Longer-term interest rates, specifically 10-year government debt yields, rose across the world as signs of stronger growth and somewhat higher consumer prices led global investors to sell longer-duration bonds. Oil prices climbed higher and the U.S. dollar fell against other major currencies on signs of improving growth in Europe. This combination led investors to adopt a better outlook for U.S. corporate earnings in the second half of the year, while it also increased confidence in the sustainability of the economic expansion.
The Federal Reserve remained on course to begin normalizing monetary policy by raising the Fed Funds rate at least once later this year. The second quarter rebound in U.S. economic growth, which was evidenced by better consumer spending, stronger housing activity and continued strong employment gains, is consistent with this expectation for higher short-term interest rates.
While U.S. stocks were essentially flat for the quarter, foreign-developed market stocks generated a small gain, despite the fact that most equity markets suffered in June as the Greek debt crisis came to a head. European markets traded sideways in the second quarter as investors adopted a “show me” mentality regarding the real impact of the European Central Bank’s aggressive new stimulus policy, before suffering losses as the Greek crisis unfolded. The Chinese market, which had been on a tear, experienced a material decline late in the quarter as speculators sold positions; meanwhile, the broad emerging markets index produced a small gain.
Fixed income, especially long duration, performed poorly in the quarter as long-term interest rates rose. Commodities, other than oil, generated negligible returns at best as emerging market growth remained questionable and inflation stayed calm. U.S. Real Estate Investment Trusts suffered double-digit losses as the positive impact of low interest rates dissipated.
For the remainder of the year, we anticipate somewhat higher short- and long-term interest rates, rising volatility and the potential for greater foreign turmoil in markets such as Greece and China. We expect the U.S. economy to continue to rebound from the weak first quarter and believe U.S. and global equities still offer a relatively attractive risk/return trade-off for long-term investors.
It should be noted, however, that the level of risk in the financial markets has risen and investors should be prepared for more instability than we’ve seen in the recent past. Yet, we believe investors can successfully manage this volatility while still meeting their goals through prudent diversification and a patient, long-term approach.
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