BENEFITS AND INVESTMENT SOLUTIONS (BIS) First Quarter 2001 Merrill Lynch Benefits and Investment Solutions Merrill Lynch Benefits and Investment Solutions Copyright 2001. All rights reserved. Printed in USA The information set forth herein was obtained from sources which we believe reliable, but we do not guarantee its accuracy.
Neither the information, nor any opinion expressed, constitutes a solicitation by us of the purchase or sale of any security or commodities. U.S. MARKET OVERVIEW Stocks continued to retreat in the quarter ended March 2001, as the bear market intensified.
But bonds moved to the upside. The stock market sustained new losses as it reeled under a relentless stream of earnings shortfalls announcements. Following a brief upturn in January, technology stock prices resumed their tumble.
Many investors, finding that even the staunch "old economy" stocks were declining in value, simply withdrew from the equity market. The Wilshire 5000 stock index, a proxy for the domestic stock market, lost 212.3 % for the quarter. Although some economic sectors suffered more than others (especially the technology and telecom groups) hardly any sector went unscathed.
In contrast, the Merrill Lynch Domestic Bond Master index, our bond market proxy, produced a positive +3.0 % return for the quarter. The Merrill ... more. less.
Lynch Balanced 50/50 index, which combines these two domestic markets equally, lost 24.8%. Overseas stock market results were also negative, influenced by strong spillover effects from the US markets, and once again from the strength of the US dollar.<br><br> The MSCI EAFE index, our international stock markets proxy, lost 2 13.7% in the March quarter. EQUITY MARKETS A burst of investor relief and bullishness greeted the Federal Reserve 9s quick 1% reduction of its rates in January. It did not last.<br><br> Investors focused once more on the rapidly evaporating earnings, and the seemingly unstoppable grinding to a halt, if not recession, of the US economy. Every new market low was followed by a lower low, until investors became thoroughly discouraged. Even the Fed 9s additional 1/2 % reduction in March was viewed as too little, and observers remembered that it takes many months before the impact of rate cuts is manifested in the economy.<br><br> In this gloomy environment, all categories of stocks recorded declines. The Wilshire 5000 index 9s loss of 212.3% for the quarter was similar to the Russell 3000 index decline of 212.2% and the S&P 500 index 9s decline of 211.9%. These losses come on the heels of an already sharply 2negative quarter ended December 2000, so that the combined two 2quarter losses were of bear market proportions.<br><br> For the six months ended March, 2001 the Wilshire 5000 index lost a total of 221.3%, the Russell 3000 index lost 220.1%, and the S&P 500 index lost 218.8%; the NASDAQ composite index, viewed as a proxy for technology stocks, lost half of its value. Disappointing earnings announcements coming from every direction persuaded investors that a general "earnings recession" was at hand, and the continued liquidation of technology stock holdings did not generate much rotation into other sectors. For example, health care stocks were badly hit, and other groups that had been relatively reasonably valued, such as consumer staples and financials, also recorded significant losses.<br><br> Even defensive groups like energy and utility stocks showed losses of 25% to 215%. For portfolios that follow either growth or value styles, negative returns were the rule in the March quarter. However, large differences in returns appeared because losses in the value styles were generally much smaller than losses of the growth 2oriented portfolios, many of which held technology stocks that were big percentage losers.<br><br> Thus the large cap Russell 200 (large company) growth index declined 220.0% for the quarter versus a much smaller loss of 26.9% for the Russell 200 value index. A similar comparison can be noted for the Russell midcap growth index 9s decline of 225.1 % versus the small loss of 23.5% of the Russell midcap value index. With respect to small companies, the Russell 2000 (small cap) growth index fell 215.2%, while the Russell 2000 value index was virtually flat at +1.0%.<br><br> In the foreign equity markets, the MSCI EAFE (Europe, Australasia and Far East) index was down a significant 213.7% for the quarter ended March 2001, in US dollars. The loss for the six month period since September 2000 comes to a discouraging 216.1%. Note that the US dollar continued to strengthen during much of the quarter, so that 5% to 7% of the loss is attributable to the relative weakness of European currencies, while Japan 9s bleak economic outlook hurt its currency by a steep 8 1/2 % loss against the dollar.<br><br> In general, overseas markets seemed to follow whatever was happening in the US markets, given that the US economy is by far the largest consumer of their products and services, and a major participant in the markets they share. The March quarter loss for the European region at 215.5% was clearly not helped by the weakened euro. In the Pacific region, a rally of sorts in Japan 9s markets brought local performance up to about even for the quarter, but reduced it to 29.2% due to the negative impact of the yen.<br><br> The emerging markets overall rebounded somewhat from their headlong slide in the December quarter, but still declined by 25.5% for the quarter. 2 BIS Market Focus FIXED INCOME MARKETS Bonds continued to surprise investors with robust returns during the March 2001 quarter. In a new initiative, more investors returned to long 2neglected corporate bonds, both investment grade and high yield, now that stock returns were languishing.<br><br> The Merrill Lynch Domestic Bond Master index scored an impressive +3.0% for the March quarter. The latest economic statistics confirmed the growing weakness across the economy, and the Federal Reserve seemed to signal its concern by reducing rates twice during January, and again in March, for a total reduction of 1 1/2 %. Yields declined by about 0.2% to 1.0% in the March 2001 quarter, though the most significant yield declines took place in the short maturities (3 years or less).<br><br> This reduction in yields produced price gains, which together with the coupon brought returns for the quarter up to +3.0%. Once again, the money 2market portion of the yield curve (3 2month Treasury bills), with slightly higher yields, suggested that the Fed 9s monetary policy required further loosening. In general, the price gains helped bonds to earn returns well above their coupons.<br><br> Thus the short term Merrill Lynch 1 23 year Treasury index returned +2.8% in the March 2001 quarter, while the longer Merrill Lynch 5 210 year Treasury index returned +3.0%. At the very long maturity end, however, the Merrill Lynch 15+ Year Treasury index 9s returned just +1.1% for the quarter, retreating a bit due to scattered signs that the prospects for inflation might be strengthening. Investor sentiment towards bonds grew steadily more positive during the March quarter as investors turned away from investing in stocks.<br><br> Investment grade corporate bonds came back into favor. The Merrill Lynch Corporate Bond Master index showed a positive +4.4%. The rebound of high 2yield (junk) bonds was even more impressive, with the Merrill Lynch High 2 Yield index returning 6.2% for the quarter.<br><br> Municipal bonds also for the most part recorded small price gains that resulted in a positive performance. The Merrill Lynch Municipal Master index gained +1.8% for the quarter. For mortgages, the price gains were somewhat restrained by the rising prepayment risk posed by lower yields: The Merrill Lynch Mortgage Master index gained +2.7% for the March quarter.<br><br> Market Index Returns ML Capital Markets Index Balanced 50/50 Index Wilshire 5000 S&P 500 (Large Cos.) Russell 200 (Large Cos.) Russell 200 Large Cap Growth Russell 200 Large Cap Value Russell Mid Cap Russell Mid Cap Growth Russell Mid Cap Value S&P Midcap (Midsize Cos.) Russell 2000 (Small Cos.) Russell Small Cap Growth Russell Small Cap Value ML Domestic Bond Master ML 1 23 Yr. Treasuries ML 1 210 Yr. Corp./Govt.<br><br> 90 Day Treasury Bills ML Convertible Bond Index ML High Yield Bond Index MSCI World Index MSCI EAFE Index MSCI Europe Index MSCI Pacific Index * Morgan Stanley Capital International Indexes (MSCI) All indexes include dividend reinvestment Equity Fixed Income Global Equities* 1Q01 27.7 24.8 212.3 211.9 213.3 220.0 26.9 210.5 225.1 23.5 210.8 26.5 215.2 1.0 3.0 2.8 3.4 1.3 26.0 6.2 212.9 213.7 215.5 29.2 2000 25.3 0.2 210.8 29.1 212.1 224.5 2.3 8.2 211.7 19.1 17.5 23.0 222.4 22.7 11.7 8.0 10.1 6.4 211.7 23.8 213.1 214.1 28.1 225.6 3 BIS Market Focus Market Focus The first quarter of 2001 was a continuation of the downtrend in stocks that started in 2000, only more intense and widesp read as many investors turned away from stocks in general. Both large and small stocks joined in the decline, as proxied respectively by the S&P 500 index and the Russell 2000 index. As may be expected, however, there were often wide variations in price changes among different sectors and individual stocks.<br><br> The performance of international markets, proxied by the MSCI EAFE index, was equally disappointing. In contrast, bonds performed well, continuing their year 2000 uptrend. · Market Performance Cumulative Returns 12/31/95 - 3/31/01 Dec-95 Mar-96 Jun-96 Sep-96 Dec-96 Mar-97 Jun-97 Sep-97 Dec-97 Mar-98 Jun-98 Sep-98 Dec-98 Mar-99 Jun-99 Sep-99 Dec-99 Mar-00 Jun-00 Sep-00 Dec-00 Mar-01 -25 0 25 50 75 100 125 150 175 104.5 52.8 66.8 40.9 21.8 31.8 14.8 S&P 500 Balanced 50/50 Index Russell 2000 ML Domestic Master Treasury Bills MSCI EAFE Inflation S&P 500 Russell 2000 Balanced 50/50 Index ML Domestic Master MSCI EAFE Treasury Bills Inflation 1996 22.9 16.5 12.2 3.6 6.0 5.2 3.3 1997 33.4 22.4 20.2 9.7 1.8 5.3 1.7 --------- ANNUALIZED RETURN % --------- 1998 28.6 22.5 16.8 8.9 20.0 5.2 1.6 1999 21.0 21.3 10.9 21.0 27.0 5.0 2.7 2000 29.1 23.0 0.2 11.7 214.1 6.4 3.4 1Q01 211.9 26.5 24.8 3.0 213.7 1.3 1.3 12/31/95 - 3/31/01 Annualized 14.6 8.4 10.2 6.8 3.8 5.4 2.7 Est.<br><br> 4 BIS Market Focus Equity Focus The total market capitalization of the S&P 500 index at the end of March 2001, standing at some $10.3 trillion, had declined a huge $1.3 trillion from year-end 2000. Much of the decline is attributable to losses by the Information Technology sector (-24.4% for the quarter), although some degree of loss affected almost all groups. By the end of March 2001, the percentage weight of the Information Technology sector, though still the largest sector, had shrunk to 19% -- a far cry from its peak of 34% a year before (March 2000).<br><br> One consequence of the continuing shrinkage in the relative weight of Information Technology was its effect in boosting upward the relative weights of the other sectors. The only other sector which recorded a decline in its percentage weight was the Health Care sector (to 13.9% from 14.3% at year-end), due to its own above average losses (-14.8% for the quarter). · S&P 500 Economic Sector Weightings % As of March 2001 19.1% 17.5% 13.9% 11.0% 10.9% 8.2% 6.8% 6.1% 4.2% 2.4% Info Technology Financials Health Care Consumer Discretionary Industrials Consumer Staples Energy Telecommunication Utilities Materials S&P 500 Sector Returns Consumer Discretionary Telecommunication Materials Energy Utilities Consumer Staples Financials Industrials Health Care Info Technology -60 -40 -20 0 20 40 60 80 1.9 -20.7 -0.6 -39.6 -5.7 -18.5 -6.2 14.5 -7.0 54.7 -9.8 16.4 -9.8 25.6 -10.7 5.6 -14.8 38.1 -24.4 -40.3 1Q01 2000 5 BIS Market Focus Equity Focus The chart depicts the market course of the growth and value styles, as proxied by the Russell indexes, over the two years through March 2001.<br><br> The index movements reveal that an early pattern of sharp divergence occurred between growth and value styles in favor of growth , through the period ended March 2000. But the pattern dramatically reversed since then -- and more than reversed - so that the value indexes are all showing positive returns for the total two-year period, while the growth indexes all finished with negative numbers. · This chart depicts the contrasting movements of three Russell sub-indexes over the last four years, to represent three capitalization segments of the stock market.<br><br> Note that the divergence in performance between them grew more pronounced after 1997. The large cap index, which is dominated by growth-style companies (especially technology and communication stocks), jumped even faster between September 1998 and March 2000. But the period since then shows a continuing convergence in the relative performance of the three indexes.<br><br> · Growth and Value Styles 3/31/99 - 3/31/01 -40 -20 0 20 40 60 80 100 Jun-99 Dec-99 Jun-00 Dec-00 -7.6 -26.8 2.0 -3.3 18.6 -4.3 35.3 Russ Sm Val Russ Mid Val Russ 200 Lg Val Russ Mid Gr Russ Sm Gr S&P 500 Russ 200 Lg Gr Index Returns S&P 500 Russell 200 Lg Growth Russell 200 Lg Value Russell Mid Growth Russell Mid Value Russell Sm Growth Russell Sm Value 1Q01 211.9 220.0 26.9 225.1 23.5 215.2 1.0 2000 29.1 224.5 2.3 211.7 19.1 222.4 22.7 Annualized Return 3/31/99 2 3/31/01 23.9 214.5 1.0 21.7 8.9 22.2 16.3 Cumulative Return 3/31/99 2 3/31/01 27.6 226.8 2.0 23.3 18.6 24.3 35.3 Cumulative Performance for Selected Stock Indexes Large vs. Midcap vs. Small -20 0 20 40 60 80 100 120 140 Jun-97 Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 63.2 64.1 38.3 Russell Mid Cap Russell 200 Russell 2000 6 BIS Market Focus Fixed Income Focus Bond prices again advanced in the quarter ended March 2001, as interest rate levels continued to decline.<br><br> Notable were the gains in corporate bonds, which were at the head of the list in relative performance. Most impressive was the +6.2% jump by the high yield bonds, reflecting in part a rebound from their dismal performance in the December quarter. In general, shorter term bonds enjoyed a bigger price flip because of the way in which the yield curve shifted, from flat to an upward-sloping curve.<br><br> Convertible bonds did not participate in the broad bond rally, however, showing instead a loss of -6%, attributable to their dependence on the underlying stocks that were mired in their own bear market. · Fixed Income Index Return Comparison High Yield L/T High Grade Corp. Master 3-5 Yr.<br><br> Tsy. 5-7 Yr. Tsy.<br><br> Corp. & Gov 9t. Domestic Master 1-3 Yr.<br><br> Tsy. 7-10 Yr. Tsy.<br><br> Mortgage Master Gov 9t. Master 91 Day T-Bills Long Term Tsy. Convertibles -20 -10 0 10 20 30 6.2 -3.8 5.0 12.7 4.5 9.1 3.2 10.8 3.2 13.2 3.1 11.9 3.0 11.7 2.8 8.0 2.8 14.6 2.7 11.3 2.5 13.1 1.3 6.4 1.1 20.9 -6.0 -11.7 1Q01 2000 Fixed Income Characteristics as of 3/31/01 * Weighted Average Life for Mortgages Long Term Tsy.<br><br> L/T High Grade 7-10 Yr. Tsy. Corp.<br><br> Master Corp. & Gov 9t. Gov 9t.<br><br> Master Domestic Master 5-7 Yr. Tsy. High Yield Mortgage Master 3-5 Yr.<br><br> Tsy. 1-3 Yr. Tsy.<br><br> 91 Day T-Bills 0 10 20 30 40 11.5 21.6 11.1 27.0 6.4 8.4 5.7 10.6 5.6 9.4 5.5 8.9 5.0 8.1 4.8 5.9 4.5 7.2 3.7 5.0* 3.4 3.9 1.6 1.7 0.2 0.2 Yrs. Duration Yrs. Maturity 7 BIS Market Focus Fixed Income Focus In the first quarter of 2001, investors seemed to rediscover the attractions of the high coupon rates that are paid out by corporate bonds.<br><br> Most striking was the sharp about-face (+6.2% for the quarter) made by the high yield (junk) bond sector, which during the previous quarter had endured severe liquidity pressures. Compared with Treasury and Agency bonds, corporate bonds were the best- performing segment of the bond market in the March 2001 quarter. Even so, however, in the two years since end-March 1999, high yield bonds had recovered only a fraction of their coupon return, accumulating to only +2.7% over the period.<br><br> · The Treasury yield curve declined sharply again during the March 2001 quarter, helped along by the Federal Reserve 9s dramatic 1 1/2 % reduction of its key interest rates. Bond prices had already advanced in response to a drop in the yield curve, as shown in the chart, from end-September to end-December 2000. The further drop in the yield curve to end-March 2001 caused bond prices to advance again, especially for shorter maturity bonds where interest rate declines were more prominent.<br><br> The yield curve 9s shape changed, moreover, to an upward-sloping or "normal" curve, responding to the rapidly slowing economy and the decline in demand for new short term borrowings. · Cumulative Price Change for Bond Sectors Corporate Bonds vs. ML High Yield Master -10 -5 0 5 10 15 Jun-99 Dec-99 Jun-00 Dec-00 12.6 2.7 ML Corporate Master ML High Yield Master Treasury Yield Curve 3 Mos.<br><br> 6 Mos. 1 Yr. 2 Yr.<br><br> 3 Yr. 5 Yr. 10 Yr.<br><br> 30 Yr. 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 9/30/00 12/31/00 3/31/01 8 BIS Market Focus International Focus Most stock markets around the world extended, and even accelerated, the losses recorded in the year 2000. In general, foreign returns were additionally depressed by the strength of the US dollar.<br><br> The major markets in Europe all recorded large losses, while the loss shown by Japan 9s market was mostly attributable to the weakness of the yen. Given that the US stock market was acting just as poorly, it is not surprising that the loss by the World index for the March 2001 quarter was of the same order of magnitude. · MSCI EAFE Returns March 2001 Quarter and Year 2000 Country Weightings as of 3/31/01 -30 -25 -20 -15 -10 -5 0 5 Japan UK Germany France EAFE -8.6 -28.0 -12.5 -11.5 -14.5 -15.2 -17.0 -4.1 -13.7 -14.1 1Q01 2000 23.9% 21.6% 8.8% 11.2% 100.0% Return Comparison Source: MSCI Indexes -16 -14 -12 -10 -8 -6 -4 -2 0 S&P 500 Europe World EAFE -11.9 -9.1 -15.5 -8.1 -12.9 -13.1 -13.7 -14.1 1Q01 2000<br><br>