July 2012: SEI Market Commentary


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July 2012: SEI Market Commentary

  1. 1. SEI Investment Management UnitCommentaryMarket & Performance UpdateJuly 2012 A degree of calm returned to the financial markets in July, but disappointing economic data ensured a subdued mood. The European Central Bank’s “whatever it takes” commitment to save the euro helped buoy sentiment at month end. Global equities and bonds posted marginal gains.Economic BackdropLeading central banks remained accommodative as part of ongoing efforts to stimulate global growth. The EuropeanCentral Bank (ECB) further lowered eurozone interest rates (to 0.75%) and also reduced the deposit rate for banksplacing money with them to 0% to help boost liquidity. This news was positively received, as were comments from theECB’s president later in the month. Mario Draghi’s statement on July 26 reiterated a collective drive to support theeurozone, assuring that the ECB would do “whatever it takes.” While the Bank of England voted to maintain interest ratesat the historic low of 0.50% once again in July, the committee acknowledged the need for further stimulus measures in theU.K. and agreed to expand the scope of the asset purchase program by a further £50 billion. The Bank of Japan and theU.S. Federal Reserve (Fed) also kept interest rates low.For the eurozone as a whole, economic data released during the month painted a gloomy picture. The struggling Spanisheconomy remained a problem as a number of local governments were forced to request state financial support even asthe national government was simultaneously planning additional spending cuts and austerity measures. The Spanishunemployment rate remained high, while the number of jobless in the eurozone marginally increased from May to June.Advanced readings of service and manufacturing output for the single currency union indicated further declines. The ZEWIndicator of Economic Sentiment for Germany (a survey which also covers analyst opinions for Europe, the U.K., Japanand the U.S.) fell again in June. However, eurozone inflation remained steady at 2.4% in June and was estimated to havemaintained this rate during July.The economic slowdown in the U.K. accelerated as positive data points became fewer and further between. While growthin the U.K. manufacturing sector improved between May and June (as measured by Markit surveys), it slowed in theservices sector and revised figures for June retail sales showed only a marginal 0.1% growth (month-on-month).Lackluster consumer confidence surveys further solidified the view that the recession in the U.K. was deepening. Thismood was confirmed by the release of estimated second-quarter growth readings. The advanced reading was far worsethan market participants had expected, with initial figures showing a contraction of 0.7%. One area of positive news for theU.K. came through the announcement that the annual inflation rate, as measured by the U.K. Consumer Price Index, onceagain fell more than expected, from 2.8% in May to 2.4% in June.U.S. economic data in July was rather mixed, but still pointed to slow yet positive growth. The Fed’s Beige Book describedthe U.S. economy as expanding at a modest to moderate pace despite weakness in manufacturing, with strength seen inretail sales as well as housing, which appears to be stabilizing at depressed levels. The advanced reading of secondquarter gross domestic product (GDP) showed that the economy grew at a tepid pace of 1.5%, albeit surpassing theconsensus rate of 1.4%. The growth rate for first quarter GDP was revised higher to 2.0%. Unemployment held steady at8.2%, and consumer confidence rebounded more than expected in July, although it remains depressed relative tohistorical data.© 2012 SEI 1
  2. 2. Market ImpactEmerging market debt led fixed-income markets, followed by corporate bonds and high-yield debt, which benefited fromincreased investor risk appetite towards month end. While government bonds lagged in comparison to other fixed-incomeinvestments, demand for “safe haven” debt continued due to investor uncertainty. Consequently, global government bondyields (which move inversely to prices) generally fell across the yield curve. Indeed, yields on German government bondswith short maturity dates (two years or less) declined into negative territory. The government debt of Spain, Italy andPortugal were notable exceptions and yields for these countries continued to rise. Ten-year Spanish government bondyields hit a euro-era high during the month.Global equity markets fell for much of the month, but managed to claw back into positive territory to finish July. Peripheraleurozone countries struggled the most due to ongoing concerns about the eurozone debt crisis and the impact of austeritymeasures on future growth prospects. Spanish equities in particular had a difficult month. Within the MSCI AC WorldIndex, most sectors were slightly positive, with only Materials and Utilities in negative territory for the month (in U.S. dollarterms). The Telecommunications, Energy and Consumer Staples sectors performed best.Index Data The Dow Jones Industrial Average index returned 1.15%. The S&P 500 Index climbed 1.39%. The NASDAQ Composite Index returned 0.20%. The MSCI AC World Index, used to gauge global equity performance, gained ($) 1.37% over the month. The Barclays Global Aggregate Index, which represents global bond markets, rose by ($) 1.16% during the period. The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index”, moved from 17.08 to 18.03 during the month, but reached 20.47 on July 24. WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $84.96 a barrel at the end of June to $88.06 by July 31. The U.S. dollar strengthened against the euro and sterling during July, but weakened against the Japanese yen. The euro weakened against most major currencies in the month. The U.S. dollar ended July at $1.57 against sterling, $1.23 versus the euro and at 78.10 yen.Portfolio ReviewThe recent flight to safety has resulted in the market paying a multi-decade-high premium for yield and safety, whilediscounting prospects about the future, whether it is mean reversion or future growth. Europe has taken important steps toimprove its crisis, however, more work needs to be done. For large-cap equity, Consumer Staples were the greatestcontributors to relative underperformance as a few names within the food, beverage and tobacco industries sold off. Insmall-cap equity, security selection was positive in Consumer Staples and offset by detractors in Information Technology,including hardware picks, and Consumer Discretionary holdings. Off-benchmark exposure to Canadian and emergingmarket stocks was a boost to performance of international equity, but this was offset by an underweight to Australia.For investment-grade securities, an overweight to Commercial Mortgage-Backed Securities was a positive contributor, aswas an overweight allocation to financials as spreads tightened. A short duration posture modestly detracted fromperformance as Treasury yields fell at the intermediate part of the curve. Health Care bonds continued to rally in the wakeof the U.S. Supreme Court decision to uphold the constitutionality of recent health care legislation, helping high-yieldreturns. Detracting from performance were underweight allocations to outperforming Energy and Utility sectors. Inemerging markets a short duration position hurt as U.S. interest rates continued to fall, while an underweight to Lebanon,where bonds posted negative returns on rising concerns in the Middle East, was a positive contributor.© 2012 SEI 2
  3. 3. Contributors Detractors Large-Cap Equity Energy and Materials – stock Stock Selection in Large-Cap Equity – a few higher selection within these sectors was strong conviction names underperformed Health Care in Small-Cap Equity – biotechnology Overweight to Utilities and underweight to Industrials selections performed well in Small-Cap Equity – the sectors were strong and Stock Selection in International Equity – Energy and weak performers respectively Telecommunications picks outperformed Financials and Consumer Staples in International Regional Allocations in Emerging Markets Debt – Equity – stock selection was negative in these sectors underweight in Malaysia, which lagged the Security selection within Technology in High-Yield benchmark given its already rich valuations Debt – telecom equipment providers struggled with a reduced growth outlookManager Positioning and OpportunitiesSEI’s portfolio managers rely on investment-manager selection and portfolio construction in an effort to deliver diversifiedsources of excess return for our portfolios. In large-cap equity, investment managers are maintaining overweights to ITand Consumer Discretionary. Fundamental investment managers continue to have a quality bias, believing that the U.S.economy is in for an extended period of low growth, but not an outright recession. In small-cap equity, the outlook for aslow growth economic trajectory is reflected in a slightly pro-cyclical posture expressed through overweight positions toIndustrials, particularly in capital goods and commercial and professional services, and to a lesser extent in Energy.International equity retains off-benchmark allocations to emerging markets and overweights to small and mid-capitalization stocks. In contrast, investment managers are underweight to the aging economy of Japan. Japan may onlyhave a few more years before it must confront its staggering fiscal deficit; therefore our managers continue to employshrewd stock selection to uncover any pockets of strength in that country.In investment-grade fixed income, duration was shorter than the benchmark at the end of the month given the low level ofTreasury yields and negative real yields. Spread sector allocations have been and continue to be focused on thesecuritized sectors as they represent the greatest fundamental relative value. Within high-yield debt, an allocation to bankloans has been maintained due to their more defensive positioning and event-driven opportunities. In emerging marketdebt, investment managers remain defensive although some strong-conviction positions remain in high-yield sovereigncredits given their attractive valuations. The uncertainty in the market has kept bullishness in check as volatility due to theEuropean crisis and slower global growth would likely have a negative impact on local currencies.Our ViewSEI continues to hold a neutral view on stocks versus bonds. There is the potential for big surprises – either to thedownside (e.g. further economic weakness, the crumbling of the eurozone) or the upside (e.g. more forceful actions inEurope, quantitative easing or a breaking of the fiscal logjam in the U.S.). We might be inclined to favor equities if themarkets weaken materially further. This view assumes that the soft patch in the U.S. economy proves temporary; thatEurope muddles through into 2013 without a major break-up; and that the currency depreciation and pro-cyclical monetarypolicies in China and other emerging economies start to bear fruit going into year end.Momentum trends appear to continue to favor U.S. equities versus international, particularly against Europe and theeurozone. We recognize that this trend has been in place for more than a year. Recession and the possibility of aeurozone break-up have caused European equities to weaken to an extreme extent. We look for the cycle of panic,government response, relief and panic to continue in European markets.We also favor U.S. high-yield debt and other corporate credits versus U.S. Treasurys and the sovereign debt of othercountries. Investor demand remains buoyant for higher yielding assets because central bank policies have compressedyields to record-low levels around the globe. Issuers also generally remain in good shape, keeping default rates at lowlevels. In the near-term, worries about the economy could cause some widening in spreads versus Treasurys. We wouldview this as a buying opportunity.© 2012 SEI 3
  4. 4. Benchmark DescriptionsThe Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 blue-chip New York Stock Exchange stocks which are selected by editors of the Wall Street Journal.The S&P 500 Index is a capitalization-weighted index made up of 500 widely held large-cap U.S. stocks in the Industrials,Transportation, Utilities and Financials sectorsThe NASDAQ Composite Index is a market-value-weighted index of all common stocks listed on the NationalAssociation of Securities Dealers Automated Quotations (NASDAQ) system.The MSCI All Country World Index is a market-capitalization-weighted index composed of over 2,000 companies, and isrepresentative of the market structure of 48 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.The Barclays Capital Global Aggregate Bond Index (formerly Lehman Brothers Global Aggregate Index), anunmanaged market-capitalization-weighted benchmark, tracks the performance of investment-grade fixed- incomesecurities denominated in 13 currencies. The index reflects reinvestment of all distributions and changes in market prices.The Chicago Board Options Exchange Volatility Index (VIX) tracks the expected volatility in the S&P 500 over the next30 days. A higher number indicates greater volatility.© 2012 SEI 4
  5. 5. This material represents an assessment of the market environment at a specific point in time and is not intended to be aforecast of future events, or a guarantee of future results. This information should not be relied upon by the reader asresearch or investment advice regarding the Funds or any stock in particular, nor should it be construed as arecommendation to purchase or sell a security, including futures contracts. There is no assurance as of the date of thismaterial that the securities mentioned remain in or out of SEI Funds.For those SEI Funds which employ the ‘manager of managers’ structure, SEI Investments Management Corporation(SIMC) has ultimate responsibility for the investment performance of the Funds due to its responsibility to oversee thesub-advisers and recommend their hiring, termination and replacement. SIMC is the adviser to the SEI Funds, which aredistributed by SEI Investments Distribution Co. (SIDCO). SIMC and SIDCO are wholly owned subsidiaries of SEIInvestments Company.To determine if the Funds are an appropriate investment for you, carefully consider the investment objectives,risk factors and charges and expenses before investing. This and other information can be found in the Funds’prospectuses, which can be obtained by calling 1-800-DIAL-SEI. Read them carefully before investing.There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risksas well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, fromdifferences in generally accepted accounting principles or from economic or political instability in other nations. Narrowlyfocused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in valueas interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile thaninvestment-grade securities, due to the speculative nature of their investments. Emerging Markets involve heightenedrisks related to the same factors as well as increased volatility and lower trading volume.Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Pastperformance does not guarantee future results Index returns are for illustrative purposes only and do not represent actualportfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannotinvest directly in an index. Not FDIC Insured No Bank Guarantee May Lose Value© 2012 SEI 5