The second quarter brought good news. The broad-based advance in equities, commodities and riskier fixed-income assets accelerated as interest rates generally declined and vaccinations climbed around the world.
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Hi, I'm Kevin Barr, head of SEI's investment management unit. Over the next few minutes, I'll provide an overview of the global financial markets and our perspective on them.
The second quarter brought good news. The broad-based advanced in equities commodities in riskier fixed income assets accelerated as interest rates generally declined and vaccinations climbed around the world. Major stock indices improved on their already impressive first quarter results. Equity markets advanced together until mid June when the U.S. pulled ahead once again.
The June surge was fueled by news from the U.S. Federal Open Market committee. The central bank announced its expectation that stronger economic growth and higher inflation in the months and years ahead would lead to an interest rate hike in 2023.
The Fed's announcement set short-term rates upward while intermediate to long-term rates continued to decline resulting in a flatter yield curve. U.S. treasury rates had been declining across most maturities through April and May after increasing during the first quarter.
The Fed's announcement that interest rates are finally projected to move higher, had just as much of an impact on stocks as it had on bonds. The rotation favoring cyclical and value-oriented asset classes that had began during the second half of last year was set back a bit by the Fed's latest projection. Both large and small cap value stocks sold off and only partially recovered their gains thereafter. Small cap growth also sold off, but then rallied in a similar manner to large cap growth. Large cap growth stocks faltered briefly and then benefited from the strong rally into the end of the quarter.
The U.S. was the best performing major equity market during the second quarter which can skew our perceptions about global returns. Let's see what happens when we exclude the U.S.
We can see that the developed market equities outpaced emerging markets in the second quarter. The performance differential widened in May and remained wide from the majority of June before nearly closing the gap at the end of the quarter.
The general decline in interest rates during the second quarter boosted bond prices. This was not a surprise given the inverse relationship between bond prices and yields. It comes falling a first quarter that was defined by an increase in interest rates that had a significant negative impact on fixed income asset classes.
We can see that some of the first quarter's hardest hit areas of the fixed income universe were the second quarters best performers. Emerging market debt, investment grade corporates performed particularly well. High-yield, a rare bright spot last quarter did well again while inflation protected securities also delivered strong returns amid firming inflation expectations.
The combination of above average economic growth, rising inflation, increased federal government spending and monetary policy aimed at suppressing interest rates is driving price gains in riskier investments. It is also creating conditions that can lead to speculative bubbles. We believe this merits watching as we look ahead.
Looking backward, the last several weeks have witnessed a partial and whining of the rotation into value stocks that began last autumn. We believe this is a temporary pause in the longer-term upswing. With many countries still imposing lockdown measures to fight COVID, we believe the global recovery and expansion have a long way to go.
In today's environment, with economies opening up and interest rates still at extraordinarily low levels, the dominant trend favors further price gains over the next year or two.
Investors should take into account that the U.S. economy appears to have reached peak growth and consider the merits of diversifying with international assets. Many countries are behind the U.S. in their pace of their economic recoveries. We expect other advanced economies to record strong results in the second half of the year and into 2022, exceeding the pace in the U.S.
On behalf of everyone at SEI, thank you as always for your trust and confidence.
Glossary of Financial Terms
- 10 Year U.S. Treasury rate: The 10-year U.S. Treasury rate is the interest rate, or yield, paid to owners of the 10-year U.S. Treasury note at its current price (fixed-income yields and prices have an inverse relationship).
- Bubble: A bubble refers to a period when the prices of an asset class or classes grow rapidly without the full support of strengthening fundamental justification, typically leading to either a slow deflating or quick collapse of prices.
- Bull market: A bull market refers to a market environment in which prices are generally rising (or are expected to rise) and investor confidence is high.
- Inflation-protected securities: Inflation-protected securities provide investors with protection against inflation. The principal of an inflation-protected security typically increases with inflation and decreases with deflation.
- Price-to-earnings (PE) ratio: The PE ratio is equal to the market capitalization of a share or index divided by trailing (over the prior 12 months) or forward (forecasted over the next 12 months) earnings. The higher the PE ratio, the more the market is willing to pay for each dollar of annual earnings.
- Value: Value stocks are those that are considered to be cheap and are trading for less than they are worth.
- Yield: Yield is a general term for the expected return, in percentage or basis points (one basis point is 0.01%), of a fixed-income investment.
- Yield curve: The yield curve represents differences in yields across a range of maturities of bonds of the same issuer or credit rating (likelihood of default). A steeper yield curve represents a greater difference between the yields. A flatter curve indicates the yields are closer together.
- Bloomberg Barclays 1-10 Year US TIPS Index: The Bloomberg Barclays 1-10 Year US TIPS Index measures the performance of inflation-protected public obligations of the U.S. Treasury that have a remaining maturity of 1 to 10 years.
- Bloomberg Barclays U.S. Corporate Bond Index: The Bloomberg Barclays U.S. Corporate Investment Grade Index is a broad-based benchmark that measures the investment-grade, fixed-rate, taxable corporate bond market.
- Bloomberg Barclays U.S. Treasury Index: The Bloomberg Barclays U.S. Treasury Index is an unmanaged index composed of U.S. Treasurys.
- ICE BofA U.S. High Yield Constrained Index: The ICE BofA U.S. High Yield Constrained Index tracks the performance of below-investment-grade, U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market and caps exposure to individual issuers at 2%.
- JPMorgan EMBI Global Diversified Index: The JPMorgan EMBI Global Diversified Index tracks the performance of external debt instruments (including U.S. dollar-denominated and other external-currency-denominated Brady bonds, loans, eurobonds and local-market instruments) in the emerging markets.
- JPMorgan GBI-EM Global Diversified Index: The JPMorgan GBI-EM Global Diversified Index tracks the performance of debt instruments issued in domestic currencies by emerging-market governments.
- MSCI ACWI Index: The MSCI ACWI Index is a market capitalization weighted index composed of over 2,800 companies, and is representative of the market structure of 49 developed and emerging market countries in North and South America, Europe, Africa, and the Pacific Rim. The index is calculated with net dividends reinvested in U.S. dollars.
- MSCI Emerging Markets Index: The MSCI Emerging Markets Index is a free float-adjusted market-capitalization-weighted index designed to measure the performance of global emerging-market equities.
- MSCI World ex USA Index: The MSCI World ex USA Index is a free float-adjusted market-capitalization-weighted index that is designed to measure the equity-market performance of developed markets, excluding the U.S.
- Russell 1000 Growth Index: The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth values.
- Russell 2000 Growth Index: The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 Index companies with higher price-to-value ratios and higher forecasted growth values.
- Russell 1000 Value Index: The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values.
- Russell 2000 Value Index: The Russell 2000 Value Index measures the performance of small-cap value segment of the U.S. equity universe. It includes those Russell 2000 Index companies with lower price-to-book ratios and lower forecasted growth values.
- S&P 500 Index: The S&P 500 Index is an unmanaged, market-capitalization weighted index that consists of the 500 largest publicly traded U.S. companies and is considered representative of the broad U.S. stock market.
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