Staying on course as Greece enters uncharted waters

Russ Koesterich, BlackRock’s global chief investment strategist comments on the possible investment implication of the Greek referendum outcome and recent volatility on Chinese stock markets.

Investors Shun Risk

Last week was dominated by a widespread aversion to risk, a function primarily of increasing worries over Greece, with most equity markets falling and so-called “safe haven” bonds rallying. The Dow Jones Industrial Average fell 1.21% to 17,730, the S&P 500 Index declined 1.19% to 2,076 and the tech-heavy Nasdaq Composite Index lost 1.40% to close the week at 5,009. Meanwhile, the yield on the 10-year Treasury fell from 2.48% to 2.39%, as its price correspondingly rose.

Still, most of the selling was confined to last Monday following the unexpected announcement of a Greek referendum. And although volatility rose, the decline was orderly and modest relative to past incidents. While the market is likely to experience further selling as investors digest the chaotic situation in Greece, a still benign monetary environment and low bond yields should mitigate the size of any correction.

Central Banks Still Helping—Except in China

Stocks sold off sharply last Monday with the U.S. trading down to a three-month low, but the damage was contained. Volatility briefly spiked, with the VIX Index hitting a four-month high of nearly 19. However, even at its peak, volatility remains below both its January high and its long-term average. Even in Europe, obviously more exposed to the outcome of the crisis in Greece, selling was measured. Stocks were down roughly 4%, but peripheral bond spreads held steady.

The damage to equities was at least partially muted by a good week for bonds. Despite more credit risk emanating from Puerto Rico, where the governor signaled his intention to seek a broad restructuring of debt, U.S. bonds benefited from a safe-haven bid as well as a recalibration of the date of a likely interest rate hike by the Federal Reserve (Fed) following June’s jobs report. While job creation continues to be strong (the 12-month average is close to 250,000), investors took note of stagnant hourly earnings and a 38-year low in labor force participation. Given that wages have yet to rise as fast as job creation would imply, the Fed may temper any plans for a September hike. This helped the two-year Treasury note rally, pushing yields down to 0.63%, below where they started the year, while the yield on 10-year government bonds fell back below 2.40%.

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