Group
February 6, 2012
Market and Economic Review
The fourth quarter continued to be dominated by macroeconomic news with the primary focus on the ongoing sovereign debt crisis in Europe. Capital markets maintained a high level of volatility during the last several months of the year, with movements generally driven by the confidence, or the lack thereof depending upon the day, in European policymakers’ ability to collectively find a tenable solution to the debt crisis.
October featured downgrades to the sovereign debt of both Italy and Spain while MF Global filed for bankruptcy protection. Nevertheless, equity markets shook off concerns related to these events and rose sharply for the month as investors became optimistic that a unified resolution among leaders in Europe would be enough to stem the burgeoning European debt crisis. Markets became choppier in November, falling sharply before rallying toward the end of the month, primarily on the strength of generally solid retail sales. Early December featured the biggest one-day U.S. equity market surge since March 2009. This was driven by the coordinated response from global central banks to flood markets with cheap access to U.S. Dollars. The end of the quarter featured choppy equity market performance amid ongoing conversations about the future of the Euro.
The fourth quarter also featured compelling news at the company level. Long awaited IPOs for both Groupon and Zynga were offered to the market from the information technology sector. However, most of these IPOs were only met with initial “pops”, if anything at all. Overall, new IPO offerings were very disappointing and at their lowest levels since the second quarter of 2009 when equity markets bottomed out. Meanwhile Netflix dominated the news early in the quarter with their aborted plan to split their business in two after a public outcry from their customer base.
Fixed income markets within the U.S. were higher across the board in the fourth quarter, led by a turnaround in high-yield bonds. These securities, as measured by the Barclays U.S. Corporate HY Index, returned 6.5% for the quarter. Inflation concerns continued to drive strong performance within the TIPS (Treasury Inflation Protected Securities) market as the Barclays Capital U.S. Treasury: U.S. TIPS benchmark returned 2.7% for the quarter, giving that benchmark a return of 13.6% for the year. Outside the U.S., however, ongoing sovereign debt concerns in Europe weighed on bond markets. Non-U.S. bond markets collectively delivered modestly negative returns, as measured by the Barclays Capital Global Aggregate x U.S. benchmark, which returned -0.4% for the final three months of the year.
A large majority of global equity markets rallied sharply for the quarter with most providing double-digit returns in the process. U.S. equity markets were positive across the board, after a difficult third quarter, with the Russell 3000® Index and the S&P 500 Index returning 12.1% and 11.8%, respectively. Within U.S. equity markets, smaller-cap equities rallied the furthest, returning 15.5% as measured by the Russell 2000® Index. U.S. largecap equities protected better in the third quarter than did small-cap equities, but failed to keep pace with the fourth-quarter rally, although they still returned 11.8% as measured by the Russell 1000® Index. At the sector level, more commodity-driven sectors, such as energy (18.7%), industrials (17.2%), and materials (16.4%), led the way after being the worst performers the prior quarter. Non-U.S. developed markets continued to struggle relative to the U.S. and only returned 3.3% for the quarter, as measured by the MSCI EAFE Index. The same can be said for emerging markets, which offered positive returns (4.4% as measured by the MSCI Emerging Markets Index), however not nearly enough to make up for losses in the third quarter or to match the returns generated by U.S. equity investments.
As we enter 2012, volatility looks like it will persist within global capital markets — at least until there is more longterm certainty about the future of European sovereign debt and the Euro. Until that time, we continue to believe that markets will react with an elevated level of volatility, with gains and losses tied primarily to investors’ day-to-day perception of the ability of policymakers to manage this situation effectively.
Despite the persistent negative headlines, primarily surrounding the European sovereign debt crisis and the stubbornly high unemployment here in the U.S., there are signs of improvement as we head into the New Year. At the company level within the U.S., profitability remains high and balance sheets remain strong, particularly relative to several years ago. However, excess costs have been extracted out of businesses across virtually all sectors, and in order to continue to improve profitability in 2012, business owners are going to have to improve upon top-line growth, as many cost cutting measures have seemingly been exhausted. Overall, we certainly believe it to be a positive sign that corporations generally maintained or expanded profitability throughout the past year despite the uncertainty in Europe and the unforeseen events in Japan and its subsequent disruption in supply chains throughout the world, which had a meaningful impact to a number of key sectors in the U.S. Ultimately, improved profitability needs to be driven by top-line growth expansion in businesses, and while many corporations have the cash to deploy to help accomplish this, most are waiting on the sidelines for a resolution to macroeconomic uncertainty. In addition to the uncertainty related to policymakers’ ongoing efforts in Europe, 2012 is an election year in the U.S., which also will likely lead investors to be hesitant in the months leading up to the election. So, although fundamentals continue to be improving and we are cautiously optimistic in our outlook, we recognize that 2012 may continue the trend we witnessed in the last two quarters of 2011 with investors focused on headlines as opposed to the underlying strength of companies and their earnings.
Overall, we continue to believe that investment opportunities exist, particularly for the long-term investor with the discipline to recognize that shorter-term volatility can often be an opportunity to take advantage of mispriced assets. This opportunity continues to look particularly compelling for those investors who can withstand this shorter-term volatility as safe-haven assets such as U.S. Treasuries continue to offer historically low yields and negative real returns when factoring in inflation.
Please note that all performance data and comments are for the period from September 30, 2011 through December 31, 2011. Any sectors, industries, or securities discussed should not be perceived as investment recommendations. The views expressed represent the opinions of Managers Investment Group LLC and are not intended as a forecast or guarantee of future results. The information and opinions contained herein are current as of December 31, 2011 and are subject to change without notice. Information has been obtained from sources believed to be reliable, but its accuracy, completeness, and interpretation are not guaranteed. The S&P 500 Index is proprietary data of Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. The Russell 1000®, Russell 2000®, and Russell 3000® Indexes are trademarks of Russell Investments. Russell® is a trademark of Russell Investments. All MSCI data is provided ‘as is’. The products described herein are not sponsored or endorsed and have not been reviewed or passed on by MSCI. In no event shall MSCI, its affiliates, or any MSCI data provider have any liability of any kind in connection with the MSCI data or the products described herein. Copying or redistributing the MSCI data is strictly prohibited. An investment cannot be made directly into an Index. Index returns do not reflect any fees, expenses or sales charges.
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