Both stocks and bonds fell last week, a reversal of the prior week's result. 
The Dow Jones Industrial Average dropped 0.93 per cent to 17,947, the S&P 500 Index declined 0.40 per cent to 2,101 and the tech-heavy Nasdaq Composite Index, despite touching a new record high, lost 0.71 per cent to close the week at 5,080. Meanwhile, the yield on the 10-year Treasury rose from 2.26 per cent to 2.48 per cent, as its price correspondingly fell.
The key culprits in last week's market action? Greece certainly did not help (and is likely to cause still more volatility), nor is an emerging bear market in China. But for US investors, the bigger problem may be one closer to home: the Federal Reserve and the virtual promise of higher rates.
A sensible course for equity investors, in our view, is to maintain a bias toward cyclical companies, such as technology, which tend to hold up better amid rising interest rates. At the same time, ease up on utilities and real estate investment trusts (REITs), which are expensive and vulnerable to losses in a rising-rate environment.
Performance of indices in 2015
Source: FE Analytics
Sticky situation in Greece
Despite the broad market losses, last week was not without a few bright spots: There was the Nasdaq’s new record high and a notable rally in hospital stocks when the Supreme Court upheld the current subsidy scheme under the Affordable Care Act. Overall, however, the US equity market has remained stuck in a fairly narrow trading range since February.
Several factors are dampening investor sentiment. The most obvious one is Greece. While last week initially provided some hope that Greece and its creditors were moving closer together, market expectations for a quick resolution took a nosedive over the weekend.
Greek prime minister Alex Tsipras's announcement of a referendum was swiftly followed by the Eurogroup announcing that the programme of financial support due to expire on 30 June would not be extended. Following that decision the European Central Bank announced that it will not increase the lifeline emergency funding that has largely funded depositors’ withdrawals from Greek banks.
Given these developments, banks in Greece will be closed through the week. The Greek referendum to be held 5 July will be a pivotal risk moment. Our base case remains that the European authorities will make every effort to minimise contagion and that the impact on other European financial markets, beyond short-term sentiment driven markdowns, is limited.
Performance of indices in 2015
Source: FE Analytics
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 per cent on Friday and are now roughly 19 per cent 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 per cent 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.
Performance of indices over 1yr
Source: FE Analytics
...and the Fed in the US
Finally, here at home, the bigger headwind for investors may be the Fed and, more precisely, the realisation 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 US 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 24 June, $3.8bn exited US bond funds, helping to push the yield on the 10-year treasury back toward the 2.50 per cent level.
For equity investors, we'd reiterate some of our recent views: Favour 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 emphasise 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.
Russ Koesterich is global chief investment strategist at BlackRock. The views expressed above are his own and should not be taken as investment advice.
