If you missed our market overview of Second Quarter 2015, click here.
Stock markets worldwide retreated sharply in the third quarter. The S&P 500 notched its first quarterly decline since the fourth quarter of 2012, ending its 10-quarter winning streak with a 6.4% drop. The index also entered “correction territory,” following the all-time high it reached on May 20 of this year. Stocks overseas experienced even steeper declines than in the U.S., particularly in emerging markets. Concerns about slowing growth in China, as well as weakness in commodity prices and emerging-markets currencies, all weighed heavily on results.
As the quarter drew to a close, Speaker John Boehner announced his resignation from Congress, effective October 31. On the last day of the quarter, just hours before the deadline, Congress passed an interim spending bill to avert a government shutdown…until December 11, at least. Uncertainty remains about a future budget deal and the debt ceiling, as well as the timing of interest rate hikes, which the Fed declined to enact in its September meeting. For the quarter, the yield on the 10-year Treasury note fell from 2.35% to 2.06%, and the Barclays Capital Aggregate Index posted a 1.2% gain.
Longer maturity Treasuries did best in the “flight to quality.”
In the U.S., large-cap stocks proved more resilient than small caps in the quarter’s sell-off. The Russell 2000 Index of small-cap stocks lost 11.9%. From a style perspective, large-cap value stocks trailed growth by a good margin, but the opposite occurred in small cap.
This has been an unusual period in which growth has outperformed value for the past one-, three-, five- and ten-year periods across all market caps, a challenging environment for value stocks. This quarter, the Energy and Materials sectors of the S&P 500 dropped more than 17% each.
International stocks suffered bigger losses in the quarter. Developed countries retreated 10.2% (US$), while emerging markets plunged 17.8% (US$). China, where industrial companies reported 9% year-over-year earnings declines for the month of August, fell 22.7% (US$).
Commodity prices plummeted in the face of lower expectations for global growth, taking a toll on emerging-markets stocks and currencies.
In other areas of fixed income, municipal bonds produced solid returns during the quarter, rising 1.3%. High-yield bonds, however, lost 4.3% as corporate spreads over Treasuries widened, a result of investors demanding higher yields for those riskier bonds. Developed-country bonds turned in positive returns (+0.6%), but emerging markets took a hit along with those currencies — local currency bonds sank 10.5%.
Until this quarter, investors had enjoyed an almost unbroken string of advances since the market bottomed in 2009. This experience, however, is more the exception than the rule. Corrections are a normal phase of markets, and we have gone much longer than history would have us expect without one. While many investors have questioned owning bonds at a time when yields seem to have nowhere to go but up, a quarter like this highlights one of their important roles in a portfolio — providing stability and diversification during a stock downturn.