Economic Backdrop

Continued economic expansion in advanced economies is creating optimism, while emerging economies sort through political, financial and social reforms. Overall world growth, however, still remains less than robust in absolute terms despite the passage of roughly five years since the credit crisis. Emerging economies face potential negative impacts from the sanctions levied on Russia due to its invasion of Crimea and from China’s slowdown in growth. Improving growth in the advanced economies has been supported by a regime of stimulative monetary policy, with output in the U.S. and U.K. finding solid footing. Even in Europe, where growth had been missing for some time, improvements in domestic demand turned the recession into a modest recovery.

As world output continues to progress, global central banks have generally remained committed to providing stimulus in one form or another. The U.S. Federal Open Market Committee (FOMC) remains committed to its low interest rate policy, but it has reduced its monthly asset-purchase program by $10 billion in each of its past meetings. Meanwhile, the Bank of England’s (BoE) Monetary Policy Committee voted unanimously in March to keep its interest rate target unchanged (current rate at 0.5%). The European Central Bank (ECB) also left rates unchanged (0.25%), but lowered its official inflation forecasts, which could point to additional easing in the future. Finally, the Bank of Japan voted to continue efforts to expand its monetary base as it seeks to achieve an inflation target of 2.0%.

In the U.S., the Commerce Department reported a third estimate of fourth-quarter growth of 2.6%, which was slightly higher than the previous estimate but below the original. In the first quarter, economic data hit a soft patch but appeared to recover by the close. The Commerce Department also reported that personal income and consumer spending were moderately higher in February, roughly in line with expectations. In addition, U.S. manufacturing eased in March but remained in solid growth territory, according to Markit, after recording a multi-year high in February. Existing home sales fell for the sixth time in seven months during February, according to the National Association of Realtors, due to weather and higher mortgages. However, February housing starts stabilized. Consumer price inflation came in near the low end of consensus in February, rising 0.1% from January and 1.1% from a year ago.

Economic activity in the eurozone continues to show modest gains, but deflationary concerns persist. The region’s manufacturing sector remained in growth territory during February, according to Markit, as Europe continues to recover from its recent financial crises. While overall economic activity remains muted—albeit positive—with fourth-quarter gross domestic product rising 0.3%, economic sentiment improved by more than predicted. Employment also rose slightly from the third quarter of 2013 to the following quarter, but it was still below the fourth quarter of 2012. While prices rose in the eurozone during March (0.5%), the trend of inflation undershooting expectations continued—leaving observers to wonder if and when the European Central Bank would respond. In addition, February money-supply figures from the ECB showed that private-sector bank lending remains sluggish.

U.K. economic activity remained fairly strong in the fourth quarter, posting quarterly growth of 0.7%. Along with the economic momentum, household sentiment reflected higher home values for the twelfth straight month in March. The U.K. labor market also continued to show gradual improvement in February with the number of benefit claimants falling by more than expected, while the unemployment rate remained the same. Retail sales appeared softer than expected in March compared to a year ago, which economists attributed to Mother’s Day and Easter falling later in the year. February retail sales were better than expected, although January’s estimates were revised downward. Consumer prices rose during February after declining in January, while the monthly and yearly changes were in line with expectations.

Market Impact

Global fixed-income markets started the year in surprising fashion, with rates generally falling despite firming developed market growth and continued bond-purchase tapering by the Fed. This led to a solid quarterly gain for the Barclays Global Aggregate Bond Index (2.40%). Across global investment-grade bonds, government and corporate debt posted similar returns, while securitized markets (asset-backed securities and commercial mortgage-backed securities) slightly lagged. Non-traditional fixed-income exposures, such as high-yield bonds (which are rated below investment grade and considered riskier) and emerging-market debt, were among the strongest performing areas.

Global equities rebounded from an early setback to reach positive territory by the close of the first quarter. However, emerging markets continued to be plagued by a combination of political and financial concerns. As a result, they lagged developed-country equities and posted a negative quarterly return overall. Performance was positive across most sectors of the MSCI AC World Index, with notable outperformance by the utilities, health care and information technology sectors. The telecommunications, consumer discretionary and industrial sectors were the worst performing market areas, posting losses in the period. Regionally, optimism regarding growth led investors to favor Europe over most other markets, while Japan struggled. In emerging markets, Russia and China were material underperformers, as the political and financial challenges facing these markets have dominated headlines.

First Quarter Index Data

The Dow Jones Industrial Average Index returned -0.15%.
• The S&P 500 Index gained 1.81%.
• The NASDAQ Composite Index returned 0.83%.
• The MSCI AC World Index, used to gauge global equity performance, rose by 1.09%.
• The Barclays Global Aggregate Index, which represents global bond markets, gained 2.40%.
• The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index that is also known as the “fear index,” was essentially flat in the quarter, moving from 13.72 to 13.88.
• WTI Cushing crude oil prices, a key indicator of movements in the oil market, moved from $98.42 a barrel at the end of December to $101.58 on the last day in March.
• The U.S. dollar was unchanged versus the euro, while it weakened slightly against sterling and yen. The U.S. dollar ended March at $1.38 against the euro, $1.67 versus sterling and at 102.98 yen.

Disclosures

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.