The second quarter of 2015 was heading toward a happy ending for the broad indexes when worries over Greece intruded in the last couple weeks of June to knock markets backward. The S&P 500 ended up in the red for the quarter, losing 0.2% while the Dow Jones Industrial Average lost 0.9%. On a year-to-date basis the S&P 500 was up 0.2% as of June 30 and the Dow was down 1.14%. U.S. small cap stocks have performed better than large caps so far this year, reversing the trend from 2014. The Russell 2000 small cap index was up 4.1% as of June 30. International markets were mixed. Germany was about flat while Japan was up 12.7%. Bonds slid significantly in the quarter as investors anticipate the Federal Reserve beginning to increase interest rates—perhaps as early as September. The 10-year Treasury yield rose from 1.93% to 2.33% during the quarter.

From the beginning of 2015 until the middle of June, U.S. stocks were fairly volatile on a daily basis but had remained in a very tight trading range. While the U.S. economy has continued to progress nicely, two concerns have arisen in the past few weeks that have caused increased volatility in both U.S. and overseas markets.

First, the Greek crisis is coming to a head. On June 30, Greece defaulted on a $1.73 billon payment due to the International Monetary Fund (IMF). As of this writing, there is no new bailout package in place. The Greeks are due to make a $3.9 billion payment to the European Central Bank (ECB) on July 20th. If Greece is unable to make the payment, the ECB will not be able to provide Greek banks the emergency lending that is now keeping them afloat. Thus, if June 21 arrives without a new deal, the situation in Greece will probably deteriorate rapidly and could lead to Greece re-introducing its own currency and leaving the Eurozone. While this story is all over our newspapers, the U.S., as can be seen in the chart below, has relatively little direct exposure to Greek debt. However, Greece exiting the Eurozone may jolt our markets a bit.

Second, the Chinese stock market is on a rollercoaster ride—first rising 160% from its 2014 lows and now down more nearly one-third since the June 12 peak. The Chinese government has been intervening forcefully using a variety of measures, including cutting its benchmark lending rate, suspending the stock listings of more than 1,400 companies and instituting a 6-month ban on any selling by 5% shareholders. So far, the government’s intervention has not managed to stem the decline and restore confidence in the markets. However, as the chart below shows, it is only the latecomers to the market that have been losers. Nevertheless, investors in China (and increasingly elsewhere) are getting nervous that the government may not be able to arrest the decline.

Shanghai Composite Index Source: BigCharts

While the standoff over Greece and the Chinese market volatility have been unsettling to investors, these events may ultimately have a limited effect on our markets. While it is true that China’s economy—the world’s second largest—accounts for more global economic growth than any other country, it remains to be seen if the stock market troubles will bleed into China’s economy and cause it to slow. In fact, given the tumult overseas, our currency, government bonds, and stock markets may look increasingly like safe havens to foreign investors.

Meanwhile, our domestic economic situation is relatively good. U.S. consumers and manufacturers are enjoying very low energy prices. (Oil is at $53/barrel as I write this.) Employment continues to improve steadily; June saw job adds of 233,000 and the unemployment rate fall to 5.3%, roughly in line with the recent trend. Home prices have also been on the rise, according the S&P/Case-Shiller Home Price Indices, which show further rises in home prices nationally this spring, but not an acceleration.

U.S. stocks continue to trade at above-average valuations and the 2015 earnings picture for the S&P 500 has been dented by the fall in energy prices. But while profits at energy companies will be much lower in 2015, there will be corresponding benefits on the income statements of their customers. The strong U.S. dollar has also served to bring down earnings estimates for U.S. companies. (Overseas earnings translate into fewer dollars when the dollar is strong.) Our multinationals also have a tougher time competing with foreign companies when the dollar is stronger. Given the global backdrop, investors would be prudent to keep their expectations for stocks modest this summer.

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