Last quarter was the best for international equity markets in more than two decades. Investors stepped up bets on a quick recovery for the world economy, sending share prices to levels unseen since the early days of last year’s financial crisis. Value stocks outperformed growth stocks by a large margin, while the U.S. dollar traded lower against most major currencies. The MSCI EAFE Index gained for the quarter, moving it into positive territory for the year.

A rush of optimism invigorated Asian markets during the second quarter, sending stock prices to the highest level since early October. The MSCI Pacific Index posted a gain, as 463 of 491 companies advanced. Singapore was the best-performing country in the developed world. According to The Economist, trade is equal to 95.8% of Singapore’s GDP, making it the most heavily trade-dependent nation globally after Aruba. With simultaneous recessions underway in Japan, the U.S. and Europe, exports out of Singapore fell 17% in March (year-over-year). A record number of Singaporeans lost jobs during the first quarter, amid the nation’s worst economic contraction since independence in 1965. Early indications of economic stabilization in the U.S. and China thrust the MSCI Singapore Index into a 46.0% rally, the country’s largest since a 101.5% surge during the first three months of 1975. Japanese shares lagged neighboring countries, but still managed a 23.1% gain. After nearly three years of downbeat assessments, the Bank of Japan upgraded its estimate of the local economy, noting that second quarter output should be “significantly better” than prior periods. Japanese consumer confidence rose to a ten-month high, while industrial production increased 5.2%, the most in fifty-six years.

European bourses rallied hard last quarter, slamming the door on six consecutive quarterly losses. The benchmark MSCI Europe Index had its biggest gain in thirty-four years. Every country except Ireland increased at least 10%. Financial shares spiked an average 47.1%, while materials companies gained 34.4%. Central bankers loosened monetary policy and politicians promoted economic stimulus plans. The European Central Bank (ECB) dropped its benchmark lending rate to a record low 1% and announced it would begin buying assets backed by mortgages and public sector bonds. The National Bank of Denmark and the Swedish Riksbank followed suit, cutting rates to historic lows. Germany announced $106 billion in government spending to kick start its economy. Spain earmarked $66 billion. The U.K. government planned $37 billion in stimulus spending with the Bank of England injecting another $110 billion through a program of quantitative easing. Lagging indicators underscored the scale of the damage wrought by the credit crisis. Economic output in Germany, Italy and the broader euro region contracted at the fastest pace on record during the first quarter. Standard & Poor’s put the U.K. on a negative credit watch for the first time ever. A raft of other European nations were already downgraded or on negative outlook, including Ireland, Portugal, Iceland, Greece and Spain.

The Allianz NACM International Fund delivered a positive return in the second quarter and trailed the MSCI EAFE Index. The portfolio was hurt by stock selection in the Materials and Financials sectors but helped by selection in Energy. On a country level, select names in Japan detracted the most from performance, though selection in France and the UK also caused drag. Stock selection in Spain and Hong Kong contributed positively.

Credit Agricole, a French banking and insurance provider, was one of the biggest detractors to performance. The stock was punished as Italian regulators renewed their objections of a pact between the company and Generali regarding voting procedures for each company’s shares of Italian bank Intesa Sanpaolo. Credit Agricole has been ordered by the regulator to cut its 5.8% stake in Intesa to less than 2% this year, which could be at a loss if forced to sell in the current market conditions. Another negative contributor was Enel, an Italian utility company. In an effort to diversify its business the company purchased a 25% share in Spanish utility company Endesa. Investors reacted negatively to the transaction on concerns of capital impacts to Enel.

Spanish bank Banco Santander was a leading contributor to performance during the quarter, adding to relative performance. Investors reacted favorably to a series of analyst upgrades during the month, a result of the bank trading at a discount to local and global peers despite more visible earnings and sound capital ratios. The portfolio’s material underweight to Swiss pharmaceutical company Roche Holding was also additive to performance. The stock tumbled during the period on news of Avastin, a cancer drug that the company recently added to its shelf following its purchase of Genentech in March, failed early-stage trials for early-stage cancer treatments. Further troubling are new studies that suggest that under certain circumstances the drug, which is currently approved to treat advanced colon, lung, breast and brain tumors and generates $4.8 billion in global annual sales, may actually promote tumor growth in distant organs. Not owning this significant Index holding contributed to the quarter’s returns.

Based on bottom-up selection, at the end of the period the portfolio was overweight Energy and underweight Consumer Discretionary and Consumer Staples. On a country basis it was overweight Spain and France and underweight Australia, Japan, and Switzerland.

With global stock markets and commodities up sharply since March, investors are asking whether the worst is behind us. Certainly, authorities worldwide have pulled out all the stops, using monetary and fiscal policies and government balance sheets to thaw frozen credit markets. As a result, we have seen stabilization in the rate of economic decline around the world and the large contractions witnessed in 4Q08 and 1Q09 should not be repeated. Still, we would prepare for a prolonged period of below-potential growth. The de-levering of the American consumer, growth engine for international export markets, will probably take time. Unemployment will likely continue to rise in many countries, as it is usually a lagging indicator. We also expect higher tax rates, as we have already seen in the U.K. and proposed in the U.S., and higher government involvement in industries ranging from financial services to health care.