The second quarter of 2015 will most likely be remembered for several news stories that seemed to have significant implications for investors. While the headlines were dominated by the Greek crisis in Europe, financial markets were also concerned with the ongoing municipal bond default saga in Puerto Rico and the dramatic sell off in the Chinese stock market.
The Greek crisis continues to evolve by the hour. It is important to remember that the Greek economy is very small (around 2% of the Euro area’s GDP); the majority of Greek debt is currently held by the IMF, the ECB, or other European governments. Investors typically have very little direct exposure to Greek markets. While sentiment may lead to increased market volatility, the direct impact of the Greek crisis may ultimately prove to be inconsequential to US investors.
Closer to home, Puerto Rico continues to edge closer to default. But Puerto Rico truly is an outlier when compared with the 50 states, all of which have been experiencing improved economies, better budget performance and shrinking debt loads. For bond investors considerations such as the direction of interest rates and the shape of the yield curve will have a far greater impact on future performance than the ultimate outcome in Puerto Rico. As rates rise and bond market volatility increases, disciplined investors should be able to find better buying opportunities than have been available over the last seven years.
Across the Pacific, the Chinese market sold off dramatically in the second quarter, losing over 20% from its market top. Most of the most recent rally in Chinese stocks has been driven by local investors buoyed by last fall’s stimulus efforts by China’s central bank. The recent selloff seems to be driven by doubt that this stimulus-fueled rally is sustainable. China’s central bank has already responded to this selloff by injecting even more stimulus into the financial system. The situation in China is probably the most worrisome for investors and is something that should be carefully monitored going forward.
Despite the negative headlines, global equity markets were mostly flat for the quarter. Despite no direct action by the Federal Reserve to raise rates, bond markets sold off in June as interest rates spiked. The 10-year Treasury, which began the quarter at 1.9%, reached 2.5% before ending the quarter at 2.3%. As a result, the Barclay’s US Aggregate Bond Index was down -1.7% for the quarter, which pushed its year-to-date return to -0.1%. As interest rates rose, sectors that are particularly interest rate sensitive also sold off. The Wilshire US REIT Index was down -9.9% and the Alerian Energy MLP Index was down -6.1% for the quarter. Among the best performing stock sectors were health care stocks, which are up almost 10% year-to-date and Consumer Discretionary stocks, which are up almost 7% so far this year.