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The build up to war, and the subsequent invasion of Iraq by
the US-led coalition, dominated market sentiment during the first
quarter. Most major equity indices staged a brief rally at the
start of the New Year but by mid January, US military rhetoric,
in the face of a growing anti-war movement, provided the catalyst
for a further sell-off in equity markets. Against this backdrop,
bond yields continued to fall reflecting the continued aversion
to risk. UK bond yields were relatively unchanged over the quarter,
but at their low point reached the levels last seen after the
Asian currency crisis in 1998. The continuing volatility of equity
markets kept many investors on the sidelines over the period,
as evidenced by the historically high levels of cash and money
market funds.
Markets drifted as the world awaited a conclusion to the escalating
crisis in the Middle East, reacting to updates given by Hans
Blix to the UN and warnings from both the US and the UK governments
of military action against Saddam Hussein's regime in the absence
of full compliance of UN resolution 1441. A sell-off in equity
markets gathered momentum in early March and in the UK the FTSE
100 closed down over 18% (from the end of December) at its worst
point during the quarter, broadly in line with other major equity
indices. This capitulation in equity markets in the UK was accompanied
by a fall in bond yields resulting in a reversion of the gilt:equity
yield gap, for the first time since 1959. However, equities were
quick to rebound alongside the invasion by coalition forces over
the course of the following week, retracing much of the quarter's
decline. Nevertheless, the initial expectations of a short conflict
turned to concern over the economic and political cost of a protracted
confrontation and markets, led by fervent media coverage, closed
the quarter in negative territory.
In the UK, the FTSE 100 index ended the period lower by 1.5%
led by the Life Companies and Insurers, despite a relaxation
in the solvency regulations by the FSA in January. The decline
was broadly typified across the other UK indices, with the Mid
Cap 250 and the Small Cap indices lower by 5.1% and 7.4% respectively.
The wider FT-All Share index closed down 2.1% over the quarter.
During the period the MPC surprised the City in lowering interest
rates by 0.25% to 3.75% which, despite being at their lowest
level since 1955, was not applauded by an already pessimistic
audience. Given the developing situation in the Middle East it
was unsurprising to see a number of economic releases below consensus
forecasts and increasing signs of caution being adopted by the
UK's highly indebted consumers. In London, having seen the greatest
increases in house prices, cracks began to emerge in the residential
market, exacerbated by cautious press comment for the outlook
in 2003/4.
US equities were among the best performers globally (in local
currency terms) during the quarter. The Dow Jones Industrial
Average closed lower by just 0.2% whilst the S&P 500 rose
by 0.4%. The NASDAQ index, having fallen by 75% since it's March
2000 peak earlier in the period, closed the quarter higher by
3.8%. US interest rates remained unchanged at 1.75%, the Federal
Reserve having led the way in 2002. European bourses displayed
similar trading patterns to the UK, and the Dow Jones Euro Stoxx
index fell by 5.8% over the period. The German market had fallen
by over 30% by early March, but subsequently rallied to close
down 8.3% as measured by the Dax. The weakening economic climate,
particularly within Germany, led the ECB to cut interest rates
by 0.25% to 2.5%. In the Far East, the Japanese Nikkei 225 index
fell by 5.4% to close at levels last seen in 1983 and Hong Kong's
Hang Seng ended lower by 3.4%. Markets in the Asian region continued
to be nervous over North Korea's missile tests in addition to
the Middle East conflict and, toward the end of the quarter,
problems were compounded by the widely reported 'SARS' respiratory
virus and concerns that it may affect the region's economies.
Further afield, the Australian ASX 200 fell a more modest 0.4%
as the relatively buoyant level of commodity prices helped to
pare losses.
The conflict in the Middle East resulted in the price of oil
extending gains made in previous quarters, peaking at just under
$35 in early March. However, the price collapsed to just under
$26 in little over a week as hopes of a preserving the Iraqi
oil fields took hold, but rose again slightly to close at $25.43,
down 15.2% over the quarter.
Commodity markets generally experienced a similar trading pattern
over the quarter, rising throughout January and into February
before falling toward the latter part of the quarter. The price
of Gold, which had rallied strongly during 2002, peaked at $381.25
(a rise of over 9% in little over a month) before falling back
to end the quarter lower by 6.5% at $325.55.
Major currencies ended the period broadly unchanged although
the Euro continued to rise against the dollar closing at 1.074,
its highest quarterly closing level since 1999.
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