Putting the Greek Crisis in Perspective

Greece Euro

Following a dramatic announcement of a national referendum on whether Greece should accept the terms proposed by its European creditors in order to continue its bailout program, the country is experiencing a financial crisis. Greek citizens, anticipating that their country will leave the euro zone and that they’ll be left owning less valuable currency, have been lining up at banks to withdraw their money. The Greek government has been forced to close the banks and initiate capital controls to prevent money from leaving the country. The result is substantial economic pain for the Greek people as well as intense geopolitical drama. But how much trouble will it cause for your investment portfolio?

The short answer is “probably not too much,” although that largely depends on whether the problems remain isolated to Greece or spreads to other euro zone countries. At this point the situation in Greece isn’t all that different from the situation in Cyprus in early 2013, when Cypriot banks collapsed and the country had to initiate capital controls. Cyprus agreed to a bailout program, the country was able to keep using the euro as its currency, and the financial trouble didn’t spread to other countries.

There are two major differences between Greece now and Cyprus two years ago. One is that Greece is larger, although economically it is still a minnow from a global perspective. According to the International Monetary Fund, Greece’s economy makes up less than one third of one percent of the global economy. Similarly, the size of its stock market is negligible compared to the size of the global stock market, or even just the European market.

The second difference between Greece and Cyrpus is the political situation. The Greek government, led by prime minister Alexis Tsipras and his Syriza party, came to power promising to end the austerity policies that had been imposed on Greece in its bailout agreements. Its major creditors (the European Commission, the European Central Bank, and the International Monetary Fund), are reluctant to agree to any deal that would encourage other countries to copy Greece and demand more lenient bailout terms. This impasse not only makes a bailout agreement between the two sides difficult to achieve, but it also means that a Greek exit from the euro zone would likely be messy.

While European stocks will likely fall a bit as the financial drama in Greece unfolds, the key point to pay attention to is whether it triggers a financial “contagion” that spreads to other countries. As long as the crisis doesn’t spread beyond Greece, its impact on overall global financial markets is likely to remain relatively small.

9 Bond Fund Risks to Evaluate

MH Bonds Graph 1

Government agencies, exchanges, major bond investors, and main street investors are again preparing for the long awaited upward shift in interest rates and a potential collapse in bond market prices and liquidity. Deja vu, right? Know your risk exposures and understand the location of your hard earned dollars!

Here are nine not-so-obvious risks to evaluate in your bond exposures:

1. The “bond” label is not always synonymous with conservatism or lower risk. The opening graphic plots daily percent yields for the “risk-free” US 10-year bond from 6/19/2014 to 6/19/2015. Price movement in this key benchmark rate is likely to experience historic volatility in the future. Other segments (high yield, municipal, emerging, mortgages) of the bond market are smaller and less liquid than treasuries.

2. Principal, maturity, and credit features are not guaranteed or insured. Many investors do not realize, understand, or appreciate that bond funds can fall in price. Bond funds are not insured or guaranteed by FDIC, the U.S. Securities Investor Protection Corporation (SIPC), or by any other government agency, regardless of underlying holdings, or how a bond fund is purchased or sold—whether through a brokerage firm, bank, insurance agency, financial planning firm, registered investment advisor, or directly.

3. A net asset value (NAV) of fund shares is no guarantee. The ability to sell fund shares on any business day does not necessarily translate into the characteristics of “liquidity.” Funds make pricing assumptions, and they can receive much lower prices when they actually sell their holdings. Note: closed-end bond funds trade at premiums and discounts to their underlying NAVs.

4. Embedded leverage is the proverbial double-edged sword. Funds use yield enhancement strategies to try and boost returns and market their portfolios to attract or maintain investors’ money. This activity can translate into less obvious risks.

5. Is the Fund 100% committed to owning actual bonds? Whether due to fund size or purposeful strategy, additional risks are introduced with the use of synthetic positions and derivative contracts rather than actual bonds.

6. Date & data matching on fund report cards. Always check the “as of” date on top holdings, risk metrics, returns, credit weightings, and asset breakdowns. Look closely, and you may see inconsistency with the published report issue date. Are you sure you know what you own?

7. Fund managers may invest outside their comfort zone. Unprecedented low rates and high prices have forced some fund managers to reach for yield outside their comfort zones or core competencies. For example, a “conservative” fund could have heavy exposures to potentially high-risk Puerto Rico and tobacco bonds.

8. Risk metrics can be misleading. Listed durations are very popular and convenient numeric gauges of interest-rate risk. Unfortunately, these generic stand-alone descriptions of price sensitivity can mislead investors due to straight-forward assumptions and limitations. Most bond funds consist of hundreds or even thousands of bonds across a spectrum of maturities, sectors, credits, and bond features–so accurately portraying a full portfolio’s risk is more complex.

9. Historical “average” returns should not be extrapolated into the future. The chart below shows a clear example of unprecedented U.S. Central Bank activity beginning in 2008, when the Federal Reserve began increasing the size of its balance sheet from $900 billion to $4.5 trillion. Translation: Objects as seen in the seven year rear-view mirror are very distorted.

MH Bonds Graph 2

This article is an excerpt from a post that first appeared on the Empowered Portfolios blog.


Should You Worry About a Chinese Stock Market Bubble?

Shanghai Skyline

China’s economic growth has recently been characterized by diminished expectations. Over the past decade the economy of the world’s most populous country has often handily exceeded the government’s usual target of 8% annual growth. But last year the growth rate failed to meet the government’s reduced 7.5% target, and in March the government reduced its target for this year to 7%. Yet despite these disappointments, Chinese stocks have been among the world’s best performers so far in 2015. Is that dichotomy a worrying sign that China’s stock market gains will prove ephemeral?

Many experts believe the answer to that question is “yes,” and there’s evidence to back up that view. Price-to-earnings ratios for many smaller companies are over 100. Chinese citizens have opened new trading accounts in record numbers. The amount of margin financing (debt being used to buy stocks) has soared. These are all classic signs of a stock market bubble.

But US investors—even those with substantial exposure to Chinese stocks—may be largely isolated from this ostensible bubble. While valuations on many smaller Chinese companies do seem excessive, those for the larger companies that make up the bulk of the stock market are more in line with historical norms. By some metrics Chinese stocks overall may even be undervalued.

Furthermore, US investors (through the funds that they invest in) typically own shares of Chinese companies listed in Hong Kong rather than mainland China. Since late last year the value of the stocks listed on the mainland has surged, and on average they’re currently about 30% pricier than the Hong Kong shares of the same companies. That might be further evidence of investors being irrational, but it also suggests that US investors will be hurt far less than mainland Chinese investors if stock prices decline.

US investors aren’t completely isolated from the bubbly nature of some Chinese stocks: a dramatic loss of wealth for Chinese investors could reverberate throughout the country’s economy and stock market. But bigger-picture issues, such as whether the government can successfully manage the slowdown in the economy’s growth rate, are likely to be more important.

Three Portfolio Moves to Consider Now


While the first quarter largely played out as I expected, there were a few surprises, including the rapid appreciation of the dollar, another drop in rates and the strong performance from overseas markets. Given this, now may be a good time to review your portfolio positioning for 2015.

To help you, the 2015 Spring Update to The BlackRock List, BlackRock’s annual outlook, provides a concise look at what happened in the first quarter and what we expect to happen going forward. It’s BlackRock’s take on the essential things you need to know about the markets.

So what portfolio moves should you consider making as the second quarter kicks off? Before we focus on the future, it’s helpful to first reflect on the first-quarter surprises.

So far, 2015 is broadly developing as we predicted back in January, divergence being the central theme. The Federal Reserve (Fed) is preparing a course for higher interest rates, just as the central banks in Europe and Japan are doing the opposite.

This dynamic, however, has contributed to some of the surprises of 2015, including the rapid strengthening of the U.S. dollar. The stronger dollar helps explain why U.S. stocks have seen relatively lackluster performance, while stocks in Europe and Japan have done much better.

The continued downward movement on U.S. bond yields has also been somewhat unexpected, given that the Fed is setting the stage for higher interest rates later this year. It’s partly the consequence of an arguably bigger surprise: the softening of the U.S. economy, at least relative to expectations, as U.S. companies feel the impact of the strong dollar.

Looking ahead, here are three moves to consider to prepare for the next act of the Age of Divergence.

1. Prefer Stocks Over Bonds, But Be Choosy.

At BlackRock, we continue to favor stocks over bonds, which are even more expensive, and cash, which offers near-zero returns. But within equities, we remain cautious of bond market proxies, like Utilities. They are both expensive and extremely sensitive to even a small change in rates. We believe greater value can be found in sectors positioned to benefit from economic growth, such as technology and large integrated energy companies.

2. Look Overseas for Opportunities.

Stock market performance this year serves as a reminder of why it makes sense to consider including international stocks in your portfolio. We expect that European and Japanese stocks will continue to outperform U.S. ones in 2015, given their more attractive valuations and Europe and Japan’s more market-friendly central bank policies. We also continue to see value in select emerging markets, mostly in Asia. That said, we do see U.S. stocks climbing higher, although the gains should continue to be muted and expect volatility going forward.

3. Watch Your Step in Bonds.

A Fed hike in the back half of the year will likely cause rising volatility in the short-end of the yield curve. And with yields still low for longer maturities, there are few bargains for buyers of bonds. However, we do see some opportunities in the high yield sector, and municipal bonds look attractive, especially longer maturities (20 years and up).

These additions can help diversify a portfolio while providing greater growth opportunities. Diversification doesn’t guarantee profits or prevent loss (nothing does), but it does allow you to spread your risk across a broader set of instruments that may respond differently to a given set of market conditions. And in a world that still offers little in the way of screaming opportunities, mixing it up may be one of the best things you can do.

Source: Bloomberg

This post, Three Portfolio Moves to Consider Now, first appeared on the BlackRock blog.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to BlackRock’s The Blog and you can find more of his posts here.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities. There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.

©2015 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.


What’s the Matter with Utilities Stocks?

Utilities Performance

2015 has so far been a middling year for the stock market, with the S&P 500 index of large US stocks up slightly since the start of the year. But one sector of the market has stood out: utilities have been by far the worst-performing sector among US stocks, losing more than 6% while almost every other sector has provided investors with positive returns. What’s causing utilities to struggle?

The utilities sector is comprised of companies such as electricity and gas providers whose businesses and profitability are heavily regulated by the government. That regulation makes utilities less tied to the ups and downs of the economy than other sectors. Utilities are therefore generally considered “defensive” stocks, meaning that they often lag the overall market when the market does well and outperform when the broader market struggles.

But this year hasn’t been a banner year for the stock market, so that phenomenon doesn’t explain why utilities are lagging. And last year utilities were actually the top-performing sector even as the S&P 500 index posted double-digit returns.

Instead, the explanation is likely related to another characteristic of utilities stocks: their fairly stable profits allow them to pay substantial dividends to their investors. With the Federal Reserve keeping its benchmark interest rate near zero to try to boost the economy, some investors have viewed the dividends paid by utilities stocks as an alternative way to generate income from their portfolios.

That increased demand for utilities stocks likely explains part of the sector’s surge in 2014, and it’s made utilities more expensive by many valuation metrics. According to data from Yardeni Research, the forward P/E ratio for the utilities sector at the start of 2015 was among the highest of all the sectors (although it’s since fallen back a bit due to the sector’s poor returns this year).

The lofty valuations, combined with the possibility that the Fed could start raising interest rates later this year, have likely made the sector less attractive for many investors. This explanation suggests that utilities’ struggles could continue as the era of near-zero interest rates comes to a close.