Meanwhile, a Bear Looms in China...
Greece dominated headlines, but last week also featured news in China. Following a feverish rally, Chinese stocks are now on the cusp of a bear market. Stocks fell more than 7% on Friday and are now roughly 19% from their highs. Friday’s selling was most acute in small-cap and technology stocks, two segments that have dominated the bull market of the last year.
While we remain comfortable with China’s economic outlook, several factors suggest it may be too early to aggressively buy this market. First, China continues to be dominated by speculation. Even with the recent sell-off, margin debt remains close to an all-time high. Second, despite a near-20% correction, equity valuations are still elevated relative to a year ago. For those looking for exposure, the H-Share market, traded in Hong Kong, is proving a less volatile way to access China's equity market.
...and the Fed in the U.S.
Finally, here at home, the bigger headwind for U.S. investors may be the Fed and, more precisely, the realization that a rate hike is probable this fall. While the data continue to be mixed (durable goods and the Chicago Fed's National Activity Index were both soft), most of the economic evidence suggests the U.S. has recovered from its first quarter economic contraction. Both existing and new home sales exceeded expectations, and personal spending notched its strongest gain in six years.
The firmer tone to the data increases the odds for a rate hike before year's end. Indeed, Fed Governor Powell last week forecasted a hike as early as September, with an encore in December. The prospect has investors paring back their bond positions. For the week ended June 24, $3.8 billion exited U.S. bond funds, helping to push the yield on the 10-year Treasury back toward the 2.50% level.
For equity investors, we'd reiterate some of our recent views: Favor technology and other cyclical companies, which tend to hold up better during periods of rising interest rates. At the same time, we'd suggest underweighting traditional yield plays, such as utilities and REITs. While these stocks have already underperformed year-to-date, they remain expensive and vulnerable to a further rise in rates. For those investors looking to emphasize less economically sensitive parts of the market, we continue to prefer health care, which historically has been less sensitive to rising rates than other traditionally defensive sectors.