Market Commentary – June 2015

Greek DebtUncertainty and volatility gripped the global financial markets, putting the brakes on stock market performance and driving down bond market returns. Most notable, Greece’s long-standing debt crisis finally reached a tipping point. Late in the quarter, bailout negotiations between Greece and the European Union broke down, culminating in a shutdown of Greece’s banking system and the June 30 default of the nation’s $1.7 billion payment to the International Monetary Fund (IMF). Greece’s financial crisis triggered losses throughout the global financial markets, highlighting the fragile nature of the global economy.

The U.S. continued to demonstrate better relative economic growth than many other countries, where aggressive central bank quantitative easing (QE) remained in play. Modest U.S. economic gains led to continued speculation as to when the Federal Reserve (the Fed) would begin removing the remaining component of its stimulus program—near-zero short-term interest rates. Expectations for the Fed to hike rates later in the year pushed Treasury yields higher. Meanwhile, early signs the European Central Bank’s (ECB) QE program was working prompted a significant sell-off among European bonds, which also triggered losses in the U.S. and other bond markets. Additionally, optimism surrounding the ECB’s QE caused the euro to rally versus the U.S. dollar.

In this environment, broad U.S. and non-U.S. stock benchmarks held onto fractional gains for the quarter. Global bond markets struggled, and most major bond market benchmarks posted negative second-quarter total returns.

 

U.S. Stocks: June Downturn Stalled Quarterly Performance 

Healthy stock market gains in April and May gave way to plunging performance in June, leaving the S&P 500 Index barely in the black for the second quarter. With a total return of 0.3% for the April-June period, the U.S. large-cap stock benchmark eked out its 10th-consecutive quarterly gain.

Small-cap stocks, which are typically less influenced by global factors, generally outperformed mid- and large-cap stocks. Growth stocks maintained an edge over value stocks across the capitalization spectrum. Small-cap growth stocks were the quarter’s top performers, up 1.98%, while mid-cap value stocks (Russell Midcap® Index) were the weakest, falling -1.97%.

Investor optimism generally prevailed during April and May, largely due to better-than-expected first-quarter corporate earnings results and tempered expectations for Fed interest rate hikes. U.S. economic data were mixed, with housing and labor market improvements offset by some relatively soft gross domestic product (GDP), inflation, and manufacturing readings. This uninspiring mix of data led to increased speculation that the Fed would hold off raising interest rates until later in the year, which helped support stock gains in April and May.

Investor sentiment shifted sharply in June, as European and domestic factors unnerved U.S. stock investors. Greece’s worsening financial crisis captured headlines, and a late-month shutdown of the nation’s banking system and ultimate default on its IMF payment sent stocks lower. Meanwhile, signs the U.S. economy was gathering steam prompted a fresh round of rate-hike speculation, with September emerging as the consensus frontrunner for the Fed’s first short-term rate hike since June 2006. Specifically, housing, consumer spending, and consumer confidence data closed out the second quarter on an upbeat note.

 

Non-U.S. Stocks: Greece’s Debt Woes Rattled Markets

Similar to U.S. stocks, non-U.S. stocks generally declined in June, leaving the broad developed and emerging market benchmarks with fractional gains (in U.S. dollar terms) for the second quarter. In a reversal from recent quarters, the U.S. dollar declined in value versus the euro and pound, which helped boost non-U.S. developed market stock returns for U.S.-based investors. Local currency returns throughout Europe were generally negative.

The ECB’s QE program, which the central bank launched during the first quarter, showed some early signs of success, as economic growth data and forecasts out of the Eurozone generally improved. Despite the positive signs on the economic front, Europe couldn’t escape the negative influences from Greece. Optimism regarding a potential bailout deal with the ECB faded as June progressed, and on the last day of the quarter the debt-plagued nation defaulted on its nearly $2 billion payment to the IMF, sending shockwaves throughout the stock markets in Europe and the rest of the world.

 

U.S. Rate Hike Fear, European Sell-Off Drove Interest Rates Higher

U.S. bond investors faced negative returns for the quarter on concerns of an improving economy and action by the Fed.  All sectors of the U.S. investment-grade bond market declined, with corporate bonds posting the weakest results (-3.16%, according to Barclays) while the overall bond market declined -1.7%.

We continue to welcome modest increases in yield as higher yields generate higher long-term returns for our bond investors while also providing more discipline to the capital markets.  We continue to believe, however, that in this environment of globally low interest rates, U.S. rates are unlikely to increase substantially from current levels.