Global stocks rose modestly in a volatile quarter marked by heightened concerns about threats to worldwide economic growth. Stocks initially dropped sharply after British voters on June 23 approved a ballot measure to leave the European Union, but a strong bounce-back rally erased most of the losses. Rising oil prices fueled gains in the energy sector while consumer discretionary stocks declined. High-grade bonds, the U.S. dollar and gold rallied.
Index Returns (Quarter)
U.S. stocks ended the second quarter with modest gains overall despite weakening economic data and the turmoil caused by the U.K.’s vote to exit the European Union. The broad Standard & Poor’s 500 Composite Index rose 2%; the Dow Jones Industrial Average also advanced 2% and the Nasdaq composite was flat.
The quarter was characterized by a flight to safety as investors shifted into defensive sectors and safe-haven investments. The telecommunication services and utilities sectors rose 7%, while consumer staples gained 5%. Information technology and consumer discretionary were the only sectors to post declines, losing 4% and 1%, respectively. Apple shares fell 12% as its earnings release revealed declining iPhone sales. E-commerce giant Amazon’s shares soared 21% as it handily beat earnings and sales forecasts to post its fourth consecutive quarterly profit, largely on the strength of its web services business. Retail sales were stronger than expected in April and May, but several retailers, including Macy’s and Target, fell short of sales forecasts, which sent their shares lower. Energy shares advanced 12% as they continued to recover from last year’s slide.
S&P 500 companies were on track to record a fifth consecutive quarter of declining earnings growth, according to market data provider FactSet. The information technology sector led downward revisions, including bellwether companies Apple, Microsoft and IBM, while industrials was the only sector to record an upward revision overall.
Crude oil futures gained more than 25% over the quarter, ending June above $48 a barrel. Other energy commodities were similarly strong. Gold ended June at $1,318 an ounce – up 7% for the quarter and 24% since the start of the year.
Mergers-and-acquisitions activity was brisk but slightly below 2015’s pace. Among the larger deals, Abbott Laboratories purchased St. Jude Medical in April for about $25 billion in cash and stock, Germany’s Bayer moved to acquire seed and chemicals giant Monsanto in May for around $62 billion, and Microsoft bought business-oriented social network LinkedIn in June for $26 billion. Late in the quarter, privately held confectioner Hershey rejected a $23 billion half-stock, half-cash offer from Mondelez International.
Data releases revealed a mixed picture in which the U.S. economy seemed to expand modestly while the employment situation began to show cracks. Gross domestic product growth for the first quarter was revised upward to 1.1%. The Institute for Supply Management’s purchasing managers index was 53.2 in June, indicating a fourth consecutive month of expansion. Housing and retail sales data also improved. But the Bureau of Labor Statistics reported the economy added just 38,000 jobs in May, compared to a consensus expectation of 162,000, and revised down numbers for March and April. While the unemployment rate fell to 4.7% in May from 5.0%, the decline was largely attributed to a fall in the labor force participation rate to near a four-decade low.
Given the unemployment data, the Federal Reserve opted to maintain the fed funds target rate in a range of 0.25% to 0.50% at its June meeting. The U.K.’s June 23 referendum on membership in the European Union also factored into the Fed’s decision, said Chair Janet Yellen. While the median forecast of Fed policymakers remained at two additional rate hikes in 2016, the number of officials who see just a single move rose to six from one since the previous poll in March.
On the political front, Congress created a federal oversight board with authority to negotiate the restructuring of Puerto Rico’s $70 billion in debt. The U.S. territory authorized the suspension of payments on its general obligation debt just before it was due to make payments totaling $1.9 billion on July 1.
In bond markets, the Barclays U.S. Aggregate Index rose 2.2%. The yield on the benchmark 10-year Treasury note fell 29 basis points to 1.49%. Political and economic uncertainty provided another volatile quarter. Although the Fed had signaled in May that it may raise rates over the summer, weak employment growth and the Brexit referendum instead drove Treasury yields down. Investment-grade corporate spreads to Treasuries ended 7 basis points lower at 156 basis points. Stronger inflation readings boosted Treasury Inflation-Protected Securities (TIPS), which gained 1.7%. Corporate bonds rose 3.6%, and municipal bonds notched a 2.6% return. High-yield corporate bonds gained 5.5%. Oracle sold $14 billion of bonds in the year’s third largest corporate debt offering; it consisted of five tranches, including a $3 billion 10-year note yielding 2.65%. The deal, which priced on June 29 – less than a week after the Brexit vote shook investors – demonstrated the resilience of the investment-grade market.
European stocks declined after British voters approved a ballot measure to leave the European Union, raising questions about EU stability and the potential for an economic downturn. Equity markets fell sharply following the June 23 referendum and the pound sterling plunged to levels not seen since the 1980s. However, markets staged a strong bounce-back rally in the final few days of the quarter, erasing some of the losses. Overall, the MSCI Europe Index rose 1% in local currency terms, but fell 3% for U.S. dollar-based investors.
In the so-called “Brexit” referendum, 52% of British voters expressed a desire to leave the 28-nation bloc while 48% voted to stay in the EU. British Prime Minister David Cameron, who led the “stay” campaign, announced his resignation and said he would step down after a new prime minister is chosen. EU leaders called for the U.K. to immediately begin the exit process, which is expected to take two years. Equity market losses were largely attributed to the uncertainty over what happens next, given that an established member of the EU has never left before.
Bank of England Governor Mark Carney said the central bank may need to cut interest rates to help support the British economy. Prior to the vote, BOE officials had warned that leaving the EU could push the U.K. into a recession because the uncertainty would likely hurt business investment, consumer confidence and direct investment flows. European Central Bank President Mario Draghi assured markets that the ECB is “ready for all contingencies,” fueling speculation of further rate cuts and an expansion of the bank’s bond-buying program.
Economically sensitive sectors generally fared worse than defensive stocks as investors moved away from relatively riskier assets. The consumer discretionary sector suffered the biggest losses, falling about 8%. Daimler shares declined sharply as the outlook diminished for luxury car sales. In addition, Daimler came under pressure amid softening global demand for trucks and other heavy commercial vehicles. Among luxury goods makers, shares of LVMH lost ground on worries about declining consumer spending.
Financial stocks tumbled 7%, weighed down by recession fears and concerns about a slowdown in finance and investment activity. Shares of Lloyds Banking fell amid investor fears that U.K. banks may lose access to the European common market. Many other European banks experienced double-digit declines amid worries of a broad recession in Europe and the potential loss of the U.K. as a key hub for finance. Meanwhile, the telecommunication services and information technology sectors declined about 3% each.
Energy stocks enjoyed the best returns, gaining 19% in aggregate as oil prices moved significantly higher over the quarter. Shares of oil giants BP and Royal Dutch Shell rose more than 20%. The health care sector provided another bright spot, rising 8% as investors favored defensive, dividend-paying stocks. Shares of drug makers Novartis, Roche and GlaxoSmithKline posted solid gains. The utilities and consumer staples sectors advanced 7% each amid the flight-to-quality trend.
In fixed income markets, European government bonds rallied on expectations for interest rate reductions from the ECB, the BOE and potentially other central banks. The yield on Germany’s benchmark 10-year note moved into negative territory for the first time in history, ending the quarter at −0.13%. Following the Brexit vote, Standard & Poor’s revoked the U.K.’s triple-A credit rating, citing the resulting political and economic uncertainty. S&P downgraded its assessment of the country’s creditworthiness by two notches to double-A. Meanwhile, the pound tumbled 7% against the dollar.
Japan was among the worst returning developed equity markets in the second quarter, sinking amid a strengthening yen and a sluggish economy. Concerns over geopolitical risk in Europe as well as slowing global growth further pressured stocks. Overall, the MSCI Japan Index fell 8%, while the MSCI Pacific Index sank 4%. The Japanese yen gained 10% against the U.S. dollar.
Japan’s economy grew faster than expected, while inflation remained tepid. First-quarter gross domestic product was revised up to 1.9%, its highest level in a year, although the increase was partially attributed to the “leap year effect.” The nation’s core inflation decreased 0.4% in May from last year, while prices excluding food and energy gained 0.7%. Both readings were unchanged from April’s report and remained far from the central bank’s 2% target rate. The Bank of Japan’s mid-June decision to keep its monetary stimulus plan steady caused a steep selloff in Japanese stocks and pushed the yen to its highest point against the dollar in almost two years. However, following the Brexit decision two weeks later, Prime Minister Shinzo Abe urged the central bank to closely monitor currency markets and take additional steps if necessary. Earlier in the quarter Abe announced his decision to delay a scheduled consumption tax hike, fearing it could hurt domestic demand.
The consumer discretionary and financials sectors each declined 13%. The strong yen held back exporters, including automobile manufacturers. Shares of Toyota, Honda and Nissan all fell by double digits. Tire maker Bridgestone traded lower after posting a 21% drop in earnings, citing currency headwinds. Shares of Nomura Holdings plummeted 29%, in large part due to global uncertainty and reduced investment appetite following the U.K. referendum. Large Japanese banks also declined sharply. Toshiba was a bright spot, climbing 26%. Investors cheered the announcement of an aggressive cost-cutting plan that would halve its capital base.
Australian equities rose 4%, led by metals and mining companies. Shares of Newcrest Mining soared 36% after the company announced production increases and lower input cost. BHP Billiton, Rio Tinto and Fortescue Metals also benefited from rising commodity prices. However, shares of Qantas Airlines declined 31%, hurt by rising oil prices and concerns that global uncertainty would reduce travel. In May, the Reserve Bank of Australia lowered its cash rate to an all-time low of 1.75%. The move contributed to a weaker Australian dollar, which depreciated 3% against the U.S. currency. Elsewhere, the MSCI Hong Kong Index traded 1% higher. Shares of Link Real Estate Investment Trust gained 17% after the shopping mall operator announced higher traffic at its properties and an increase in total distributable income for the year. Macau-based casinos weighed on the index.
Emerging markets edged higher in a volatile quarter as investors weighed the timing of the next Federal Reserve rate hike and gauged the impact of Britain’s decision to exit the European Union. The MSCI Emerging Markets IMI rose 1%, elevating its year-to-date return to 6% — the best among major global equity indices. In the second quarter, the consumer staples sector led gains, while industrials led declines. U.S. dollar–denominated bonds, as measured by the J.P. Morgan EMBI Global Index, rose 5.4% as investors searched for higher yields in a low-rate environment. Local currency debt, as measured by the J.P. Morgan GBI-EM Global Diversified Index, gained 3% in dollar terms.
Brazilian stocks led returns for major developing countries. The MSCI Brazil IMI surged 14%. As anticipated, President Dilma Rousseff was suspended from office on allegations she disguised a budget deficit. The temporary government, led by Michel Temer, has proposed to cap government spending and push pension reform to help lift Latin America’s largest economy out of recession. The real climbed 11% against the dollar, while Brazil’s dollar-denominated bonds soared 22%. Elsewhere in Latin America, Mexican stocks fell 7% as the government trimmed its 2016 growth projections due to lower oil prices and sluggish manufacturing exports. Moody’s also cut its outlook for Mexico to negative from stable. Telecommunications giant América Móvil was one of the biggest decliners, sliding 16%. The peso, under heavy pressure this year, declined 7% against the dollar.
In China, stocks finished flat as investors gauged the pace of the country’s economic growth. A batch of April data disappointed investors following encouraging readings during the first quarter. Concerns resurfaced over how much stimulus the government would provide to sustain growth and the amount of debt on corporate balance sheets. Private sector investment also continued to decelerate. Internet firm Tencent was a top gainer, rising 12% on solid first-quarter earnings. Web search giant Baidu declined 13%, hit by a weak quarterly revenue forecast. Year to date, Chinese stocks fell 5%.
Asian stocks mostly ended higher. The MSCI India IMI rose 5%, helped by favorable quarterly earnings at a number of companies. India’s economy also grew a faster-than-expected 7.9% in the first quarter. Mortgage provider Housing Development Finance Corp. and cigarette maker ITC were among the top gainers. Indonesian stocks advanced 5%. The country’s central bank cut its benchmark interest rate to 6.5%, its fourth cut this year. Separately, Indonesia’s parliament cleared a tax amnesty bill to shore up government revenue as policymakers step up infrastructure spending. Stocks in the Philippines gained 7% amid optimism for growth under new president Rodrigo Duterte, who assumed office June 30. Stocks in South Korea fell 1%.
South African stocks rose despite political turmoil and economic woes. Gross domestic product contracted 1.2% in the first quarter amid declining exports. South Africa’s faltering economy prompted Standard & Poor’s to warn it may strip the country of its investment-grade status. The MSCI South Africa IMI gained 2%. Shares of AngloGold Ashanti surged 31% as gold prices rose amid global growth worries. Media conglomerate Naspers also advanced.
Russian stocks marched higher despite a weak economy. The MSCI Russia IMI gained 5%, helped by a 26% increase in the price of Brent crude, a key export. Russia’s economy still remains wobbly as international trade sanctions have derailed growth. Shares of banking giant Sberbank rose 23% on improving profitability, while food retailer Magnit tumbled 17% on slowing revenue.
Turkish stocks stumbled amid geopolitical tensions and questions regarding the strength of the country’s economy. The MSCI Turkey IMI lost 8%, following strong first-quarter gains. President Recep Erdoğan rattled the markets with the appointment of a new prime minister seen as more receptive to his political agenda. Meanwhile, Turkey’s central bank cut the overnight lending rate to help support the economy, which grew a better-than-expected 4.8% in the first quarter. Erdoğan also sought to mend ties with Russia in a bid to revive Turkey’s tourism industry, which is mired in a deep slump due to Russian sanctions and terrorist attacks.
In debt markets, Argentina sold $16.5 billion of dollar-denominated debt in the largest-ever bond sale by a developing nation. The well-received offering marked Argentina’s return to international debt markets after a 15-year absence. Qatar sold €10 billion ($9 billion) of eurobonds in the biggest-ever bond issue from the Middle East, where governments are seeking to plug budget holes amid lower oil prices. Brazilian companies were active in the corporate market. Cash-strapped Brazilian oil producer Petrobras sold $6.75 billion of bonds in two tranches: $5 billion in five-year notes yielding 8.625% and $1.75 billion in 10-year notes yielding 9%. Mining giant Vale raised $1.25 billion in dollar-denominated bonds with a yield of 5.875%.