The end of the second quarter provides a good opportunity to review what happened the first half of the year and to share some insight into our plan for the rest of the year.
Let's start with a general review of the markets to date. Before looking at individual asset categories, there is one overall market note. The Greek debt situation is coming to a head with negotiations coming down to the wire. Will Greece exit the Euro zone or will they reach a deal? The uncertainty surrounding this question triggered a selloff in late June into July both domestically and internationally. In addition, the Chinese stock market woes did not help as the Shanghai composite shed 32 percent from its June 12th high. That said, here are some additional highlights for the first half:
-The broader U.S. market moved sideways the first half of the year with a fair amount of volatility. The U.S. total stock market indexes posted less than 2 percent gains in the first half.
-The Greek selloff in June and July affected international stocks more than U.S. stocks. But even with the larger giveback, international stocks still drove performance in the first half of the year.
-As expected, fixed income was a drag on returns. Interest rates rose in the second quarter in anticipation of a Federal Reserve rate hike that likely will come in the fall. The rising rates caused the year-to-date returns for U.S. aggregate bond indexes to end in negative territory at the end of the second quarter.
-In terms of S&P 500 sectors, health care finished the second quarter with the strongest returns, up almost 10 percent for the year. Energy was the worst performing sector in the second quarter with nearly a 6 percent decline.
Looking forward, here is what to expect:
-We will keep our current allocation to international stocks and may increase our exposure when the Greek situation has more clarity. A Greek exit from the Euro zone will roil the markets, but after the drama passes, the European markets should recover and move upward as the European economy continues to strengthen.
-Domestic stocks remain more expensive than international stocks. We believe that the best opportunities this year will continue to be in small- and mid-cap stocks as well as in three sectors.
-The financial sector of the S&P 500 has lagged the broader index over the past 5 years. As a result, it is relatively undervalued. As the economy continues to strengthen, so will loan activity which will enable banks to put near-zero-interest cash to work. Furthermore, higher interest rates will increase banks’ interest margins. Both developments would boost earnings.
-Technology stocks have outpaced the broader index over the past 5 years. Although valuations are a little expensive, they are still reasonable based on expected growth. We believe technology stocks have momentum and that CFOs will allow hardware and software upgrades when they believe the economic recovery is on sound footing.
-The health care sector has consistently outperformed the broader S&P 500 index the past five years, besting the broader index by 60% over that period. However, like technology, the sector generally has reasonable valuations when future growth is considered. We expect returns in the health care sector will be higher than the broader index, albeit more modest than the 20% annualized returns we have seen in the past. We expect that higher utilization and continued innovation should be able to overcome the headwinds created by implementing provisions of the Affordable Care Act and managing downward price pressure created by Medicare.
-Fixed income will continue to be a drag on returns, but we need to hold an underweighted position to provide some buffer if there are large negative events in the stock market.
Please contact us if you have questions or would like to review your account’s performance.