Three headwinds make for one big investor headache

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By Russ Koesterich, BlackRock’s Global Chief Investment Strategist

US markets make a U-Turn

Both stocks and bonds fell last week, a reversal of the prior week’s result. The Dow Jones Industrial Average dropped 0.93% to 17,947, the S&P 500 Index declined 0.40% to 2,101 and the tech-heavy Nasdaq Composite Index, despite touching a new record high, lost 0.71% to close the week at 5,080. Meanwhile, the yield on the 10-year Treasury rose from 2.26% to 2.48%, as its price correspondingly fell.

The key culprits in last week’s market action? Greece certainly did not help (and is likely to cause still more volatility this week), nor is an emerging bear market in China. But for US investors, the bigger problem may be one closer to home: the Federal Reserve (Fed) and the virtual promise of higher rates.

A sensible course for equity investors, in our view, is to maintain a bias toward cyclical companies, such as technology, which tend to hold up better amid rising interest rates. At the same time, ease up on utilities and real estate investment trusts (REITs), which are expensive and vulnerable to losses in a rising-rate environment.

Sticky situation in Greece

Despite the broad market losses, last week was not without a few bright spots: There was the Nasdaq’s new record high and a notable rally in hospital stocks when the Supreme Court upheld the current subsidy scheme under the Affordable Care Act. Overall, however, the US equity market has remained stuck in a fairly narrow trading range since February.

Several factors are dampening investor sentiment. The most obvious one is Greece. While last week initially provided some hope that Greece and its creditors were moving closer together, market expectations for a quick resolution took a nosedive over the weekend.

Greek prime minister Alex Tsipras’s announcement of a referendum was swiftly followed by the Eurogroup announcing that the program of financial support due to expire on June 30th would not be extended. Following that decision the ECB announced that it will not increase the lifeline emergency funding that has largely funded depositors’ withdrawals from Greek banks.

Given these developments, banks in Greece will be closed through the week. The Greek referendum to be held July 5th will be a pivotal risk moment. Our base case remains that the European authorities will make every effort to minimize contagion and that the impact on other European financial markets, beyond short-term sentiment driven markdowns, is limited.

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