Despite the issues looming ahead, equity markets had a remarkably strong quarter. This was the second consecutive year that the S&P 500® Index gained over 10% in the first quarter of the year. Interestingly, it was the more defensive sectors such as health care, consumer staples and utilities that led the rise. The S&P 500® Index reached an all-time high at the end of the quarter, which represents a full recovery from the 2007-2009 bear market. U.S. small cap stocks, as measured by the Russell 2000® Index, were up 12.39% in this period. Overall, stocks rallied in large part due to the overall strength of corporate financial positions, steady earnings growth and the Fed’s stimulus measures.
Although U.S. economic growth may not be as robust as one might expect given these massive doses of stimulus, it is positive and gives many the feeling that the U.S. economy is gaining some traction. One example of this is the U.S. housing market. It is good to see positive signals in this industry led by the uptick in housing prices along with noticeable improvement in housing starts, new home sales and existing home sales. This sends a very positive message that reverberates throughout the economy.
During the first quarter, the move into riskier assets only intensified, with major central banks around the globe influencing financial markets to a greater degree than just a few months ago. Not only has the Fed significantly expanded its footprint in the financial markets by increasing the pace of its bond buying from last year, but the Bank of Japan has signaled that it is also taking direct measures to ease their monetary policy in an attempt to revive the Japanese economy.
Non-U.S. stocks were also positive but not to the same extent as U.S. equities this quarter. The non-U.S. equity markets, as measured by the MSCI ACWI ex-US index, was up 6.7% in their respective local currency, but only 3.17% in U.S. dollar terms. The U.S. dollar was very strong during this quarter relative to many foreign currencies but especially versus the Japanese yen where the yen depreciated almost 9% versus the U.S. dollar.
Although this quarter in hindsight provided a tailwind for risky assets such as equities, these trends did little for most commodities. Many commodity markets appear to be reflecting a modest outlook for the global economy, concerns over slowing Chinese demand, uncertain global growth prospects and adequate supplies of raw materials. One might think the "risk-on" mentality that propelled equities this quarter would bode well for commodities but that was not the case. Copper, for example, is regarded as a predictor of economic activity. However, copper prices fell 6.8% in the quarter due to increasing supply and fears of falling Chinese demand. One bright spot in the energy sector was natural gas. It rose 20% for the quarter because much of the U.S. experienced an extended cold winter. This drove demand and pushed prices above $4 for the first time since October 2011.
Fixed income markets, however, saw more mixed performance as investors this quarter noticeably moved cash toward more risky assets. Interest rates were essentially flat compared to last quarter with the most noticeable move coming in the 30-year U.S. Treasury bond which moved from 2.95% up to 3.10%.
Fed policymakers remained cautious about the durability of the U.S. economy given the fiscal headwinds and the level of economic growth. Unemployment has slowly trickled down to a level of 7.7%, which is still well above the Fed’s target of 6.5%. Expect the Fed to keep the stance of monetary policy easier for now.
Even though we are at a record high for the U.S. large cap equity market, equities have not reached extreme valuation levels. In general, U.S. equities may be nearer to fair value yet they continue to look attractive compared to bonds. However, there are still many challenges ahead. Investors would be best served to maintain their commitment to a well-diversified asset allocation portfolio strategy, one that reflects their level of risk tolerance in order to best achieve their long-term investment objectives.
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All indices are unmanaged and not available for direct investment. Index performance assumes no taxes, transaction costs, fees or expenses. This update is prepared for general information only and it is not to be reproduced.
GuideStone Capital Management, a controlled affiliate of GuideStone Financial Resources, serves as the investment adviser to GuideStone Funds.