2014 got off to a rocky start for investors as concerns about growth in a tighter monetary policy environment put pressure on developed equities despite signs of on-trend growth in the U.S. Europe, and Japan. Markets rebounded in February, however the rally stalled as investors focused on the situation in Ukraine and on comments made by Janet Yellen hinting at a forward shift in the timing of future rate increases. Overall the MSCI World index rose a modest 1.3% during the first quarter. Going forward, geopolitical issues are becoming more of a factor once again as Russia escalates tensions in Ukraine. GDP growth in the first quarter slowed to just 0.1%, however most analysts attribute this to unusually harsh winter weather. Barring unforeseen macro issues, earnings should accelerate in the second quarter.
Q1 produced modest positive returns for U.S. equities. The S&P was up 1.8% and the Dow Jones Industrial Average was up 0.2%. The Fed began its tapering program during the quarter at a pace of $10 billion/month. Additionally, Fed Chair Janet Yellen calmed markets by signaling that no changes would be made to the tapering schedule of QE and that rates would likely remain low for some time. From a style perspective, mid-cap value was the best performing sector at 5.2% while small-cap growth performed worst at 0.5% for the quarter. Utilities, which were up 10.1%, led the way for the quarter as capital flowed into more defensive sectors. Consumer discretionary, which lost 2.8%, was the only sector which retreated for the quarter as consumer spending was hurt by winter weather effects.
Going into 2014, it appears Europe has emerged from the lingering issues of the Eurozone crisis. Over the course of the quarter investors were reassured by solid earnings reports as economic news continues to indicate slow but stable growth in Europe. The MSCI Europe index was up 2.1% for the quarter despite increasing tensions in Ukraine. Markets were little affected by the ongoing issues in Ukraine, however there continues to be concern over possible Russian sanctions that could cut off European companies from Russian markets. Japanese equities were off 7.5% for the quarter. While economic data was positive, the impending sales tax hike in April overshadowed solid signs of growth. Emerging markets saw resumed capital outflows and market losses after the Fed began its tapering program in January. MSCI Emerging Markets index was off 0.4% for the quarter, however there was wide dispersion between individual countries. Frontier markets were up 7.5% driven by returns in Indonesia, Greece, and Egypt. Chinese and Russian equity returns dragged down the entire index as they were down 5.8% and 9.7% respectively.
After their first negative year since 1999, bonds had a strong start to the year by outperforming global stocks. Treasury yields fell sharply in late January as volatility in emerging markets and weak economic data sparked a “risk-off” trade. The 10-year Treasury yield fell from 3.03% to 2.76% during the quarter. The ML Corporate Bond index gained 2.7% while the ML High Yield index appreciated 2.8%. The best performing market for credits was the US and European credits lagged other markets.
REITs and Commodities led the way in Q1, appreciating 8.5% and 7.0% respectively. Growth in real estate was driven by a growing economy – higher corporate profitability leads to demand for commercial real estate. Commodities were up due to strong energy prices, increasing food costs, and precious metals which benefited from the “risk-off” trade. Hedge funds appreciated in Q1, as the HSFRX index was up 1.1%. January and February allowed for healthy returns for hedge funds, however they had difficulty in March and manager dispersion was high. Long/short equity, arbitrage strategies, and event driven funds were all up +2% as increased M&A volume allowed for managers to generate returns. Global macro and managed futures were both negative for the quarter as a lack of exploitable trends in global markets created a difficult environment for those strategies. In private equity, Q1 saw 688 PE backed buyouts with an aggregate value of $80 billion, representing a 31% rise in the aggregate value of global deals compared to the prior quarter. 2013 was one of the strongest years ever for PE fundraising. That coupled with an increase in corporate mergers and acquisitions bodes well for private equity going forward.