January 2016 Monthly Market And Economic Outlook

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After three years of strong market returns, 2015 performance was relatively flat combined with higher volatility across most asset classes. Sluggish global economic growth, concerns over a hard landing in China, a further decline in oil prices, and the anticipation of the Federal Reserve’s first interest rate hike since 2006 weighed on markets. The U.S. dollar was a top performing asset class, gaining more than 9%, while commodity-related assets were the worst performers. Large cap U.S. equities outpaced small cap and international equities, fixed income delivered lackluster returns, and alternative strategies generally underperformed expectations, resulting in a difficult year for diversified investors.

Despite a robust fourth quarter, U.S. equity markets ended the year with a small gain on a total return basis. There was also wide dispersion across sectors. Consumer discretionary dominated with a double-digit gain, followed by healthcare and technology. Energy experienced a greater than -20% loss for the year. With sluggish economic growth as the backdrop, investors significantly favored growth over value from a style perspective across all market capitalizations, but particularly in the large cap space where the spread was more than 900 basis points. Small caps faded after a strong start to the year, with the Russell 2000 Index declining more than -4%.

BRICDeveloped international equity markets performed in line with U.S. markets in local terms during 2015, but lagged in U.S. dollar terms. Unlike in the U.S., small caps outpaced large caps in international markets. Japan was the strongest performing market with a gain of almost 10%. Emerging markets significantly underperformed developed markets. The weakest performer was Brazil, with a decline of more than -40% in U.S. dollar terms. Of the BRIC countries, only Russia was able to deliver a positive return.

Longer-term U.S. Treasury yields moved slightly higher in 2015, with the 10-year rising 10 basis points to end the year at a level of 2.27%. The shorter-end of the curve moved higher, resulting in a modest flattening of the yield curve. Even with the Fed’s actions, we expect longer-term rates to remain range-bound in the intermediate term. All investment-grade fixed income sectors except for corporate credit delivered modest gains, and municipal bonds outperformed taxable fixed income. High-yield credit spreads widened meaningfully throughout 2015 and the asset class declined more than -4%. Technical pressures, including increased supply and meaningful outflows, weighed on the high-yield market with the most impact on lowest-rated credits; however, we have yet to see a meaningful decline in fundamentals.

The global macro backdrop keeps us positive on risk assets over the intermediate term as we move through the second half of the business cycle. However, we acknowledge that we are in the later innings of the bull market that began in 2009, and the risks must not be ignored. We find a number of factors supportive of the economy and markets over the near term.

  • Fed_OutlookGlobal monetary policy accommodation: Despite the Fed beginning to normalize monetary policy with the initial rate hike in December, their approach should be patient and data-dependent. The European Central Bank (ECB) and the Bank of Japan have been more aggressive with easing measures in an attempt to support their economies. China is likely going to require additional support.
  • U.S. growth stable and inflation tame: U.S. economic growth has been modest but steady. Payroll employment growth has been solid, and the unemployment rate has fallen to 5%. Wage growth has been tepid at best despite the tightening labor market, and reported inflation measures and inflation expectations remain below the Fed’s target.
  • Deal Activity: Mergers and acquisitions (M&A) deal activity continues to pick up as companies seek growth.
  • Washington: With the new budget, fiscal policy is poised to become modestly accommodative, helping offset more restrictive monetary policy.

However, risks facing the economy and markets remain, including:

  • Policy mistake: The potential for a policy mistake by the Fed or another major central bank is a concern, and central bank communication will be key. In the U.S., the subsequent path of rates is uncertain and may not be in line with market expectations, which could lead to increased volatility.
  • Slower global growth: Economic growth outside the U.S. is decidedly weaker, and a significant slowdown in China is a concern.
  • Wider credit spreads: While overall credit conditions are still accommodative, high-yield credit spreads have moved significantly wider, and weakness has spread outside of the commodity sector.
  • Commodity price weakness: Weakness in commodity-related sectors has begun to spill over to other areas of the economy, and earnings have weakened as a result.
  • Geopolitical risks could cause short-term volatility.

Market technicals remain weak, but valuations are back to more neutral levels. Investor sentiment, a contrarian signal, is near extreme pessimism territory. We expect a higher level of volatility as markets digest the Fed’s actions and we move through the second half of the business cycle; however, our view on risk assets remains positive over the near term. Increased volatility creates opportunities that we may take advantage of as active managers.

Source: Brinker Capital. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Brinker Capital, Inc., a Registered Investment Advisor.

Early Concern in 2016 Yields Opportunity

Miller_HeadshotBill Miller, Chief Investment Officer

Overall global economic concerns and yesterday’s market events present a great opportunity to remind investors to stay focused on their goals. To that end, we highlight two performance metrics:

First, as illustrated below, some asset classes, including gold, U.S. Treasury bonds, TIPs and pipeline Master Limited Partnerships, finished up yesterday in the face of poor global equity performance. In some cases, this is the opposite of last year’s performance. Such a flip-flop in performance across asset classes only serves to highlight the value of Brinker Capital’s multi-asset class investment philosophy. A commitment to diversification can help calm investors on bad days and moderate enthusiasm on good days.

Performance Across Asset Classes

Source: Brinker Capital, FactSet

Second, big drops in the S&P are infrequent but certainly not an unfamiliar occurrence on an absolute basis. There have been single-day dips of 2% or greater in the S&P 500 a total of 222 times in the trailing 20 years, or just slightly under 5% of the total number of trading days.

More importantly, following these dips the median S&P return in the following month (2.44% over the subsequent 20 trading days) has been more than double that of the median 20-day S&P return over the period on a non-conditional basis (1.01%).

Over the last 20 years, a strategy that fled to cash for 20-day periods following those 2% S&P 500 declines would have fared 2% worse on an annualized basis than staying 100% invested in equity. That’s a cumulative return difference of 151%.

S&P 500 Performance

Source: Brinker Capital, FactSet

Again, yesterday’s volatility presents a great opportunity early in 2016 to remind investors that it’s not time to panic–it’s important to stay focused on their goals. While we can’t predict what specifically may happen in the future, Brinker Capital has been identifying trends and leveraging our six-asset class philosophy when positioning our portfolios to anticipate a period of increased market volatility in many of our strategic and tactical portfolios.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

The “Don’ts” for Periods of Market Volatility

Crosby_2015Dr. Daniel Crosby, Founder, Nocturne Capital

Having checked in this week with many of our advisors and the clients they serve, we know that this has been a stressful week for everyone involved in the market. On Monday, we wanted to provide a few proactive starting points and created a list of “do’s” for volatile markets. However, at times like this, knowing what not to do can be just as important as knowing what to do. With that, we present a list of things you should absolutely not be doing in periods of market volatility.

  • Don’t lose your sense of history – The average intrayear drawdown over the past 35 years has been just over 14%. The market ended the year higher on 27 of those 35 years. A relatively placid six years has lulled investors into a false reality, but nothing that we have experienced this year is out of the average by historical measures.
  • Don’t equate risk with volatility – Repeat after me, “volatility does not equal risk.” Risk is the likelihood that you will not have the money you need at the time you need it to live the life you want to live. Nothing more, nothing less. Paper losses are not “risk” and neither are the gyrations of a volatile market.
  • Don’t focus on the minute to minute – Despite the enormous wealth creating power of the market, looking at it too closely can be terrifying. A daily look at portfolio values means you see a loss 46.7% of the time, whereas a yearly look shows a loss a mere 27.6% of the time. Limited looking leads to increased feelings of security and improved decision-making.
  • Don’t forget how markets work – Do you know why stocks outperform other asset classes by about 5% on a volatility-adjusted basis? Because they can be scary at times, that’s why! Long term investors have been handsomely rewarded by equity markets, but those rewards come at the price of bravery during periods short-term uncertainty.
  • Don’t give in to action bias – At most times and in most situations, increased effort leads to improved outcomes. Want to lose weight? Start running! Want to learn a new skill set? Go back to school. Investing is that rare world where doing less actually gets you more. James O’Shaughnessy of “What Works on Wall Street” fame relates an illustrative story of a study done at Fidelity. When they surveyed their accounts to see which had done best, they uncovered something counterintuitive. The best-performing accounts were those that had been forgotten entirely. In the immortal words of Jack Bogle, “don’t do something, just stand there!”

Views expressed are for illustrative purposes only. The information was created and supplied by Dr. Daniel Crosby of Nocturne Capital, an unaffiliated third party. Brinker Capital Inc., a Registered Investment Advisor

Monthly Market and Economic Outlook: July 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Uncertainty over the start of the Federal Reserve’s rate hike campaign, the possibility of a default in Greece and Puerto Rico, and the drop in China shares each weighed on financial markets in June, resulting in a quarter of flat to negative performance across most asset classes. The increased volatility and higher level of dispersion across and within asset classes has benefited active management.

The S&P 500 Index fell almost -2% in June but was able to eke out a small gain for the quarter, despite the negative headlines. The healthcare and consumer discretionary sectors continued to lead, while bond proxies like dividend-paying stocks and REITs struggled. Energy stocks continued to lose ground as well despite a stabilization in crude oil prices. From a market cap perspective, small caps are leading large and mid caps, but the margin isn’t as wide as it is between growth and value. Through the first half of the year, all style boxes are positive except for large cap value, which is modestly negative. However, dispersion is wide, with small cap growth outpacing large cap value by more than 900 basis points over that time period.

Greece_OutlookThe rally in international equities slowed in the second quarter as fears surrounding Greece prompted a sharper sell-off in June; however, international markets still ended the quarter ahead of U.S. markets and continue to have a sizeable lead through the first half of the year. The U.S. Dollar Index (DXY) was weaker in the second quarter, but has still posted gains of more than 5% in the first half, dampening international equity returns for U.S. investors.

In developed markets, Japan, fueled by its expansive quantitative easing program, has been the top performer year to date, gaining almost 14%. Europe, despite a weaker second quarter, has gained more than 4%. Emerging markets soared in April, but gave most of the gains back in May and June to end the quarter in line with developed international markets. June’s significant decline in the Chinese local stock market, which had gained more than 110% since November, prompted a number of policy responses. However, for investors the vast majority of exposure is gained through listings on the more open Hong Kong exchange, which has not experienced gains and losses of even close to the same magnitude.

Anticipation of a Fed rate hike in the fall incited a rise in long-term U.S. Treasury yields, with yield on the 10-year note climbing 41 basis points during the quarter to 2.35%. As a result, the Barclays Aggregate declined -1.7% in the second quarter and is slightly negative through the first six months of the year. All fixed income sectors were negative for the quarter, led by U.S. Treasuries. The macro concerns caused both investment grade and high-yield credit spreads to widen, but due to its yield cushion, the high-yield index was flat for the quarter and remains the strongest fixed income sector year to date with a gain of +2.5%. Despite the recent widening, spreads are still at levels below where we started the year. Municipal bonds finished the quarter ahead of taxable bonds, but are still flat year to date. Increased supply weighed on the municipal market in the second quarter.

Our outlook remains biased in favor of the positives, but recognizes that risks remain. We’re solidly in the second half of the business cycle, but the global macro backdrop keeps us positive on risk assets over the intermediate term. As a result, our strategic portfolios are positioned with a modest overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy accommodation: Despite the Fed heading toward monetary policy normalization, their approach will be cautious and data dependent. The ECB and the Bank of Japan have both executed bold easing measures in an attempt to support their economies.
  • U.S. growth stable and inflation tame: Despite a soft patch in the first quarter, U.S. economic growth is forecast to be positive in the second quarter and the labor market continues to show steady improvement. While wages are showing signs of acceleration, reported inflation measures and inflation expectations remain below the Fed’s target.
  • U.S. companies remain in solid shape: M&A activity has picked up and companies also are putting cash to work through capex and hiring. Earnings growth outside of the energy sector is positive, and margins have been resilient.
  • Less uncertainty in Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year; however, Congress will still need to address the debt ceiling before the fall. Government spending has shifted to a contributor to GDP growth in 2015 after years of fiscal drag.

However, risks facing the economy and markets remain, including:

  • Fed tightening: The Fed has set the stage to commence rate hikes later this year. Both the timing of the first rate increase, and the subsequent path of rates is uncertain, which could lead to increased market volatility.
  • Slower global growth: Economic growth outside the U.S. is decidedly weaker. It remains to be seen whether central bank policies can spur sustainable growth in Europe and Japan. Growth in emerging economies has slowed as well.
  • Contagion risk relating to the situations in Greece and China must continue to be monitored.
  • Geopolitical risks could cause short-term volatility.

Despite higher than average valuations, neutral investor sentiment and a weaker technical backdrop, we believe the macro picture supports additional market gains over the intermediate-term. However, with headline risk of events in Greece and the Fed set to normalize monetary policy, a larger pull-back is not out of the question. The S&P 500 Index has gone more than 900 days without a 10% correction, the third longest period on record (Source: Ned Davis Research). However, because of our positive macro view, we’d view a pull-back as a buying opportunity and would expect the equity market to continue its uptrend.

Fed_OutlookWe expect U.S. interest rates to continue to normalize; however, U.S. Treasuries still offer relative value over sovereign bonds in other developed markets, which could keep a ceiling on long-term rates in the short-term. With the Fed set to increase the federal funds rate this year, we should see a flattening of the yield curve. Our portfolios are positioned in defense of rising interest rates, with a shorter duration and yield cushion versus the broader market.

As we operate without the liquidity provided by the Fed and move through the second half of the business cycle, we expect higher levels of both equity and bond market volatility. We expect this volatility and dispersion of returns to lead to more attractive opportunities for active management across and within asset classes. Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class Outlook Comments
U.S. Equity + Quality bias
Intl Equity + Neutral vs. US
Fixed Income +/- Favor global high yield
Absolute Return + Favor fixed income AR, event driven
Real Assets +/- Favor global natural resources
Private Equity + Later in cycle

Source: Brinker Capital

Brinker Capital, Inc., a Registered Investment Advisor. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting.

International Insights Podcast – Europe and Negative Interest Rates

Stuart Quint, Investment Insights PodcastStuart P. Quint, CFA, Senior Investment Manager and International Strategist

This audio podcast was recorded March 19, 2015:

Stuart’s International Insights Podcast focuses on a new and growing phenomenon in European fixed income–negative interest rates

Highlights of the discussion include:

How did we get here?:

  • ECB QE drove bond values up and yields down
  • One out of every five euros of government debt trades with a negative interest rate (0 such securities existed in the summer of last year)
  • Non-ECB banks Switzerland and Sweden cutting interest rates to dissuade capital inflows in an effort to manage exchange rate
  • Asset managers and insurance companies trying to fund longer-term liabilities but they earn lower or negative spreads without price appreciation.

Potential implications:

  • Scenario 1: Little to no economic growth
    • Near-term, stimulative to European equities
    • Potentially helpful to the U.S. dollar, but less so for export earning of large U.S. companies
  • Scenario 2: Moderate to high economic growth
    • ECB potentially steps back to review QE perhaps pushing bond yields upward
    • Fixed income globally would be most at risk

Click here to listen to the full audio recording

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, a Registered Investment Advisor.

Monthly Market and Economic Outlook: March 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Global equity markets delivered solid gains in February, helped by a stabilization in crude oil prices, signs of better economic growth in Europe, and a short-term resolution in Greece. It was a “risk-on” environment for U.S. equities, with the S&P 500 gaining 5.8%, despite more mixed economic data. Cyclical sectors, like consumer discretionary and information technology, posted gains of more than 8%, while the more defensive utilities sector fell more than -6% during the month. In the U.S. growth outpaced value, but there was little differentiation by size.

International developed equities were slightly ahead of U.S. equities in February despite continued U.S. dollar strength. European equities in particular exhibited strength ahead of the ECB’s quantitative easing program. Emerging market equities had positive returns in February, but lagged developed markets. Brazil, India and China were all relatively weak, while emerging European equities fared the best. A ceasefire agreement with Ukraine, as well as the stabilization in oil prices, helped boost Russia’s currency and their equity markets, which gained more than 22% in USD terms.

U.S. Treasury yields rose in February, with the yield on the 10-year Treasury note climbing 32 basis points to 2.0%. In her comments to Congress, Fed Chair Yellen laid the groundwork for the Fed’s first rate hike this year, which could come as early as June. All sectors in the Barclays Aggregate were negative in February, with Treasuries experiencing the largest decline. High yield credit spreads tightened meaningfully during the month and high yield bonds gained more than 2%. Municipal bonds were slightly behind taxable bonds for the month.

Our outlook remains biased in favor of the positives, while paying close attention to the risks. We feel we have entered the second half of the business cycle, but remain optimistic regarding the global macro backdrop and risk assets over the intermediate-term. As a result our strategic portfolios are positioned with a modest overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy accommodation: Despite the Federal Reserve heading toward monetary policy normalization, the ECB and the Bank of Japan have both executed bold easing measures in an attempt to support their economies.
  • U.S. growth stable: Economic growth has improved over the last few quarters. A combination of strengthening labor markets and lower oil prices are likely to provide the stimulus for stronger-than expected economic growth in the near-term.
  • Inflation tame: Reported inflation measures and inflation expectations in the U.S. remain below the Fed’s 2% target.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets are beginning to put cash to work. Earnings growth has been decent and margins have been resilient.
  • Less uncertainty in Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year; however, Congress will still need to address the debt ceiling before the fall. Government spending has shifted to a contributor to GDP growth in 2015 after years of fiscal drag.

However, risks facing the economy and markets remain, including:

  • Timing/impact of Fed tightening: The Fed has set the stage to commence rate hikes later this year. Both the timing of the first rate increase, and the subsequent path of rates is uncertain, which could lead to increased market volatility.
  • Slower global growth: While growth in the U.S. is solid, growth outside the U.S. is decidedly weaker. The Eurozone is flirting with recession and Japan is struggling to create real growth. Growth in emerging economies has slowed as well.
  • Geopolitical risks: Issues in Greece, the Middle East and Russia, could cause short-term volatility.
  • Significantly lower oil prices destabilizes global economy: While lower oil prices benefit consumers, should oil prices re-test their recent lows and remain there for a significant period, it would be a negative not only for the earnings of energy companies, but also for oil dependent emerging economies and the shale revolution in the U.S.

While valuations have moved above long-term averages and investor sentiment is neutral, the trend is still positive and the macro backdrop leans favorable, so we remain positive on equities. The ECB’s actions, combined with signs of economic improvement, have us more positive in the short-term regarding international developed equities, but we need to see follow-through with structural reforms. We expect U.S. interest rates to remain range-bound, but the yield curve to flatten. Fed policy will drive short-term rates higher, but long-term yields should be held down by demand for long duration safe assets and relative value versus other developed sovereign bonds.

However, as we operate without the liquidity provided by the Fed and move through the second half of the business cycle, we expect higher levels of market volatility. This volatility should lead to more opportunity for active management across asset classes. Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class Outlook Comments
U.S. Equity + Quality bias
Intl Equity + Country specific
Fixed Income +/- HY favorable after ST dislocation
Absolute Return + Benefit from higher volatility
Real Assets +/- Oil stabilizes; interest rate sensitivity
Private Equity + Later in cycle

Source: Brinker Capital

Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

Chasing Markets

Jeff RauppJeff Raupp, CFA, Senior Investment Manager, Brinker Capital

Back when I was in the U.S. Army, one thing I dreaded was the two-mile run as part of the Physical Fitness (PT) Test. I am not a runner. While most people would scoff at the notion of a two-mile run being intimidating, I looked at it as 13-14 minutes of pain. It was timed, and the better finishing times naturally resulted in a better score. Seemingly anything above 15 minutes resulted in a fail and, of course, more running.

One of the things I had the most trouble with was finding the right pace. I’d have instances where I’d try to run a balanced race only to end up having to sprint the last few hundred yards to reach my desired time. Then there were the times where I’d go out too hard and find myself stumbling into the finish line. The hills on the courses would complicate things – I’d kill myself trying to keep a constant pace uphill and downhill.

shutterstock_175699433After struggling with this for months, I came up with a better solution. We always ran as a group, and I found that I could usually find a few people that would consistently run around the same time I was looking for. Then my objective would be to keep up with them knowing that as long as I finished somewhere in their vicinity, I’d hit my goal.

The other day someone asked me whether investors’ financial goals should be to try to outperform the market, and with my response I thought there were a lot of similarities to my past running strategy.

An investor starts with an objective they’d like to get to, how much money they have, expected cash flows and their time horizon. From there it’s a matter of finding the right mix of asset classes that historically has shown a high probability of achieving the returns necessary to reach the objective(s). That mix can be thought of as your strategic plan.

Along the way, the market is a useful reference point. Investing isn’t a smooth journey, so when your strategy has drawdowns or grows faster than you expected, knowing how markets performed helps you determine if that’s just market volatility or if something may be wrong with your plan. Changing your strategic plan along the way can be dangerous, particularly at market extremes. If you’re always chasing the runner that looks the strongest at the moment, there’s a good chance you’ll burn out before the finish.

The views expressed are those of Brinker Capital and are for informational purposes only.

Educating Clients in the Search for Yield

Stuart Quint, Investment Insights PodcastStuart P. Quint, CFA, Senior Investment Manager and International Strategist

We were proud to be Premier Sponsors of this year’s Financial Services Institute’s OneVoice conference. We participated on multiple panels while there and had the opportunity to network and hear from many industry experts to learn about the latest within the industry.

I participated on the panel, Educating Clients in the Search for Yield, that addressed the issue of whether or not alternatives provide a legitimate and sustainable source of income. After a great discussion, we concluded that investors need to understand what they are buying and should consider these issues when doing their due diligence:

  • There is a variety of alternatives that come with lower (but not zero) correlation to traditional asset classes (equities and bonds) absolute return, real asset, BDC, private equity strategies have different return and risk profiles; liquid and illiquid structures.
  • It is important to be aware of the risk components within strategy: interest rate, credit, operational, funding risk.
  • Don’t stretch for promise of high yield as high yield is only one part of total return.

Click here to listen to the audio recording.

Monthly Market and Economic Outlook: January 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Despite geopolitical tensions in Russia and the Middle East, the end of the Federal Reserve’s quantitative easing program, weakness in growth abroad, and a significant decline in oil prices, U.S. large cap equities posted solid double-digit gains in 2014. International equity markets lagged U.S. markets, and the spread was exacerbated by the major strength in the U.S. dollar. Despite consensus calling for higher interest rates in 2014, yields fell, helping long-term Treasuries deliver outsized returns of more than 25%. The weakness in energy prices weighed on markets in the fourth quarter, with crude oil prices falling by almost 50%, the type of move we last saw in 2008. However, it wasn’t enough to prevent the S&P 500 from hitting all-time highs again in December. Volatility remained relatively low throughout the year. We did not see more than three consecutive down days for the S&P 500, the fewest on record (Source: Ned Davis Research).

In the U.S., the technology and healthcare sectors were the largest contributors to the S&P 500 return; however, utilities posted the biggest return, gaining more than 28%. Large caps significantly outperformed small caps for the year, despite a big fourth quarter for small caps. The spread between the large cap Russell 1000 Index and small cap Russell 2000 Index was 760 basis points. Growth outperformed value in large caps and small caps, but value outperformed in mid caps due to the strong performance of REITs.

BRICU.S. equities outperformed the rest of the world in 2014. The S&P 500 Index led the MSCI EAFE Index by more than 1,800 basis points, the widest gap since 1997. In local terms, international developed markets were positive, but the strength of the dollar pushed returns negative for U.S. investors. Emerging markets led developed international markets, but results were mixed. Strength in India and China was offset by weakness in Brazil and Russia.

As the Fed continued to taper bond purchases and eventually end quantitative easing in the fourth quarter, expectations were for interest rates to move higher. We experienced the opposite; the yield on the 10-year U.S. Treasury note fell 80 basis points during the year, from 3.0% to 2.2%. Despite a pick-up in economic growth, inflation expectations moved lower. In addition, U.S. sovereign yields still look attractive relative to the rest of the developed world. As a result of the move lower in rates, duration outperformed credit within fixed income. All sectors delivered positive returns for the year, including high-yield credit, which sold off significantly in the fourth quarter due to its meaningful exposure to energy credits.

Our macro outlook remains unchanged. When weighing the positives and the risks, we continue to believe the balance is shifted in favor of the positives over the intermediate term and the global macro backdrop is constructive for risk assets. As a result our strategic portfolios are positioned with an overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy accommodation: We anticipate the Fed beginning to raise rates in mid-2015, but at a measured pace as inflation remains contained. The ECB is expected to take even more aggressive action to support the European economy, and the Bank of Japan’s aggressive easing program continues.
  • Pickup in U.S. growth: Economic growth improved in the second half of 2014. A combination of strengthening labor markets and lower oil prices are likely to provide the stimulus for stronger-than-expected economic growth.
  • Inflation tame: Inflation in the U.S. remains below the Fed’s 2% target, and inflation expectations have been falling. Outside the U.S., deflationary pressures are rising.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. Earnings growth has been solid and margins have been resilient.
  • Less uncertainty in Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Government spending will shift to a contributor to GDP growth in 2015 after years of fiscal drag.
  • Lower energy prices help consumer: Lower energy prices should benefit the consumer who will now have more disposable income.

However, risks facing the economy and markets remain, including:

  • Timing/impact of Fed tightening: QE ended without a major impact, so concern has shifted to the timing of the Fed’s first interest rate hike. While economic growth has picked up and the labor market has shown steady improvement, inflation measures and inflation expectations remain contained, which should provide the Fed more runway.
  • Slower global growth; deflationary pressures: While growth in the U.S. has picked up, growth outside the U.S. is decidedly weaker. The Eurozone is flirting with recession, and Japan is struggling to create real growth, while both are also facing deflationary pressures. Growth in emerging economies has slowed as well.
  • Geopolitical risks: The geopolitical impact of the significant drop in oil prices, as well as issues in the Middle East and Russia, could cause short-term volatility.
  • Significantly lower oil prices destabilizes global economy: While lower oil prices benefit consumers, significantly lower oil prices for a meaningful period of time are not only negative for the earnings of energy companies, but could put pressure on oil dependent countries, as well as impact the shale revolution in the U.S.

While valuations are close to long-term averages, investor sentiment is in neutral territory, the trend is still positive, and the macro backdrop leans favorable, so we remain positive on equities. In addition, seasonality and the election cycle are in our favor. The fourth quarter tends to be bullish for equities, as well as the 12-month period following mid-term elections. However, we expect higher levels of volatility in 2015.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class Outlook Comments
U.S. Equity + Quality bias; overweight vs. Intl
Intl Equity + Country specific
Fixed Income +/- Actively managed
Absolute Return + Benefit from higher volatility
Real Assets +/- Oil stabilizes in 2H15
Private Equity + Later in cycle

Source: Brinker Capital

Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

 

Yale Endowment Proves, Once Again, That A Free Lunch is Not a Thing of the Past

Sue BerginSue Bergin, President, S Bergin Communications

In 1952, Harry Markowitz, an unknown 25-year old graduate student at the University of Chicago, defined risk mathematically for the first time. He also explained how investors could lower volatility while preserving expected returns if they incorporated different investments that are not highly correlated. He went on to explain, “diversification is a kind of free lunch at which you can combine a group of risky securities with high expected returns into a relatively low-risk portfolio, so long as you minimize the covariances, or correlations, among the returns of the individual securities.”

YaleThe most prominent institutional investor in developing the multi-asset class investment model was, and remains, David Swensen, chief investment officer of the Yale University Investment Office. The power of diversification to act as a free lunch is described in his book Pioneering Portfolio Management. Swensen, the long-term Chief Investment Officer at Yale University and father of the Yale Endowment Model, believed in avoiding liquidity rather than seeking it, since it comes at a cost of lower returns. The Yale Endowment Model emphasizes broad diversification and makes the case for allocating only a small amount to traditional U.S. equities and bonds and more to alternative investments.

Today, multi-class investing means different things to different people. Initially the Yale Model was based on an asset class composition that included six asset classes. It currently uses seven asset classes: domestic equity, foreign equity, fixed income, absolute return, natural resources, real estate, and private equity.

When it comes to achieving purity of asset class composition, Swensen had to say this:

Purity of asset class composition represents a rarely achieved ideal. Carried to an extreme, the search for purity results in dozens of asset classes, creating an unmanageable multiplicity of alternatives. While market participants disagree on the appropriate number of asset classes, the number should be large enough so that portfolio commitments make a difference, yet small enough so that portfolio commitments do not make too much of a difference. Committing less than 5 percent or 10 percent of a fund to a particular type of investment makes little sense; the small allocation holds no potential to influence overall portfolio results. Committing more than 25 percent or 30 percent to an asset class poses danger of overconcentration. Most portfolios work well with around a half a dozen of asset classes [1].

Swensen’s views on diversification and asset allocation continue to pay off. According to the preliminary 2014 results of the NACUBO-Commonfund Study of Endowments, larger, better-diversified endowments have outperformed their smaller, equity heavy peers.

On average, the 426 university and college endowments in the study returned 15.8%, while endowments with more than $1 billion returned on average 16.8%, and endowments with between $500 million and $1 billion, saw investment returns of 16.2%.

Free LunchYale University led the group, posting 20.2% gains. Further proof that the free lunch concept is alive in well in 2014.

The principles and benefits of diversification are well supported by academic thought. When selecting an investment manager, advisors and investors should consider a firm that believes in the value of the free lunch by taking a multi-asset class investment approach.

[1] Swensen, D. (2009). Asset Allocation. In Pioneering Portfolio Management (p. 101). New York: Simon and Schuster.

The views expressed are those of Brinker Capital and are for informational purposes only. Brinker Capital, Inc., a Registered Investment Advisor.