Dec2005
- 1. MARKET OVERVIEW U.S. investors saw mixed returns in December as signs the economy had recovered from Hurricanes Katrina and Rita were not enough to counterbalance emerging weaknesses in the housing and bond markets. The month started strong, with the S&P 500 notching a high for the year within the first ten trading days. Reports showed job growth, the price of gasoline and con- sumer confidence all returning to near pre-storm levels. Inflation, a key cause for concern in recent months, plunged in November with headline consumer prices falling the most in over fifty years. Regardless, as the holidays approached, prospects for a year-end rally soured. Data on the housing market revealed declining sales, and inventories of new and existing homes available for sale were the highest since 1996 and 1986, respectively. In the bond market, the yield on 10-year Treasuries slipped below the yield on 2-year Treasuries, producing the first inverted yield curve since December 2000. Although inverted yield curves aren’t always followed by economic downturn, they have foreshadowed the past four recessions. The predictive power of an inverted yield curve increases with the size of the inversion and the length of time the inver- sion persists. By historical standards, the 2005 inversion is weak and in its infancy, but of signif- icance nonetheless. The Federal Open Market Committee (FOMC) met in December and voted to boost interest rates by 25 basis points to 4.25%. It was the thirteenth consecutive rate hike since June 2004, and market par- ticipants are hopeful for an end to cyclical tightening in 2006. At the next FOMC meeting on January 31, Alan Greenspan will retire and is expected to be replaced by President Bush’s chief economic advisor Ben Bernanke. According to Thomson Financial, the year ended with a 4Q05 estimated S&P 500 earnings growth rate of 13.3%. Energy and technology businesses are expected to have the strongest earnings growth for the quar- ter, while materials companies are expected to experience the weakest. D E C E M B E R 2 0 0 5 at the margin G L O B A L E Q U I T Y M A R K E T O V E R V I E W December YTD S&P 500 0.4 4.9 NASDAQ Composite -1.7 2.1 Dow Jones Industrials -0.7 1.7 MSCI EAFE 4.7 14.0 MSCI EAFE Growth 5.3 13.6 MSCI EAFE Value 4.0 14.4 MSCI EM 5.9 34.5 MSCI ACWI xUS 4.8 17.1 MSCI Europe 3.5 9.9 MSCI Japan 8.6 25.6 Russell 1000 0.1 6.3 Russell 1000 Growth -0.3 5.3 Russell 1000 Value 0.6 7.1 Russell Midcap 1.0 12.7 Russell Midcap Growth 1.1 12.1 Russell Midcap Value 1.0 12.7 Russell 2000 -0.5 4.6 Russell 2000 Growth -0.2 4.2 Russell 2000 Value -0.8 4.7 ML High Yield Master II 0.9 2.7 As of 31-Dec-05 Market Performance VOL. 9 NO. 12 IN THIS ISSUE Market Overview . . . . . . . .1 Perspective . . . . . . . . . . . . .2 Equity Update . . . . . . . . . . .2 Chartbook . . . . . . . . . . . . . .3 Economic Scoreboard . . . . .4
- 2. PERSPECTIVE— MARKET OUTLOOK 2006 Calendar year end always allows us time for reflection on the previous year and anticipa- tion of things to come in the next twelve months. Last year, we believed that economic growth in the U.S. would continue to lead the world; that U.S. equities would return mid-single digits; and that emerging and developed markets outside the U.S. would deliver significantly greater returns than the U.S. markets. The only place where we failed was in predicting a stable dollar, as the dollar rose significantly during the year. It was also a great year of relative performance for Nicholas-Applegate strategies, with all of our key composites outperforming (gross of fees). What is 2006 likely to hold in store for us? So far, we have had a good first week, but there is a long way to go. We think the Federal Reserve will stop raising interest rates this year after one or two more increases, U.S. profit growth will finally slow to 6-8%, and the yield curve will remain relatively flat. We expect productivity growth to continue to surprise on the upside and inflation to remain low. In this environment, with global equities at 14x 2006 earnings, we think the markets can have a good year, with indexes up in double digits. We still expect foreign markets to outpace the U.S. markets in local currency terms, but with interest rate increases ending in the U.S., the dollar could weaken some- what, though we still think it will end the year within its two-year trading range of 1.20-1.35 $/euro. We wish all of you a very happy and prosper- ous 2006. Horacio A. Valeiras, CFA Managing Director and Chief Investment Officer EQUITY UPDATE GROWTH/VALUE EQUITY Growth outperformed value among small and mid-sized firms in December, while value outper- formed growth among larger firms. Across capital- izations, performance among growth stocks was strongest in the energy sector as investors rewarded oil companies for modestly rising oil prices. With a 6.7% gain, the health care sector in the Russell 1000 Value was the best-performing sector across capitalizations and styles in December, and the key to the outperformance of value stocks among larger firms. LARGE/MID/SMALL EQUITY Mid-cap stocks tacked on modest outperformance in December to finish 2005 with year-to-date gains more than twice those of either large- or small-cap stocks. Sector leadership for the Russell Midcap Index in December was broad-based, with mid-cap sectors outperforming corresponding small- and large-cap sectors 85% of the time. The best per- formance for the month tended to be from mate- rials and energy companies, while information technology companies tended to lag. INTERNATIONAL EQUITY International developed and emerging markets outperformed U.S. markets in December. On aver- age, emerging markets saw the best performance for the month and for 2005, with year-to-date per- formance of almost 35% across countries and some regions up by over 50%. Overseas markets have benefited this year from rising demand for commodities and from a strong dollar — which makes exports to the U.S. appear relatively cheaper. At The Margin is a monthly publication of: Nicholas-Applegate Capital Management 600 West Broadway San Diego, CA 92101 PHONE (619) 687-8000 FAX (619) 744-5545 Copyright 2005 ..>Nicholas-Applegate ....Capital Management 2
- 3. 3 Large vs. Small Caps Buying Cheap and Selling Expensive? Source: FactSet As of 31-Dec-05 P/ERatio ChangeinSharesOutstanding 6/0412/036/0312/026/02 10 15 20 25 30 35 Russell 1000YOY % Change in Shares Outstanding (rhs) Russell 2000YOY % Change in Shares Outstanding (rhs) Russell 1000 5-Year Average P/E (lhs) Russell 2000 5-Year Average P/E (lhs) % -25 -15 -5 5 15 25 12/056/0512/04 Shares Outstanding & Price-to-Earnings Ratios Jan-01 to Dec-05 ConsumerYield Curve Source: FactSet As of 31-Dec-05 3 4 5 6 7 8 9 95 96 97 98 99 00 Mortgage Lending Rate; Freddie Mac 30-year Fixed Rate Prime Rates Major Banks 01 02 03 04 05 % Emerging Markets Jan-99 to Dec-05 Source: A Merrill Lynch & FactSet s of 31-Dec-05 IndexLevel IndexLevel 0 10000 20000 30000 40000 50000 60000 99 00 01 02 03 04 05 0 200 400 600 800 1000 1200 MSCI Emerging Markets Index Level (lhs) Merrill Lynch Emerging Markets Spread (rhs) CHARTBOOK — RESEARCH FROM THE FIELD Using the prime rate and the 30-year fixed mortgage rate, we can formulate a consumer yield curve. While the Treasury yield curve has only recently inverted, the consumer yield curve inverted earlier in the year. Shorter- term borrowings, such as home equity lines of credit, now cost more than a vanilla 30-year fixed rate mortgage. This will cause even more stress on con- sumer credit, as many newer home- owners have used exotic credit financing, which will soon be resetting at higher rates than those for long-term fixed loans. Over the last two years, we have seen a definite trend toward an increase in shares outstanding for small-cap companies, while large-cap companies continue to take shares off the table. With the persistent disparity in valuations between the two, larger companies appear to have been reinforcing their conviction in their own businesses by effectively increasing their equity stake at a good price. At the same time, smaller companies are increasing their number of shares outstanding, getting the most for their equity stake. The emerging markets have had a nice run over the last two years. Will the markets continue their ascent or are they too expensive? Issues such as con- flicting monetary policies and elections have investors searching more critically for reasonable valuations. China and India continue to have positive growth, while Latin America is seeing some slowing in positive momentum.
- 4. 4 600 WEST BROADWAY SAN DIEGO, CA 92101 (619) 687-8000 • WWW.NICHOLAS-APPLEGATE.COM DISCLOSURE: Nicholas-Applegate Capital Management (NACM) is a registered investment advisor with the Securities and Exchange Commission. The Firm is defined as all actual, institutional and mutual fund accounts (including sub-advisory relationships) managed by NACM. The managed (wrap) account business of NACM is held out separately as Nicholas-Applegate Managed Accounts (NAMA). The effective date of NACM’s firm-wide compliance with the AIMR- PPS standards is January 1, 1993. NACM claims compliance with the AIMR Performance Presentation Standards (AIMR-PPS), the U.S. and Canadian version of GIPS. AIMR has not been involved with or reviewed NACM’s claim of compliance. To receive a complete list and description of NACM’s composites and/or a presentation that adheres to the AIMR-PPS standards, contact our Performance Measurement Group at (619) 687-2800, or write Nicholas- Applegate Capital Management, 600 W. Broadway, 29th Floor, San Diego, CA 92101, Attn: Performance Measurement Group. Under no circumstances does the information contained within represent a recommendation to buy or sell securities. Investments in overseas markets pose special risks, including currency fluctuation and political risks, and the portfolio is expected to be more volatile than that of a U.S. only portfolio. These risks are generally intensified for investments in emerging markets. Small-cap stocks may be subject to a higher degree of risk than more estab- lished companies’ securities. The illiquidity of the small-cap market may adversely affect the value of these investments. Unless otherwise noted, equity index returns reflect the reinvestment of all income dividends and capital gains, if any, and bond index returns include all payments to bondholders, if any. Index return calculations do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index. Securities, sectors, countries and representative buys and sells herein illustrate companies, sectors and countries in which the portfolios may invest. Portfolio holdings are subject to change daily. Unless otherwise noted, Nicholas-Applegate is the source of all performance data, characteristics, charts and illustrations. Past performance is not an indication of future performance. ECONOMIC SCOREBOARD COMMENTS POSITIVES Inventories November inventories-to-sales ratio at record low Consumer Confidence Two-month increase through December most in two years Valuations Risk premium models indicate equities are still cheap Industrial Production Solid November production led by high-tech industry NEUTRAL GDP Expectations for moderate 4Q05 after brisk 3Q05 Corporate Earnings 4Q05 earnings look good but below initial forecast Geopolitical Iraq elections offset continuing violence in Middle East Investor Sentiment Slightly down in December, falling more overseas Inflation Headline CPI & PPI fell in Nov. Core stats moderated Employment November unemployment steady at 5.0% Retail Sales Headline sales up moderate 0.3% in November NEGATIVES Housing Sales are falling and inventories are up Oil Prices Down from post-storm highs, but still expensive Monetary Policy Fed funds rate hits 4.25%; cyclical tightening near end? As of 31-Dec-05 Nicholas-Applegate’s Assessment of Current Economic Indicators