2nd Quarter Market Commentary

Jul 6 • Financial Planning, Investments • 1335 Views • No Comments on 2nd Quarter Market Commentary

The last few weeks have been filled with economic news and market volatility, both abroad as well as domestically. We will address the key items impacting the markets today, and provide some perspective on where we go from here.
Greece voted “No”, so now what? In the national referendum vote on July 5th, the Greek populous voted to reject the terms offered by their creditors to extend the financial bailout and continue to provide liquidity and resources to prop up their government and financial system. Where this situation goes next is uncertain. As of the drafting of this letter on July 6th, the European Central Bank (ECB) had pledged to keep Greek banks solvent for now, but the timeframe was uncertain. Eurozone heads of state and finance ministers were planning meetings on July 7th, and Greece’s leadership was preparing to offer a new proposal on terms for an acceptable bailout. Clearly further negotiations will occur over the next few days or weeks. The outcome is uncertain, however most believe that the likelihood of Greece exiting the eurozone has increased with the “No” vote.
The primary reason most market participants fear Greece exiting the eurozone is the uncertainty which it creates with the remaining eurozone participants. If Greece exits the eurozone, it theoretically opens the door for other countries to do the same. This would effectively force all of the remaining countries in the eurozone to re-evaluate their specific situation and determine whether remaining in the eurozone moving forward made the most sense for them. This could create a crisis in confidence and lead to an undesirable result. In addition to the stability of the eurozone, there is also the question of what Greece’s primary creditors, the European Union, the European Central Bank and the International Monetary Fund (the Troika), would do with all of the Greek debt that they currently hold.
As you can see, there are a lot of questions and very few answers currently. As we look at the situation, we see hard times ahead in Greece, regardless of the outcome of the current negotiations. The risk of financial contagion in broader Europe or even in the U.S. appears unlikely. This was a major concern in past crises, however the confidence in the system and current backstops in place seem to be keeping concerns to a minimum here. We think it is more likely than not that the eurozone monetary union stays intact with a common currency (the euro), however we acknowledge the risk that this could dissolve if a crisis breaks out.(1)
Opportunity often presents itself in times of volatility and uncertainty. We are watching the events in Europe closely, and will look for opportunities to reposition the portfolio as thesituation warrants. This would most likely be in the mode of rebalancing the portfolio and strategically buying European and other international equities if prices fall far enough based on emotional reactions as opposed to a change in the economic fundamentals.
In terms of the last quarter, other things have happened outside of Europe! As winter weather finally lost its grip on the U.S. economy, investors grew increasingly comfortable with the Federal Reserve’s slow-and-steady approach to determine when to raise short-term interest rates. Historic highs were reached by the large-cap S&P 500 (2,134) and small-cap Russell 2000 (1,296) during the second quarter. Unfortunately, those gains were all but wiped out as the financial crisis in Greece affected markets domestically and around the world. By the end of the quarter on June 30th, U.S. stocks as measured by the S&P 500 and Russel 2000 were up a meager 0.28% and 0.42% respectively. International stocks followed a similar pattern during the quarter, with the MSCI EAFE index up 0.62% for the quarter(2). Perhaps the most notable movement was the decline in Barclays U.S. Aggregate Bond Index(3), down 1.68% for the quarter. U.S. bonds were down as a result of rising interest rates as market participants speculated about Federal Reserve action and an accelerating U.S. economy.
Underreported in light of the situation in Greece was an announcement by Puerto Rico’s governor that the commonwealth is unable to pay its debts and needs to restructure. This has caused some reverberations in the municipal bond market, as Puerto Rican bonds have a special place in the tax code and are “triple tax exempt”, meaning income produced is exempt from federal, state, and local taxes. This made them attractive to many in the municipal bond space. Our buy list funds have virtually no holdings in Puerto Rican debt; however these bonds are held in many tax-exempt bond funds and are worth watching.
Finally, we have some good news to report. After a tough first quarter driven by a harsh winter, declining oil prices, and a strong U.S. Dollar, the U.S. economy continues to show signs of improvement and growth. Most economists expect the U.S. economy to post positive growth on the whole for 2015, and recent signs in housing, retail sales, and the unemployment rate seem to support this projection.4 All of this has led to a lot of speculation about the Federal Reserve (the Fed) starting to raise rates later this year. The Fed has continued to signal that they think the U.S. economy is improving and they will start to move interest rates higher when the time is right. There is a good chance that they take action by the end of the year, but we don’t think this will change the fundamentals substantially in the U.S. Fed action would signal the beginning of a move to a more normal monetary policy in the U.S., however, we would still be in very accommodating policy environment which should continue to be supportive for economic growth.

For more information, visit our website at makinglifecount.com or contact Lucas Bucl – lbucl@makinglifecount.com, (913) 345-1881.

Photo credit: Onkel Tuca! / Foter / CC BY-SA

Footnotes:
1 Sources used in this letter include Yahoo Finance, Marketwatch, Forefield, and John Greenwood at Invesco.
2 The S&P 500 is an unmanaged index of 500 widely held large company U.S. stocks. The Russell 2000 is an unmanaged index of approximately 2000 small company U.S. stocks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. The performance noted does not include fees or charges, which would reduce an investor’s returns.
3 The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency) bonds.
4 Data sourced from JP Morgan.

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