Bond returns are exceeding stock gains by the widest margin in nine years as optimism that greeted the year evaporates and investors around the world question the strength of the economic recovery.
Bond returns are exceeding stock gains by the widest margin in nine years as optimism that greeted the year evaporates and investors around the world question the strength of the economic recovery.
While the MSCI World Index of 24 developed countries fell 9.5 percent including dividends in the first half of 2010, bonds gained 4.2 percent, the Bank of America Merrill Lynch Global Broad Market Index shows, reversing the 5.1 percentage point lead stocks had over debt during the same period in 2009. Growing budget gaps in Greece, Spain and Portugal sent the euro down 15 percent and commodities posted the biggest loss in almost a decade as oil dropped 4.7 percent.
Concerns that Europe would lead the world into the second global recession in three years spurred losses in all 10 Standard & Poor's 500 Index industries and dragged the Shanghai Composite Index down 26 percent with dividends, data compiled by Bloomberg show. A Labor Department report tomorrow may show the U.S. lost jobs for the first time this year and President Barack Obama said that the nation faces “headwinds” from Europe.
“At the beginning of the year, the consensus was the economy is going to be strong, stocks are going to easily outperform bonds,” said Thanos Bardas, a managing director at Chicago-based Neuberger Berman LLC, which manages about $80 billion in fixed-income assets. Investors didn't “anticipate the fiscal problems and events that took place in Europe. During the last six months, people have downgraded their growth expectations.”
‘Major Downside'
Federal Reserve Bank of Atlanta President Dennis Lockhart said yesterday that the U.S. economic rebound isn't strong enough to warrant raising interest rates or shrinking the central bank's near-record balance sheet. Instability in financial markets poses a “major downside risk” to global growth and “urgent action” is needed to rein in budget deficits, the International Monetary Fund said in a report last month to Group of 20 finance ministers.
The last time bonds beat stocks by this much to start a year was in 2001. In the second half of that year, credit exceeded equities by more than 11 percentage points as the MSCI World Index sank 7.5 percent, data compiled by Bloomberg show. U.S. gross domestic product contracted at a 1.1 percent pace in the third quarter and expanded 1.4 percent in the final three months of 2001.
Economists expect a different scenario this year. The U.S. grew at a 2.7 percent annual rate in the first quarter, according to Commerce Department data released June 25. It's forecast to expand 3.2 percent in 2010, the biggest increase since 2004, according to the median estimate of 66 economists surveyed by Bloomberg.
Spain's Rating
The biggest drag continues to be in Europe. Moody's Investors Service placed Spain's Aaa credit ranking on review for a possible downgrade yesterday, citing deteriorating growth prospects and challenges in meeting fiscal targets. The rating company cut Greece four grades to junk on June 15, helping send the cost of protecting its debt from default to a record last week, according to CMA DataVision, a price-reporting service of CME Group Inc.
The euro weakened 15 percent against the dollar since Dec. 31, reaching a four-year low of $1.1877 on June 7. Its worst annual performance was a 14 percent decline in 1999, the year it was created.
As concern over Greece's finances spread to other European countries, investors added $37 billion this year to global bond funds through June 23 while pulling $19.9 million from equity managers, data compiled by Cambridge, Massachusetts-based research firm EPFR Global show. That compares with outflows of $2.49 billion from bond funds and $5.24 billion from stocks during the same period in 2009, EPFR data show.
‘Really Volatile'
“People are looking around the world saying equities are really volatile, global economic growth feels like it's slowing a little bit, meanwhile inflation is coming down and the Fed is on hold indefinitely,” said Michael Collins, senior investment officer at Prudential Investment Management Inc. in Newark, New Jersey, which has about $240 billion of fixed-income assets under management.
Treasuries returned 5.8 percent in the first six months, Bank of America Merrill Lynch indexes show. That's the biggest rally since 1995, when the Federal Reserve cut interest rates. Denmark, the best performing developed nation for the first six months of this year, has returned 9.2 percent on its sovereign bonds, followed by German bunds with a return of 7.1 percent, according to Bloomberg data.
Biggest Retreat
Those compare with a 6.7 percent loss in the S&P 500 including dividends and a 10 percent retreat in the Euro Stoxx 50 index of countries using the common European currency. China shares posted the biggest decline among major markets as the government raised bank reserve requirements to the highest level in at least three years and curbed real-estate speculation. The MSCI Emerging Markets Index lost 6.1 percent in the first half, beating the MSCI World Index by almost 3.4 percentage points.
“There clearly are concerns in the markets as it relates to sovereign risk, financial regulation and a potential slowing of the economy,” said Tom Farina, who helps manage $188 billion of assets at Deutsche Insurance Asset Management in New York.
Speculation the economy may avoid a recession even as growth slows helped most bonds post gains during the first half. U.S. corporate debt has returned 5.8 percent this year after rising 26 percent in 2009, the largest annual increase since at least 1997, according to Bank of America Merrill Lynch index data. Cash at investment-grade companies rose to $668 billion at the end of the first quarter from $580 billion a year earlier, JPMorgan Chase & Co. analysts led by Eric Beinstein in New York wrote last week. Debt fell 2 percent to $2.3 trillion.
‘Great Job'
“There are still a lot of industrial companies in this country that are doing a great job managing their overall credit quality,” Prudential's Collins said. “They're continuing to pay down debt. They're continuing to shore up their liquidity.”
While U.S. reports showing new-home sales tumbled to a record low after a tax credit expired and American employers hired fewer workers than expected in May suggest the recovery is slowing, Wall Street expects the S&P 500 to rally. The U.S. equity benchmark will rise 23 percent through Dec. 31, according to the average estimate of 13 U.S. strategists.
S&P 500 per-share profit will increase 32 percent in 2010, and 18 percent in 2011, the biggest two-year advance since the period ended in 1995, according to the average of more than 2,000 analysts survey by Bloomberg. The S&P 500 is trading at 12.7 times projected 2010 earnings, 33 percent below the 10-year average of 18.8 times the past four quarters' profits, according to data compiled by Bloomberg.
U.S., China
“People are making the conclusion that the U.S. and Chinese economies are slowing while Europe has credit problems, so earnings aren't going to be up to what we had expected and therefore we sell,” said Robert Doll, who helps oversee $3.36 trillion as vice chairman and chief equity strategist at New York-based BlackRock Inc. “I don't agree with that. I still think the recovery is intact, just at a slower rate.”
Currencies weakened in countries most dependent on commodities after prices for metals, crops and fuel posted the worst first-half return in nine years. The S&P GSCI Total Return Index of 24 raw materials dropped 11 percent, led by declines in sugar, zinc and lead.
The ruble depreciated 3.1 percent against the U.S. dollar while Russia's Micex Index of stocks in the world's largest energy exporter slid 4.4 percent. Australia's currency weakened 5.7 percent versus the U.S. dollar this year.
Oil, Natural Gas
Crude dropped 8.7 percent to $75.63 a barrel since March in its first quarterly decline since the end of 2008. Natural gas futures lost 17 percent in the first half of this year as U.S. inventories rose amid increasing production from shale wells from Texas to Pennsylvania.
As investor appetite for risk diminished, they bought gold and dollars to preserve wealth. The metal climbed 13 percent and reached a record high of $1,266.50 an ounce in New York as investors accumulated a record amount in exchange-traded funds. The Dollar Index, which measures the U.S. currency against the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, rose 10 percent this year after dropping 1.5 percent in the same period in 2009.
“Getting out of the worldwide recession was always going to be a long slog,” said Adam Sieminski, chief energy economist at Deutsche Bank AG in Washington, who forecast oil will average $65 a barrel in the third quarter and $70 in the fourth. “It's always been our view that the second half of 2010 was going to be a tough period.”
