Q2 2015 Market and Economic Update

Greece and the Fed Dominate the Markets at the end of Q2

by Jeffrey Kravetz

As Phoenix moves into the dog days of summer, Arizona investors are mindful that market volatility is heating up due to uncertainty over a resolution of the Greek debt crisis and the timing of the Federal Reserve’s first rate hike in almost a decade. Local investors in global financial markets are nervous because Greece and its creditors have failed to agree on a debt deal to keep Greece solvent. This raises the possibility that Greece will exit the euro, which could cause fallout in capital markets.

In the U.S., the Federal Reserve has taken a more dovish tone with regard to raising rates in September due to mixed economic data, which could impact Phoenix-based borrowers. If the situation in Greece worsens, the Fed may hold off on a rate hike in support of global liquidity.

Meanwhile, the Phoenix housing market continues to recover. The S&P/Case-Shiller Phoenix home price index continues on the positive trend that started in late 2011, increasing 1.7 percent in the first four months of the year.

Economic Trends

The Greek debt crisis and June Federal Open Market Committee (FOMC) meeting dominated economic news in June. Greece is relatively small in terms of global economic influence, so the economic impact from the turmoil should be small. However, on the chance of a disorderly exit by Greece from the eurozone, market volatility would likely rise in the short run. As the crisis abates, we believe the major economies will remain relatively healthy, providing the potential for improving market returns.

The June FOMC meeting concluded with no change to Federal Reserve policy and the renewal of the Fed mantra to be data dependent in their decisions. We still believe September will be the meeting for the Fed to shift away from its zero-interest-rate policy. In our view, data should improve modestly in coming months, helped by the stronger job market.

Equity Markets

Investor nervousness, angst and concern seem to be on the rise, aided by lackluster year-to-date returns, continued uncertainty surrounding Greece and the likely outcome of its debt woes, and a looming Fed rate hike decision.

Looking toward year-end and into 2016, our favorable bias for equities remains intact. Though we are mindful of the risks, the classic signs of a frothy market leading to a significant pullback or correction are not evident. Valuations are not at extremes. Investor euphoria or extreme optimism is lacking. Inflation, while beginning to surface, is still short of levels typically experienced during an overheating economy, suggesting that current multiples seem justified. And, importantly, the initial public offering (IPO) market, an indicator of management’s desire to improve liquidity/cash out, has yet to ramp.

Fixed Income Markets

The June FOMC meeting largely met our expectations. Fed officials upgraded their labor market assessment and noted that the inflation outlook was stable. As we predicted, the estimated median policy rate for 2015 still shows two 25-basis-point hikes during the remainder of the year.

In our view, Treasury yields are likely to rise modestly over the next two to three quarters as the Fed gradually removes accommodation. We also anticipate rising interest rate volatility over the coming months as well. Extraordinary Fed easing for pre-determined periods of time limited yield moves over the past few years. Since the Fed has now shifted toward a more data-dependent stance, greater sensitivity to economic releases is likely to produce increased interest rate volatility.

Real Estate Markets

On a national level, sales of existing homes advanced in March as the weather warmed but then returned with a decline in April. However, pending-sales activity increased to a nine-year high, with more and more homebuyers committing to purchase. This activity provides forward-looking indication of improving U.S. closed sales in the next couple of months.

Commodity Markets

Oil prices have remained in a tight trading range for the past two months despite signs of strong U.S. and OPEC oil production. Investors seem to view declining U.S. oil inventories and slowing U.S. production growth as off-setting OPEC production growth, leaving prices to trade around $60 per barrel for West Texas Intermediate (WTI) crude oil.

Gold prices have seen a modest rally so far this year, but we believe the likely increase in rates at the September Fed meeting will support the U.S. dollar and pressure gold. Physical demand growth from major purchasers India and China appears to be slow, with Chinese investors focused on the local stock market and Indian investors coping with high interest rates.

Jeffrey Kravetz is regional investment director for The Private Client Reserve of U.S. Bank in Phoenix.

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