After significant gains in 2013, equities took a breather in the first quarter of 2014 while fixed income assets rallied. The S&P 500 Index experienced a fair amount of volatility, retreating 5.8% at the start of the year and then rallying by more than 7% to end the quarter modestly higher. Within international markets, European, emerging markets (EM) and Japanese equities lagged U.S. equities. By the end of the quarter, however, risk assets rallied, with the EM rising about 10% from their lows in February. Fixed income saw better returns than equities. The benchmark Barclay’s Aggregate Index was up about as much as U.S. equities. Global fixed income sectors fared even better as both international developed bonds and EM bonds rose about 3%. The spread sectors within fixed income continued to perform well. Other hybrid bond like assets, such as convertible bonds, REITs and utilities were the best performing assets in the first quarter rising about 5%-7%. In a complete reversal from last year’s trend, commodities also rallied in the first quarter.
The U.S. economy experienced a slowdown partly attributed to weather, but also due to softness in housing and payback from a very strong inventory cycle in the second half of 2013. In addition, geopolitical fears intensified with Russia’s incursion into Ukraine and nervousness about the shadow banking system in China resulting in a larger than expected slowdown in the Chinese economy. Despite these setbacks, we believe U.S. growth metrics are still very positive, in the range of 2%-3% this year. Estimates for first quarter gross domestic product have been reduced, but are expected to bounce back toward the second half of the year. The euro-area continues to see tepid, but continued growth and we believe that inflation is likely to bottom.
The asset allocation team made no major changes to their views this month. We remain overweight equities overall with a slight preference for UK and Japan. In addition, we maintain an overall underweight position to fixed income, preferring high yield and EM bonds over Treasuries. Lastly, while we maintain a neutral position to emerging market equities, we are seeing positive developments. For many EM countries, exports remain the most important factor in explaining long-term growth. With recovery in the U.S. and Europe gaining momentum, and a potentially better global growth outlook, we expect a pick-up in EM exports. For long-term investors underweight in emerging market equities, this might be a time to consider adding to positions. As always, we continue to monitor global markets and will adjust our investment strategy accordingly.