U.S. equity markets tumbled over the third quarter, posting a negative 15 percent return for the broad U.S. equity market (DJW 5000 Index). This was one of the markets’ worst quarters since 2009, a time when a credit crisis was underway. International equities posted similar results, posting a negative 15.7 percent return for the quarter (MSCI EAFE Index). U.S. fixed income, however, made significant gains, no doubt helped by the rising equity volatility and the uncertainty that accompanied it. The broad U.S. fixed income market posted a strong positive 3.8 percent return (Barclays Aggregate Index). Yields, accordingly, sunk to record lows, as investors flocked to the safety of high quality investment grade debt (and to a large extent, U.S. Treasury Bonds).
The yield on the 10-year treasury ended the quarter below 2 percent, levels not seen in recent history. The decrease in yields was dramatic, as the yield on the 10-year treasury was above 3 percent at the start of the quarter. Investors are now essentially sacrificing yield for the “guarantee” that they will be paid back their money in full at some point in time. In fact, any significant pick-up in inflation would potentially mean that investors would be paying money to ensure they get their investment (principal) back at some later date. Certainly, yields could head lower, yet there is much less room to fall. Year-to-date, U.S. fixed income has posted a spectacular 6.7 percent return (Barclays Capital Aggregate Index).
European sovereign debt issues weighed on the U.S. markets over the quarter, with many U.S.-based investors concerned that these issues could tip the global economy (including the U.S.) into a recession. Due to the global economy’s interconnectivity, it is likely that the U.S. would not be immune to a failure overseas. The other notable event over the quarter was the Fed’s latest round of “quantitative easing,” essentially another attempt to help further stimulate the economy. The Fed’s new policy involves selling shorter-term debt and buying longer-term debt, in order to keep down long-term interest rates. While rates are already at historically low levels, it is important to note the Fed plans to do this through June of 2012, meaning that pressure on rates to remain at these low levels may very well be with us for a bit longer.