Equity investors began the month of December with high hopes for the holiday season. Optimistic market players continued the November rally and sent major indices towards gains not seen since the late summer. With stronger results from economic indicators, market players also looked towards slight gains in corporate earnings, the success of the war effort in Afghanistan, and the holiday retail-sales season as hopeful signs. Despite the reports of gains from discount retailers, it seemed that retailers were mired in a holiday slump, and this may have kept indices from performing as well as they could have. Nevertheless, most of the major indices achieved nice gains throughout the month, again, mostly on the strength of positive investors. The Dow played around the 10,000-point level before finishing above this level by the end of the volatile month. The NASDAQ continued its solid performance from the past few months, and even played around the 2,000-point mark a few times during the month.

Technology and telecommunications companies that had paced the economy in past months fell off slightly as the earnings picture was mixed despite an improved future outlook. Energy stocks gained on the month as a deal struck by OPEC to limit supply was seen as a positive to equity investors, despite the continuing repercussions arising from a major bankruptcy that was reported in the oil industry at the end of November. Health care stocks and the financial sector performed well yet again, although financial stocks were mixed for the month. Companies in the leisure and travel industries again performed poorly in December. Transportation stocks in the airline industries dominated the negative movers, although the automobile sector again performed well for the month. Consumers continued to take advantage of zero-percent financing spurring auto sales.

Some days of the month were particularly strong, especially in the first few days of December. Market players sent indices rushing past the 10,000-point mark as the first two days of December brought triple-digit gains. The second week of the December saw a decline back below the 10,000 point level as economic reports and another rate cut and negative comments from the Fed brought grounded investors. By the third week of December, the Dow was pushing past the 10,000-point level yet again, while the NASDAQ flirted with the 2,000-point level. As December drew to a close and the holidays came upon us, markets began to taper off, losing some steam as low volumes hit the market. Market players continue to hope that equities have already bottomed out, and the positive moves in December may be enough to prove that. Increases across major indices again outdistanced declines for the month of December. The Dow closed the month with a gain of 1.7 percent, while the NASDAQ similarly recorded a gain of 1.0 percent. The S&P 500 barely increased, finishing up just 0.7 percent for December. The Russell 2000 outpaced other indices and increased by 7.6 percent, while the market encompassing Wilshire 5000 index increased 3.3 percent in December.

Taking a look at the year in review, equity markets were sailing on some choppy seas. A swoon that began early in the year sent indices to dramatic declines; only in the past two months have equities begun a recovery. The end of last year saw bullish investors trying to maintain some strength in equities, while this year saw bearish investors dominate. The year could basically be split between pre-September 11th levels and post September 11th levels. Markets were confused as to the direction of the economy for much of the year, but any weakness was exacerbated by the terrorist attacks on New York City and Washington D.C. September and October saw dramatic decreases in equities, and November and December saw optimistic investors hoping that equity indices had hit their lows and would bounce up for the year. By year-end, the percentage loss on the Dow was just over 7.1 percent, while technology stocks floundered, leading the NASDAQ to a 21.0 percent decline on the year. The S&P 500 lost just over 13.0 percent on the year, while the Russell 2000 was the only major index to gain on the year, up just over 1.0 percent. The market-encompassing Wilshire 5000 was down 12.0 percent on the year.

The Treasury Market

A Holiday Scrooge

Equities may have performed slightly better in the volatile holiday month of December, but Treasury securities continued their November declines amidst stronger economic reports and investor optimism about future recovery. Economic reports that affected Treasury markets this month ranged from lower than expected weekly jobless claims throughout much of December, signs of recovery coming from consumer attitudes surveys released by the Conference Board and the University of Michigan, and more signs of possible recovery in the manufacturing sector. Treasury market players are concerned because if the U.S. economy recovers, it could signal the end of the Fed easing cycle.

Speaking of the Fed, December 11th saw another Fed rate cut, taking the federal funds rate to 1.75 percent, and the discount rate to 1.25 percent. The rate cut and the accompanying comments from the Fed kept Treasury investors hopeful that the easing cycle is not over. Sadly, the good news in the rate-cut announcement could not hold securities up, as illiquidity concerns hit the market as the year drew to a close. Treasury market players also went through some end-of-year consolidation as the year ended, and securities traded up slightly as December ended.

As can be seen in the chart above, yields moved up for the month of December. The mid-month figure was higher than the final figure, which saw the aforementioned consolidation, along with some equity weakness towards the end of December which helped push Treasury securities gently higher. Yields were up for the most part across the maturity spectrum. The 30-year bond gained 20 basis points on the month, while the 10-year note gained 32 basis points. The short-end of the yield curve also performed poorly, as the 5-year note increased by 30 basis points and the 2-year note increased by 20 basis points. The lone solid performer was the 3-month bill, which actually traded higher for the month and finished down 6 basis points in yield.

2001 was a very mixed year in the Treasury market, as yields bounced up and down along the yield curve. Treasury market players also received two surprise moves from the Treasury department, which eliminated the 52-week bill early in the year, and suspended indefinitely the issuance of new 30-year bonds late in the year. With the U.S. economy mired in a slump and the Fed lowering interest rates throughout the year, bond prices were generally trending higher. Then came September 11th, and the world changed. The risky situations around the globe propelled a remarkable rally that sent bond prices rising and yields tumbling down across the maturity spectrum. In the end, Treasury market players could not sustain the rally as the Treasury market may have oversold in the wake of the September 11th disaster. Illiquidity concerns closed the year off, and bond prices fell (and yields rose) as 2001 drew to a close.

The table above depicts the variations of yields over the year. The 30-year bond and 10-year note yields each ended 2001 with a 13-basis point gain from the beginning of the year. The yield on the 5-year note fell 45 basis points, while the 2-year note yield dropped 186 basis points since the beginning of the year. But after all is said and done, the decline in Treasury yields was meager compared with the 475 basis point decline in the federal funds rate. The Fed did ease quite a bit this year, but one wouldn't know it by the modest declines in Treasury security yields.

Damir Fonovich, Economist, Econoday