2Q15 Market Overview
Throughout the second quarter, we experienced continued volatility as global markets digested mixed headlines. The news focused on softer U.S. economic growth, concerns about illiquidity in the fixed income markets and geopolitics.
Overshadowing the headlines was the looming debt and economic issues in Greece. At quarter end, equity gains eroded quickly as Greece missed an IMF debt repayment in the highly political and publicized debacle. The good news is that the global markets didn’t overreact compared to the previous periods of Greece induced uncertainty. The more stable reaction was most likely due to the stronger European economy and the European Central Bank’s efforts to avert a bank run.
Despite varied news and potential Grexit, risk assets finished slightly higher while fixed income markets lost ground as interest rates inched higher.
Looking forward, we are encouraged by a slowly improving U.S. economy and the direction the Federal Reserve is headed. So far, they have been successful in removing stimulus and will now carefully consider the obvious need to raise interest rates. Based on a number of studies, long-term fixed income investors will ultimately benefit from higher interest rates since they will be able to reposition their maturing bonds into higher yielding securities. This will in turn produce superior long-term fixed income returns.
As we progress further into the second half of the year, we will continue to take advantage of diverging market trends by rebalancing to target allocations while maintaining your desired risk level. This process typically involves harvesting gains or losses in the most tax-efficient manner possible and then re-allocating the proceeds to out of favor asset classes that offer more attractive long-term opportunities such as international equities.
U.S. Equity Markets
The U.S. equity markets were relatively flat during the quarter; the Russell 3000 return was up .14% for the quarter and a modest 1.9% for the first half of 2015. Although equity markets advanced to new highs throughout the quarter, the gains evaporated near quarter end as the markets couldn’t escape the negative headlines surrounding Greece. Macroeconomic data was mixed and improving near quarter. The most notable positive news related to payroll and wage growth data which exceeded expectations and helped stabilize the late quarter volatility. The Labor Department announced that payrolls increased 223,000 in June and the unemployment rate ticked lower to 5.3%. The U.S. consumer also regained their footing and confidence in the summer months resulting in positive adjustments to consensus U.S. growth forecasts in the 2.5% range. Given the improving situation, the Federal Reserve is likely to initiate their first interest rate hike by the end of the year.
International Equity Markets
International developed equity markets posted a slight quarterly gain of .62% and more impressive 5.5% first-half 2015 return on the MSCI EAFE. More positive and improving Eurozone economic data was dominated by Greece’s hazardous debt situation resulting in MSCI Eurozone’s 4.0% local currency loss. Once Greece ultimately accepts reform terms or their dire new reality, the Eurozone should continue to benefit from the European Central Bank’s $66.3 billion per month bond buying stimulation program. In Japan, generally positive corporate profit results helped Japan’s TOPIX index outpace all developed equity markets with a 5.8% local return. Most notable Japanese strength included stronger capital expenditure data and an upward revision to first quarter GDP figures. MSCI Emerging Markets posted a modest .69% quarter gain with mixed returns. Hungary and Russia were the strongest market performers benefiting from a 15% rally in the price of oil while China’s market entered correction territory in June after reaching all time highs. After two consecutive years of underperformance relative to the U.S. markets, both developed and undeveloped international markets continue to look more attractive for long-term investors as we move further into 2015.
Fixed Income Markets
Safety-minded investors lost ground as the Barclays Aggregate retreated 1.7% for the quarter and is now flat for the first half of 2015 with .10% loss. The 10-year Treasury yield increased from 1.93% on April 1 to 2.35% on the final trading day of the quarter. As yields increase, bond prices with longer durations typically underperform since their existing yields become less valuable compared to newly issued higher yielding securities. This is exactly how the market priced in this new reality during the second quarter, by punishing the Barclays US Government Long with a 8.1% loss, Intermediate with a .43% loss and Short with a slight gain of 0.15%. In the international fixed-income arena, they also experienced a similar spike in interest rates across the board which resulted in mostly negative returns. The JPM Non-US Unhedged posted a disappointing 1.5% loss under the weight of a stronger US dollar. The Barclays Municipal couldn’t escape the downward pressure of rising rates and ended up losing .90% during the quarter.