Second Quarter Markets Review
In an effort to stimulate the economy, the Federal Reserve has implemented five distinct quantitative easing programs since 2008. The Fed’s present pace of decreasing asset purchases will end by the middle of this fall. This will allow the economic recovery to progress through the maturing growth stage that favors sectors such as energy, materials, industrials and electronic technology. The Sit growth funds emphasize these sectors.
Despite mixed news on the economy, June was primarily a "risk-on" month for stocks. Investors continue to be less risk averse, viewing the Fed’s quantitative easing as a safety net for both the economy and financial markets. This low level of risk aversion has caused investors to remain focused on lower quality companies because of the perceived safety net.
Domestic equities had a strong month and quarter through June 30th. Stocks with lower quality ratings continued to lead performance in June, the quarter, year-to-date and longer periods.
We are becoming more concerned that Europe’s economic growth may be stalling, as recent economic data has been mixed. Indicators suggest that Japan’s economy is finding its footing and appears to be weathering the consumption tax hike that went into effect in early April. Thanks to a series of growth stabilization measures introduced in China in early April, along with improving external demand, there appears to be a stabilization of economic growth.
We expect the Fed’s asset purchases, which have artificially held interest rates down, to end entirely late this year and cause interest rates to rise. As such, our strategies underweight U.S. Treasury bonds and overweight securities that minimize (or benefit from) the negative effects of rising rates, while emphasizing a yield advantage relative to the benchmark. We think the unusually high level of market complacency and potential volatility in GDP reports will provide tactical trading opportunities in the coming months.
Continued reductions in the Fed's asset purchase program (QE) and weak economic growth alleviated inflation fears, causing longer-dated U.S. Treasury yields to fall modestly. The Barclays Aggregate Bond Index return for the quarter was +2.0%. Corporate bonds were the best performing sector, primarily due to their longer duration and increased demand as investors continued to search for yield. Mortgage-backed securities were the next best performing sector, as declining purchases by the Federal Reserve was offset by a low level of issuance thus far this year.
Despite the slight rise in June, tax-exempt yields ended the quarter lower across the yield curve. Lower than average bond issuance volume, combined with demand from reinvestment and modestly positive funds flows, continued to be the main driver of performance for tax-exempt bonds during the quarter. As supply of new issuance is expected to remain light, we believe that our longer-than-portfolio tax-free benchmark durations will be rewarded in the near term. Our tax-free strategy is to remain focused on securities that provide a high level of interest income, which is the primary source of returns over longer-term cycles. We also continue to look for security structures that provide added yield without additional credit risk.