U.S. equity volatility spiked last week, driven by escalating concerns over Greece’s debt problems and a sharp volatility in Chinese equities. The Chinese stock market experienced a dramatic sell-off in recent weeks before staging a comeback toward the end of last week. Early last week, the possibility of additional Greek defaults and a potential messy exit from the eurozone intensified. By the end of the week, however, Greek officials and policymakers seemed to be approaching an agreement. In China, the focus was on the government’s increasing market intervention designed to stem the sell-off, and what the possible economic spillover effects of such actions might be. Few notable developments in the United States affected U.S. markets, although we saw some indications that low expectations for second-quarter earnings could offer a favorable setup for equities. Despite the volatility, U.S. equity prices were little changed last week, with the S&P 500 Index flat.1
Key Points
▪ The drama in Greece may persist for years, but we believe widespread contagion remains unlikely.
▪ The Chinese market volatility and economic decline are growing as issues that warrant investor concern.
▪ Despite the risks, we think the outlook for U.S. economic growth, corporate earnings and equities remains positive.
Weekly Top Themes
1. U.S. economic data is improving, and we expect the Federal Reserve to begin rate hikes this fall. In our view, the first four months of the year exhibited disappointing economic results, but conditions have been improving. The June employment report was mixed, but we are seeing strength across housing, construction, consumer spending and other leading indicators. From mid-May through the end of June, 78% of cyclical indicators have been positive, according to ISI research.
2. Corporate earnings should accelerate in the second half of this year. Earnings experienced a downtrend from late last year through the first quarter of 2015, thanks in large part to falling oil prices and a soaring dollar. We believe analysts’ revisions may have turned too negative relative to corporate fundamentals, and we expect some positive earnings surprises in the coming quarters.
3. European growth may be stumbling. In Germany, business confidence fell for a second straight month in June due to concerns over Greece’s debt problems, the recession in Russia and the severe economic slowdown in China.2 We expect European economic growth to slow somewhat in the coming quarters, but also believe the European Central Bank has the flexibility and willingness to engage in additional action to prevent widespread financial contagion.
The U.S. Economy Should Weather Escalating Global Risks
Uncertainty over the negotiations between Greece and its creditors is quite high, and markets react daily to the latest news and rumors. In our view, the odds seem to favor Greece agreeing to most fiscal reform measures, which could provide the country with some more breathing room. At this point, we think it is more likely than not that Greece will remain part of the eurozone, but the road ahead will be rocky and Greek debt issues may well remain for years to come.
The recent equity market crash in China and the government’s response is, in our opinion, potentially more serious. It is difficult to foresee how the government’s unprecedented market intervention may affect the broader global economy and financial markets, and the risks of contagion are unclear.
The Chinese market volatility and economic slowdown has helped cause another downturn in oil and commodity prices, and given the uncertainty over what may happen in China, we would not be surprised to see further near-term declines. So far, the issues in China have been relatively contained. However, given the size of the Chinese economy, the possibility of a severe slowdown in China has to be taken seriously. For the moment, we do not see enough warning signs that such a situation is imminent.
For the United States, the trifecta of Greek debt problems, the Chinese slowdown and volatile commodities present economic risks, but we believe the balance of evidence suggests that U.S. economic growth should continue to improve. The U.S. economy appears to be accelerating. While the ride will not be smooth, we expect ongoing growth in consumer spending will act as an increasingly strong tailwind for the United States. This should allow corporate earnings to recover and improve, which in turn should help U.S. equities climb unevenly higher.
1 Source: Morningstar Direct, as of 7/10/15 2 Source: Ifo Institute Center for Economic Studies (Munich)
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
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The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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