Investors continued their flight to safety in June on soft economic data and uncertainty about the impact of the euro debt crisis on the real economy. 

In the U.S., jobless claims remain stubbornly above 450k and housing data shows anemic demand following the expiration of the homebuyer tax credit.  The Federal Reserve maintained its stimulative monetary stance as deflation has become more of a concern than inflation.  Other concerns on the minds of U.S. investors included: increasing regulation on the financial industry, a moratorium on deep-water oil drilling, and likely higher taxes.

Meanwhile, the effect Europe’s debt troubles are having on the global economy remain unclear.  Unfortunately, these issues won’t be resolved this summer.  Tensions has eased a bit, though, on a combination of successful government debt auctions (notably in Spain and Portugal), a £750 billion bailout package, the extension of liquidity provisions for euro-zone banks beyond June, and the announcement that stress tests on the 25 largest banks would be released in late July.

Despite difficulties in the euro-zone, international equities outperformed domestic equities in June, although both posted losses.  International equities still have not kept pace with domestic equities on a quarter-to-date or year-to-date basis.  Emerging markets kept its lead over developed international markets, as these countries carry less debt and their economies are better positioned for growth.

In U.S. markets, large-caps outperformed mid- and small-caps in June, but large caps still trail on a quarter-to-date and year-to-date basis.

Consumer Discretionary shares were the biggest loser among S&P 500 sectors, marking an abrupt reversal in sentiment as investors turned more cautious on the economic outlook.  Increased savings rates in the U.S. and high unemployment are likely to keep a lid on performance in this sector for some time.  The other big loser was the Materials sector, which was pressured by the slowing global economic momentum.  A sharp drop in commodity prices, which may occur if economic growth slows, would depress earnings in the Material sector.

Telecommunication Services and Utilities sectors were the big winners, again benefiting from investors searching for safety and yield rather than earnings growth.  Close behind was the Healthcare sector, which is viewed as a defensive sector since healthcare spending is largely independent of wider economic conditions.  The healthcare sector also boasts nice dividends, which is attractive to investors with cash yielding nothing.

It’s worth pointing out that the Financials sector trailed the broader market despite the House and Senate agreeing on a watered-down version of the financial reform bill.  The big victory for Wall Street were provisions that limited, rather than prohibited, federally insured banks from trading derivatives and investing in hedge funds or private equity funds.

The financial stresses induced by euro-zone debt concerns, lower market confidence, and lower risk appetite could all poke holes in the global economic recovery.  Unfortunately, there don’t appear to be any catalysts on the horizon for investors to add risk to portfolios, particularly in equities.  The second-quarter earnings season that kicks off in two weeks could provide some relief, but I expect the market will be range bound for several months as investors sort through all the moving pieces.

Peter Lazaroff, Investment Analyst

www.acrinv.com