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Market Recap – Greece May See Another Bailout Package

Market Digest – Week Ending 7/10

A choppy week for stocks concluded with a Friday rally which left major indexes flattish. Greece appeared on the verge of expulsion from the Euro early in the week, but submitted a proposal that may satisfy creditors and generate another bailout package. Its ultimate acceptance by both Greek lawmakers and creditors remained unknown heading into the weekend. Chinese stocks plummeted early in the week then rebounded sharply. The volatility spilled over into other markets. On Friday, Fed Chairwoman Yellen said a rate increase remains likely this year but emphasized that increases will be gradual and measured.

Weekly Returns:

S&P 500: 2,077 (-0.0%)
FTSE All-World ex-US: (-0.6%)
US 10 Year Treasury Yield: 2.40% (+0.02%)
Gold: $1,162 (-0.3%)
USD/EUR: $1.111 (+0.2%)

Major Events:

• Monday – Oil prices fell nearly 8% on concerns about growth in China and the possibility of increased supply from Iran.
• Monday –Greek Finance Minister Yanis Varoufakis resigned to reduce friction with creditors.
• Monday – President Obama was briefed at the Pentagon on strategy against ISIS and told the media progress was being made.
• Tuesday – Carnival Cruise lines won approval to begin cruises to Cuba starting next May.
• Wednesday – The New York Stock Exchange was forced to close for a large portion of the trading day due to technology problems. Markets continued to function smoothly with the use of alternative exchanges.
• Friday – Greece submitted a bailout plan which meets most original creditor demands despite the recent referendum in which the population voted against them. The plan will be reviewed over the weekend.
• Friday – Fed Chairwoman Yellen said a rate increase is still likely this year but emphasized that increases will be gradual and measured.

Our take:

The Chinese stock market has been a wild ride. From the end of June, the Shanghai Composite dropped 18% through Wednesday then rallied more than 10% over the last two days. Even these moves seem small compared to a 150% trailing one year gain through June 12th and the 32% drop from there through Wednesday. But while the gains ran up rather quietly, recent losses captured the media’s attention and created a minor global panic. This week marked the first time market movements in China have meaningfully impacted major developed markets.

Due to restrictions on ownership, most US investors have relatively limited exposure to Chinese stocks. Popular Emerging Markets ETFs and index Mutual Funds have roughly 25% exposure to China, but unless you have a large portion of your portfolio in Emerging Markets, this probably translates to modest direct ownership. Also, these funds tend to emphasize less volatile Chinese stocks which trade on the Hong Kong exchange.

The bigger risk to most portfolios is the chance that volatility in the Chinese market causes a faster deceleration of their economy. This would reduce demand for commodities and lead to a hit to earnings for many materials, technology, industrial and consumer companies. While we wouldn’t be surprised to see China’s economy underperform expectations over the next few years, we don’t think the recent sell-off should cause much concern.

Stocks in China are still materially higher than they were a year ago. Volatility causes problems, but there is still greater stock wealth than there was in most of the recent past. Also, China remains highly centrally controlled. The government has made some awkward (and likely counterproductive) moves in response to falling stocks, but at least for the next few years they will be able to maintain significant influence on the economy and the markets. Finally, as a percentage, far fewer Chinese own stocks than people in the US, so falling prices are less likely to spill over into the mainstream domestic economy.

We think it makes sense to double check that you are comfortable with your allocation to Emerging Markets in general (we recommend about 9% of total stock exposure for most clients), but there is no reason for panic.

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