Equity markets had a rough second quarter.  For the period ending June 30, 2012 the S&P 500 index (large stocks) was down 2.8%, the Russell 2000 index (small stocks) was down 3.5%, and the MSCI EAFE index (international stocks) was down 6.9%.  The international index might have seen a double-digit decline were it not for some good news on the European debt crisis and a big rally on the last trading day of the quarter.

At the end of the first quarter I noted that, “the European debt crisis seems far from solved, and yet just the absence of bad news has had a surprisingly positive effect on global equity markets.”  Bad news returned in the second quarter, and the results reflect it.  Of course the discouraging new information was not limited to Europe as the Chinese economy showed signs of slowing down, and the U.S. recovery continues to struggle.  Nonetheless, returns for the year to date remain in positive territory, even for the international markets.

Portfolio returns were also buoyed by the strength of fixed income returns.  The broad bond index that we track was up 2.6% and some long-term government bond funds were up 12%.  The yield on 30-year Treasury bonds fell from 3.35% to 2.76% during the quarter, causing the jump in value, but reflecting the market’s expectation that low interest rates will persist for many years.  For anyone who thinks rates MUST go up from these levels, it is instructive to consider Japan.  Ten-year government bonds in Japan have been around or below 2% since 1998 and now provide a yield of just 0.85% (U.S. 10-year debt was yielding 1.67% at the end of the quarter).

2012 is showing once again that stock market returns can only be enjoyed if we are willing to accept risk and volatility.  We can also observe the benefit of diversification and the way bonds reduce volatility in a stock portfolio.