Our Take on the Second Quarter

All eyes were on central banks as volatility returned to both the stock and bond markets.

Jeremy Glaser 22.07.2013
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Volatility returned this quarter in both stocks and bonds as fears about central-bank actions across the globe made investors increasingly skittish. Despite some big swings in the market, the broad-based Morningstar US Market Index rose 3.2% during the last 13 weeks.
The Federal Reserve's next move was under intense scrutiny throughout the quarter. In May, testimony from chairman Ben Bernanke and minutes from an earlier Federal Open Market Committee meeting raised fears that the central bank was on the brink of slowing down its purchases of mortgage-backed securities. Worries about this so-called tapering intensified in June after the bank's policy statement revealed the Fed raised its projections of economic growth and said that it could begin taking its foot off the accelerator as early as the end of this year. The focus on the Fed's potential tightening sent bond markets into a tailspin. The yield on the 10-year Treasury moved from 1.61% at the beginning of May all the way to 2.60% in June, before pulling back slightly to end the quarter around 2.50%.

The Fed has begun the talk of tapering because it is starting to see improvement in the U.S. economy. Indeed the data in the quarter did show steady, if unspectacular, economic progress. Morningstar director of economic analysis Bob Johnson sees real underlying strength across a number of areas from energy production to manufacturing to housing. That being said, there are still headwinds to much faster growth. Consumers remain under pressure, employment is getting better but is still far from the peak, higher mortgage rates will have some impact on housing, and slowing emerging-markets growth could present a challenge.

Japanese prime minister Shinzo Abe's plan to reinvigorate his country's economy (Abenomics) was also a big focus in the quarter. The country took central stage in April when the new head of the Bank of Japan, Haruhiko Kuroda, announced a plan to double the size of the country's monetary base. This enormous new easing plan is designed to bring inflation up to 2% and attempt to eliminate the threat of deflation. The monetary rocket fuel sent Japanese stocks on a wild ride, with large swings coming on an almost daily basis. The Nikkei 225 gained more than 10% in the quarter and is up more than 50% during the past 12 months.  

Europe was relatively calm in the quarter, as the European Central Bank's promise to do anything in its power to keep the eurozone together continued to keep the currency union's debt crisis on the back burner. It wasn't all good news across the pond, however. Data showed that the eurozone remains mired in recession and that many of the structural problems behind the eurozone crisis remain unsolved.

Emerging markets also showed signs of economic weakness. The closely watched HSBC Flash China Manufacturing Purchasing Managers' Index hit a nine-month low in June as new orders and output fell. Add in continued worries about frothy real estate prices, an expected slowdown in government infrastructure spending, and emerging banking sector worries, and the picture in China looked somewhat gloomy in the quarter. Other emerging markets, from Brazil to India, also posted disappointing data.

Against this backdrop, companies' earnings reports were mostly in line with expectations. Top-line growth was pressured by slowdowns around the world, and profitability looked increasingly squeezed in many businesses. Morningstar's equity analyst staff sees the stock market as fairly valued. Global director of equity and credit research Heather Brilliant thinks "the outlook for the equity market is reasonably good over a longer time horizon" and that stocks remain a better bet than bonds.

The largest IPOs (as measured by market cap) in the quarter included ING U.S.(VOYA), a spin-off from Dutch financial giant ING, beauty and fragrance firm Coty(COTY), Tableau Software (DATA), and contract research organization  Quintiles Transnational Holdings (Q). Notable S-1 filings include Envision Healthcare Holdings, Midcoast Energy Partners LP, Neiman Marcus, and Burlington Holdings.

Sector-by-Sector PerformanceStock sector performance was mixed during the past three months. Consumer cyclical(up 6.3%), health care (up 5.4%), and financial services (up 5.1%) were the top performers in the mix. On the other hand, worries about a slowdown in China and rising rates left basic materials (down 8.9%), energy (down 3.7%), and real estate(down 2.0%) at the bottom of the pack.

Consumer cyclical (up 6.4%) was the also the best-performing open-end mutual fund sector-stock category. Health (up 5.9%), financial (up 5.1%) and communications(up 4%) also had relatively good quarters. Equity precious metals continued its losing streak in the quarter, falling nearly 40%. Natural resources (down 7.2%) and global real estate (down 5.1%) also had challenging quarters.

Twelve of the 16 international-stock open-end fund categories lost ground during the last three months. Japan stock (up 2.9%) and world stock (up 1.0%) were the best performers while Latin America stock (down 15.2%), India equity (down 9.0%), diversified emerging markets (down 8.4%) and Pacific/Asia ex-Japan (down 7.0%) were the laggards.

Fixed income was battered across the board as rates rose sharply through the quarter. The long-government category lost a stunning 7.2% while emerging-markets bond (down 7.0%) and inflation-protected bonds (down 6.7%) also lost more than 5.0%. The only category to post a gain were bank-loan funds which eked out a 0.2% increase.

Data as of June 27. 

Jeremy Glaser is the Markets Editor for Morningstar.com.

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Jeremy Glaser  Jeremy Glaser is the Markets Editor for Morningstar.com.

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