The S&P 500 Index turned in its 9th consecutive quarterly gain, its longest since 1998, with a modest 0.9% advance. Elsewhere, corporate credit markets produced strong returns for fixed income investors led by gains in high-yield and investment grade credit as energy prices stabilized and yields continued their downward descent. Diverging Central Bank policies dominated the investment narrative globally as currency markets and geopolitical concerns took center stage. A weaker currency and the European Central Bank (ECB) bond buying program bolstered investor optimism, leading international equity markets to outperform their U.S. brethren for the first time in nearly two years. Meanwhile, political developments in Greece continue to cast a shadow over Eurozone performance. The overarching landscape in Asia remains the most fertile with China and India positioned for attractive growth. Oil exporters such as Russia and Brazil have struggled given the sustained drop in oil prices.

The S&P 500 Index posted a gain for the ninth quarter in a row. Reported earnings exceeded analyst expectations for 75% of the companies in the Index, with Health Care and Consumer Discretionary among the top performers. Nonetheless, the strength of the U.S. dollar versus the euro, yen, and other major currencies produced a formidable headwind for earnings forecasts in 2015. Profits generated in international markets lose value when their weakened currencies are exchanged for U.S. dollars. The rising dollar had less impact on small companies given their lower percentage of overseas earnings. As such, small cap stocks outperformed large companies for the second consecutive quarter.

Despite weak economic data, deflationary concerns, and sluggish growth, international equities in developed countries outperformed the S&P 500 Index for the first time in nearly two years with a 4.9% gain. The market advance was led by export oriented countries like Japan and Germany that stand to benefit the most from weaker currencies. When measured in local currencies, the advance was even more pronounced with the MSCI EAFE Index (LCL) increasing 10.9%, the most in over five years.

Emerging market returns, as measured by the MSCI Emerging Markets Index, came in above the U.S. market with a 2.2% gain over the quarter. Performance across countries and regions varied widely. Political instability and weak energy markets pressured markets in Brazil
and Russia. Emerging Asia provided the best results led by China and India. Investor sentiment improved in both countries after central banks cut rates during the quarter. As a major importer of oil, Asia enjoyed a substantial boost to economic growth due to lower oil prices.

Despite concerns that the Fed may raise rates, the yield on the 10-year U.S. Treasury bond fell from 2.2% to 1.9% in the quarter. The falling yield continued to bolster traditional fixed income market returns. U.S. bond rates remain higher than several other developed countries, which has helped maintain interested buyers.

The global bond market as measured by the Barclays Global Aggregate Index dropped 1.9% in value for the quarter. While declining interest rates increased bond prices, these gains were more than offset by a devaluation of global currencies relative to the U.S. dollar. Of note is the 11.3% appreciation of the U.S. dollar relative to the euro in the quarter.

High yield bonds and bank loan markets rebounded nicely after a difficult back half of 2014. Investor concerns over the heightened risk of defaults among energy-related high yield bonds got a breather when the protracted decline in oil prices stalled during the quarter. Investors looking for yield returned to the higher yielding areas of the market as investment grade bond yields moved lower across the globe primarily in response to the start of the ECBs massive bond buying program. As a large buyer of bonds, the ECB will help support higher prices and lower bond yields in the region and to some extent globally.

The U.S. economy grew at a more subdued 2.2% pace for the fourth quarter after accelerating 5.0% in the third quarter. The unemployment rate dropped from 5.6% to 5.5%, while labor force participation hit a 36-year low. Consumer confidence remains at the highest levels since before the recession. The improving employment outlook, rising home prices, lower fuel costs, low interest rates, and the rising stock market buoyed consumer spending, which accounts for about 70% of U.S. GDP. The cost of living in the U.S. climbed 0.2% in February from the previous month, as fuel costs stabilized. The Federal Reserve is looking for signs that inflation is accelerating as policy makers weigh the timing of the first rate increase since 2006. When the Fed does raise rates, they will likely do so slowly to allow the economy to absorb the increase.

The Eurozone grew at a 0.3% rate in the wake of an historic one trillion euro bond buying initiative by the ECB to spur economic growth and reignite inflation in the region. The shift in monetary policy put downward pressure on the euro which resulted in the currency posting its worst quarterly retreat in its 15 year history. The region’s largest producer, Germany, reported a 0.7% gain that reflected the benefits of reduced financing costs and a lower euro. Overall, the region continues to struggle with economic growth, high unemployment, and high debt levels. France and Italy, the Eurozone’s second- and third-largest economies, stagnated in the final quarter of the year. Prospects for economic recovery in Greece look promising given temporary agreements between a newly installed government and creditors to allow for a distribution of funds that avoid default. Negotiations to reach a long-term deal are ongoing.

Japan’s economy hobbled out of a recession in the fourth quarter, advancing 0.4%. The country’s economic stimulus efforts resulted in a significant devaluation of the yen, boosting exports and corporate profits. Nonetheless, the world’s third largest economy continues to fight decades of deflationary pressure. Price inflation has been negative for most of the last decade.

The U.S. economy remains the most stable developed market and continues to grow at a measured pace. A resilient consumer, modest inflation, and low interest rates offer support for current valuation levels. The earnings outlook calls for flat to negative earnings growth in the coming quarters with modest acceleration in the back half of the year. Equity valuations based on forward price/earnings multiples are above historical averages suggesting performance should be driven primarily by earnings growth rather than rising valuations. Some investors fear the strong dollar may impede the still fragile U.S. recovery. Although it impacts corporate earnings negatively, a strong dollar makes imports cheaper and should provide a boost to consumer spending, which represents about 70% of the U.S. economy.

A weak euro, cheap oil prices, low interest rates, and an expansionary monetary policy from the ECB have European markets pointing in the right direction. Investing in the region doesn’t come without risk as Greece’s return to the headlines has the potential to unsettle markets. While the U.S. remains the most stable developed economy, the Eurozone has repositioned itself for growth, and investors are beginning to move funds into the region in anticipation of economic recovery.

The story in emerging markets continues to center on energy prices, growth, and prospects for additional monetary easing. The overarching landscape in Asia remains attractive with China and India positioned for relatively rapid growth. Moreover, governments in the region have been openly voicing their willingness to lend support if warranted. As the quarter came to a close, oil prices were depressed on prospects that OPEC member Iran could reach a deal on its nuclear program that could allow Tehran to sell more of its oil onto an already saturated market. A decline in oil prices will have differing impact on importers (e.g., China, India) versus exporters (e.g., Russia, Brazil), and could produce wide spreads in returns across countries as wealth is redistributed from oil importers to exporters.

Global bond yields remain near the historically low levels reached in the summer of 2013. The Fed has indicated a desire to raise rates, while Europe and Japan are embarking on additional stimulus efforts. There is a lot of uncertainty in the fixed income market as global government intervention is significantly impacting bond yields. Although bond yields could move lower, there isn’t much room to fall, which reduces the likelihood of significant price appreciation. Bond returns should be muted and could dip into negative territory in 2015 if the global economic growth proves stronger than anticipated.

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