Global stock markets declined for a second-straight month amid a stream of worse-than-expected economic reports in the U.S. and concerns that Greece’s sovereign debt crisis would spread through the Europe, which as a region is the world’s second largest economy.

Simply put, a self-sustaining economy in the U.S. is all about jobs and things are looking pretty meager right now.  U.S. unemployment in May came in at 9.1% and jobless claims remained stuck above the 425k-level, which suggests improvement in the labor market is not imminent.  Given the bleak jobs picture, it should be little surprise that consumer confidence readings dropped to a seven-month low – this is important because the consumer makes up roughly 70% of U.S. GDP.   Meanwhile, the housing data showed prices continue to bounce along a bottom, a trend that is expected to continue as we are years away from significant increases in house prices.

As investors grappled with weaker-than-expected economic data, sentiment was further impacted by festering sovereign debt issues in Europe.   Greece’s parliament approved budget cuts and tax increases to meet the European Union’s requirements for bailout funds, which sparked a rally during the final week of June, but it is unlikely we’ve heard the last of Greece’s woes.  It may be a few weeks, several months, or even a year from now, but tensions will rise again if Greece’s austerity measures are not met – Greece failed to meet the fiscal goals of their prior bailout plan three quarters in a row.

Continuing the theme from May, investors preferred less risky assets.  In the U.S., the S&P 500 large cap index (-1.67%) outperformed mid (-2.04%) and small cap (-2.31%) stocks.  Until the final week of June, sector performance reflected a defensive shift, with Utilities and Healthcare outperforming in the first three weeks; however, more economically sensitive sectors such Materials, Industrials and Consumer Discretionary surged in the final week of June amid the bailout plan for Greece.

In developed international markets, the MSCI EAFE Index (-2.80%) trailed the MSCI EAFE Small Cap Index (-1.68%).  Losses in the MSCI EAFE were led by Switzerland (-5.59%) as investors feared the effects of large currency gains on the country’s export industry and overheating in the real estate sector.  The MSCI Emerging Markets loss (-2.63%) was led by the Brazil (-4.01%) where stocks fell in response to a drop in commodity prices.

A slower U.S. economy and European debt issues contributed to lower commodity prices, the S&P GSCI Commodity Index of 24 commodities declined 5.31%, but China’s efforts to tighten monetary policy and rein its economy may be even more impactful to commodity prices.  According to data compiled by GMO, China consumes more than 40% of the world’s supply of the following commodities: Cement (53.2%), Iron Ore (47.7%), Coal (46.9%), Pigs (46.4%), Steel (45.4%), Lead (44.6%), Zinc (41.3%), and Aluminum (40.6%).

Fixed income investments benefited from the flight to safety in June.  The yield on the benchmark 10-year Treasury dropped as low as 2.84% before ending the month at 3.16%.  Bonds with shorter duration and lower coupons outperformed longer duration bonds with higher coupons as government stimulus begins to wind down (QE2 ended on June 30) and it is less likely interest rates move much lower.

Interestingly, TIPS funds had the best returns in fixed income, but the higher return was a result of a payout tied to a high CPI number in March rather than increased inflation expectations in June. Municipal bonds outperformed corporate debt and Treasurys due to record-low supply and demand from investors who usually buy corporate debt.  Mortgage-backed securities (MBS) were also an area of strength as investors expect U.S. homeowners will struggle to refinance out of higher interest rate loans.

Peter Lazaroff, Investment Analyst

St. Louis, MO

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