U.S. equity markets were flat for the quarter (with the DJW 5000 Index posting a zero percent return), but not without experiencing a roller coaster ride. The last month of the quarter saw equity markets heading significantly lower and well off their intra-quarter highs, and the last four trading days brought about a dramatic surge to the upside, erasing the quarter’s intra-period losses and bringing U.S. equities back to levels they were at only three months ago. International equities posted slightly better results than their U.S. equity counterparts, returning a positive 1.8 percent for the quarter (MSCI EAFE Index), but also showing similar volatility. U.S. fixed income made significant gains, no doubt helped by the spike in equity volatility that was witnessed over the quarter. The broad U.S. fixed income market posted a strong, positive 2.3 percent return (Barclays Aggregate Index).
The flight to safety into fixed income was likely encouraged by the relatively high fixed income rates witnessed at the beginning of the quarter (the 10-year Treasury bond yielded 3.45 percent as of April 1, 2011). Coupled with greater equity market volatility, investors had multiple reasons to favor fixed income investments over equities. Fund flows reversed from what was witnessed over the first quarter, with bond mutual funds experiencing inflows, totaling over $48 billion, and stock mutual funds experiencing outflows, totaling over $18 billion (Q2 estimates, Investment Company Institute). Also joining the bond buying party was the Fed, whose QE2 bond buying program ran until June 30, putting additional pressure on yields and likely helping prices (and their returns) rise.
With the Fed’s QE2 bond buying program over and longer-term rates/yields lower as a result of the second quarter fixed income rally, conditions are not as favorable for fixed income investors and markets (at least relative to how they were in the second quarter).
Equity markets, while finishing mostly flat for the quarter, did hit record highs that have not been seen over the last few years, or in some cases, since the financial crisis. One notable event over the quarter was the LinkedIn IPO (initial public offering), which raised concerns of potentially rich equity valuations. To be sure, broad market valuations are still in-line with many long-term norms; however, many concerns remain on the horizon. Volatility may well decide to stick around for awhile.