For most of the second quarter the news was very quiet, and so too were the markets. Then, in the final week of the quarter, the Supreme Court announced its decisions affirming the legality of both the Affordable Care Act and same-sex marriage. On Monday, June 29th, the “Grexit” loomed again: Greece announced that it would not be able to make the $1.77 billion debt repayment due to the International Monetary Fund on June 30th, and that it was closing its banks to prevent a run in the face of a potential default. That same day, the Governor of Puerto Rico announced that the commonwealth’s $72 billion in debt was “not payable” by the taxes collected on its 3.6 million people. Additionally, after doubling in the first five months of 2015, the Chinese stock market (Shenzhen Composite) dropped over 20% since the June 12th high, prompting talk of a Chinese bear market. As was the case in the first quarter, the US stock markets gave up virtually all of the second quarter’s return in the final two trading days of June.

For the quarter, both large- and small-cap US stocks were mostly unchanged. The various European bourses were down anywhere from 2-7% in the second quarter in local currency, after seeing returns in the high teens during the first quarter. The US Dollar rose over 20% between June 30, 2014 and March 31, 2015, before declining a modest 3%. When converting the European stock market figures to US dollar-based returns, they are muted to a 5% increase in the first quarter and a 3% decrease in the second. From 2009 lows, both the S&P 500 and the Russell 2000 indices are up 120% while the EAFE is up only half this amount, a reflection of the economic difficulties in the European Union. Meanwhile, oil, which hit a low of $42 a barrel on March 19th, recovered this quarter, trading from $50 to $60 a barrel. The price differential between West Texas Intermediate (US) and Brent (European) fell from $80 per barrel to virtually nil. After the horrific drop last fall, it looks like oil prices have finally stabilized.

The debate continues over whether our economy is still disinflating or beginning a growth era. Personal savings have risen over the last few quarters as the “gas dividend” is being saved not spent. Real wage growth continues to be sluggish at around 2% annually since the ’08 financial crisis. The combination of low wage growth and rising costs for services, especially in health care, is not a recipe for a strong economy. There has been a broad recovery in housing and a rapid rise in residential rents, especially in densely populated coastal urban centers. It seems that these factors should have a greater effect on the Consumer Price Index (CPI) than they have so far.

This economic environment is causing the Federal Reserve Open Market Committee (FOMC) to fret. The Yellen Fed has been telegraphing an increase in interest rates for a long time, but it has habitually postponed action. The challenges in Europe could give it yet another reason to wait.

It has been seven years since the 2009 market low, but we still see weak demand and a general lack of optimism. There is definitely no euphoria. We are overdue for “something to happen,” but we do not believe the Greek crisis is it (again).

If we step back and look at pervasive, long-term global problems, two stand out: sovereign debt levels are too high around the globe, and benefits costs, especially for government employees, are too high to sustain. These issues are big parts of the problem in Greece. The country may be worse off than other developed countries, but it is not alone. It has been five years since the Greek problem first arose. There has been plenty of time for all investors to eliminate exposure. Who still holds the risk? Very large and aggressive hedge funds, for the most part. These funds can dominate trading volumes, and with their Greek exposure, the market reacted badly on June 29th, wiping out nearly all of its meager gains year to date.

Puerto Rico’s debt problem will likely spill over into the broader market for municipal bonds (munis). At over $20,000 per person, Puerto Rico has borrowed more per capita than any other state or territory. This issue has long been known, and prompted rating cuts by Moody’s in 2012 and S&P in 2014. As far back as 2011, Vanguard, for example, cleaned all of the Puerto Rican bonds out of its funds. But this is not necessarily true for all muni bond funds, especially “high-yield muni” mutual funds. Additionally, many individuals have bought Puerto Rican debt because of the high yields and the fact that no state can levy taxes on income earned on debt issued by US territories. None of our clients are directly exposed to these bonds, but we believe this issue will still affect all tax-free bond prices.

Sometime in the third quarter, Congress will have to deal with raising the debt ceiling in the US again. The gulf between Democrats and Republicans being what it is, it will likely be politics as usual on this issue. This will cause some consternation in the markets, but this should be short-lived. Greece will continue to be a problem this summer. Whether the country exits the Euro now or at the next debt payment date, we think it is going to happen eventually. Until it does, however, the markets will worry that Greece is the first of the dominoes to fall. We think that post-default and Euro departure, the state of the economy in Greece will be so bad that it will discourage other weak countries from following suit. Interest rates will eventually rise to provide a real return to fixed income investors. This means bond prices have further, maybe even much further, to fall. We do not think price to earnings ratios have much room to rise, so the US stock markets will move in tandem with corporate earnings, while the overall economy continues to muddle along.

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