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Anxiety over Greece sinks stocks

There’s always been the position that the small investor has no chance against the big institutions. – Peter Lynch

After falling about 2% on Monday on fears of a Greek default, both the S&P 500 Index and the Dow Jones Industrial Average recouped some of their losses and finished the week lower by about 1%. Greece failed to make a scheduled $1.7 billion payment to the International Monetary Fund (IMF) on June 30th and was technically in default as a result. A referendum was scheduled for Sunday July 5th when Greek voters will decide whether or not to accept continued austerity measures demanded by its creditors, namely the European Commission, the European Central Bank and the IMF. A Yes vote would enable Greece to restructure its loans, continue to receive bailout funds and remain in the euro zone. A No vote might increase the bargaining power of Greece at the negotiating table but almost certainly would lead to an exit from the euro zone. After Greek Prime Minister Alexis Tsipras called for the referendum, capital controls were implemented and all banks and the stock market were closed and will remain closed until after the vote is tabulated. Regardless of the outcome, the fact that Greece is a very small country with an equally small economy should have little impact on the global financial markets on a longer-term basis. Nevertheless, the uncertainty over this unprecedented event and the fear of possible contagion to other financially troubled European countries caused nervous investors to reduce their equity holdings and level of risk. News that the commonwealth of Puerto Rico has $72 billion of debt that it may be unable to repay only increased the level of anxiety among investors. These worries overshadowed an otherwise positive week for U.S. economic data. Both housing and manufacturing data were better than expected and the employment report for June showed that 223,000 new jobs were created, fewer than forecast but still above the 200,000 threshold. In some respects, this was a Goldilocks report, not too hot as to give the Federal Reserve a reason to raise interest rates soon and not too cold as to provide heightened concern over a slowing economy.

Last Week

Aside from the drama playing out in Greece and the serious debt situation in Puerto Rico, the economic news on the home front was generally encouraging. Pending home sales rose in May to their highest level in over nine years and the S&P/Case-Shiller home price index registered a nearly 5% increase in April. The Institute for Supply Management (ISM) manufacturing index rose to the highest level since January and construction spending recorded a healthy increase. Consumer confidence also topped expectations.

While the June employment report seemed mostly positive on the surface, a closer look revealed some concerns. Although the unemployment rate fell from 5.5% to 5.3%, the reason for the decline was that fewer people participated in the workforce or looked for a job. Average hourly wages only rose by 2% in June over a year ago and a total of 60,000 jobs were removed from the April and May job reports.

For the week, the Dow Jones Industrial Average fell 1.2% to close at 17,730 while the S&P 500 Index also declined 1.2% to close at 2,076. The Nasdaq Composite Index lost 1.4% to close at 5,009.

This Week

As of Sunday evening with over 90% of the vote counted, Greece had overwhelmingly voted No to the referendum, in effect rejecting the reform proposals by its creditors and setting the stage for Greece leaving the euro zone. The government indicated that it wants return to the negotiating table on Monday, though, with presumably more strength to obtain a better deal. The European Central Bank (ECB) will also meet to discuss emergency funding for Greek banks.

The only economic reports on the calendar this week are international trade, consumer credit and wholesale inventories for the month of May, none of which should have a significant impact on the markets. A number of Federal Reserve governors and presidents are scheduled to speak, including Federal Reserve Chair Janet Yellen, who will speak before the City Club in Cleveland on Friday.

There are only ten companies expected to release earnings reports this week as traditional front-runner Alcoa kicks off the second quarter earnings season. Two other familiar companies due to report include Pepsico and Walgreen Boots Alliance.

Portfolio Strategy

While it is widely expected that the Federal Reserve will raise interest rates later this year, the somewhat disappointing jobs data coupled with China’s slowing economic growth and ongoing problems in Greece could persuade the Fed to keep rates lower for longer. It is the fear of rising interest rates that has caused bond yields to spike and utilities stocks and real estate investment trusts (REITs) to underperform the overall market this year. These investments are interest-rate sensitive and tend to do poorly in a rising rate environment. But there is no guarantee that the Fed will raise interest rates this year. In fact, based on fed-funds futures contracts, traders do not see a rate hike until the first part of 2016. Even if the Fed does begin to normalize rates in September, the Fed has emphasized that it would do so gradually resulting in minimal disruption to the fixed income market. Given their recent weakness, both utilities and REITs offer above-average dividend yields and provide a steady and reliable source of income. If the Fed does adopt a wait-and-see attitude with regard to interest rates, then high dividend paying ETFs as well as ETFs that invest in companies with a history of dividend growth should also reward investors.