Carousel of Political Discontent

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

Hung parliaments in three recent elections may have investment implications. On this latest podcast, Stuart discusses what’s happening in Spain, Austria and Australia.

Quick hits:

  • Recent elections in Spain, Austria, and Australia highlight that voters are divided and unable to render a clear mandate for government.
  • Other parts of Europe appear vulnerable.
  • Politics pose risk to financial markets; loose monetary policy likely to persist in many places.

What do Spain, Austria, and Australia have in common? (No, this is not a trivia question nor the opening line of a bad joke.)

Each country in recent weeks has held elections, all of which failed to elect governments backed by a majority of the vote (with one case leading to yet another election).  Tepid economic growth has led to divided voters that could make it more difficult for governments to enact policies needed to stimulate economies. They each are riding “a carousel of political discontent”.

Starting in Spain

On June 26, Spain held general elections for the second time in six months (results of which were overshadowed by the Brexit referendum).  Both elections failed to confirm one party with a sufficient majority to form a government.  In fact, the two centrist-right and left parties lost parliamentary seats to smaller fringe parties. However, the June election did result in a higher seat count for the ruling center-right party.  Hope exists for the incumbent center-right party to be able to form a coalition, though most likely without support of a majority of parliament.[1]

Sobering developments in Austria

In May, Austria tried to elect a president, an office with more ceremonial functions than real political power.  The two final candidates came from the Greens and the far-right Freedom Party, parties not belonging to the traditional establishment.  After a very slight victory (50.3% to 49.7%)[2] for the Green candidate, the Austrian Constitutional Court annulled the results and rescheduled the election for October.[3]  Austria potentially might be the first country in the EU to elect a president from the far right, a sobering development in light of populist antipathy to the Euro project.

Instability in Australia

Elections that were intended to solidify the ruling coalition in Australia could end up having the opposite effect.  The ruling Liberal-National party coalition has lost seats in both houses of Parliament and faces the risk of forming a minority government.  Yet again, fringe parties siphoned off votes both from the incumbents and main opposition party Liberals. Australia has already suffered through five different Prime Ministers in the last six years. The last thing it needs is another unstable government and the risk of political paralysis and potential new elections.

Notable similarities

Three different countries with three different cultures still share some common themes. Slow economic growth has contributed to disillusionment with establishment parties. The new wrinkle is that cohesion in the traditional opposition, as well as incumbent parties, is unraveling. Fringe parties representing both ideological (far right and left) as well as parochial interests are gaining. Though unable to govern themselves, these fringe parties potentially could play greater roles as “kingmakers” for establishment parties to form ruling coalitions. More focus would be spent on holding together the coalition and catering to parochial issues rather than carrying through reforms to stoke confidence in the economy. Weak coalitions are prone to collapse and thus, new elections.

What’s the impact on other countries?

Other candidates for this cycle of discontent stand out in Europe, particularly countries in the Euro.  With its past history of rotating governments, Italy might reemerge as the popularity of incumbent PM Renzi has taken a hit from reform setbacks and lack of economic growth. The fringe opposition party Five Star enjoys significant popularity as shown in victories in recent municipal elections. The party espouses holding a referendum on Italy’s membership in the Euro. It might see opportunity to challenge Renzi in October when a referendum on voting reform is scheduled. If Renzi were to lose that vote, early elections are likely to ensue.

France also stands out with a vigorous populist far-right opposition party in the National Front of Marine LePen.  General elections in 2017 with the incumbent government suffering from depressed approval ratings could introduce additional market volatility. Along with a stagnant economy, France has also suffered backlash against efforts to reform labor markets.

What needs to change?

Political malcontent with economic growth has the potential to continue and add to market volatility. It also could lead to paralysis on fiscal and structural reform needed to accelerate growth. One consequence is likely: central banks will not be retreating from active monetary policy anytime soon in the face of weak growth, even if much of their dry powder has already been spent. Government inaction will still be replaced by central bank stimulation unless the situation changes.

Click here to listen to the podcast.

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.

[1] http://www.abc.es/espana/abci-rajoy-cita-manana-moncloa-201607051229_noticia.html  accessed on July 5, 2016.

[2] http://www.abc.net.au/news/2016-05-24/independent-van-der-bellen-wins-austrian-presidential-vote/7439372  accessed on July 5, 2016.

[3] https://www.theguardian.com/world/2016/jul/01/austrian-presidential-election-result-overturned-and-must-be-held-again-hofer-van-der-bellen accessed on July 5, 2016.

April 2016 Monthly Market And Economic Outlook

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After an extremely volatile quarter, the broad equity market indexes ended just about where they started. Risk assets began the year under heavy pressure, with the S&P 500 Index declining more than -10% to a 22-month low on February 11. Concerns over the global growth outlook and the impact of further weakness in crude oil prices weighed on investors, and investor sentiment hit levels of extreme pessimism. Then we experienced a major reversal beginning on February 12, helped by a rebound in oil prices after Saudi Arabia and Russia agreed to freeze production, and more dovish comments by the Federal Reserve. Expectations regarding the pace of additional rate hikes by the Fed have been tempered from where they started the year.

All U.S. equity sectors ended the quarter in positive territory except for healthcare and financials. Dividend paying stocks significantly outperformed, resulting in a strong quarter for both the telecom and utilities sectors, and value indexes overall. From a market capitalization perspective, mid-caps outperformed both large and small caps, helped by the strong performance of REITs, another yield-oriented asset class.

Developed international equity markets lagged U.S. equity markets in the first quarter despite benefiting from a weaker U.S. dollar. Japan and Europe were particularly weak despite additional easing moves by their central banks, while the commodity-sensitive countries, such as Canada and Australia were positive for the quarter. Emerging markets outperformed U.S. equity markets for the quarter despite declines in China and India. Brazil was the strongest performer, helped by a rebound in the currency, expectations for political change, and the bounce in commodity prices.

ECBBonds outperformed stocks during the quarter, and did not even decline during the risk-on rally. Additional easing from the European Central Bank and a negative interest rate policy in Japan prevented U.S. bond yields from moving higher.

All fixed income sectors were positive for the quarter, led by corporate credit, which benefited from meaningful spread tightening, and TIPS, which benefited from their longer duration. Municipal bonds delivered positive returns, but lagged taxable fixed income.

We remain positive on risk assets over the intermediate-term; however, we acknowledge that we are in the later innings of the bull market that began in 2009 and the second half of the business cycle. The worst equity market declines are typically associated with recessions, which are preceded by aggressive central bank tightening or accelerating inflation, factors which are not present today. While our macro outlook is biased in favor of the positives and a near-term end to the business cycle is not our base case, the risks must not be ignored.

A number of factors we find supportive of the economy and markets over the near term.

  • Global monetary policy remains accommodative: Despite the Federal Reserve beginning to normalize monetary policy with a first rate hike in December, their approach is patient and data dependent. The Bank of Japan and the ECB have been more aggressive with easing measures in an attempt to support their economies, and China is likely going to require additional support.
  • Stable U.S. growth and tame inflation: U.S. economic growth has been modest but steady. Payroll employment growth has been solid and the unemployment rate has fallen to 5.0%. Wage growth has been tepid at best despite the tightening labor market, and reported inflation measures and inflation expectations, while off the lows, remain below the Fed’s target.
  • U.S. fiscal policy more accommodative: With the new budget fiscal policy is poised to become modestly accommodative in 2016, helping offset more restrictive monetary policy.
  • Solid backdrop for U.S. consumer: The U.S. consumer should see benefits from lower energy prices and a stronger labor market.

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

  • Risk of 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. Negative interest rates are already prevalent in other developed market economies.
  • Slower global growth: Economic growth outside the U.S. is decidedly weaker, and a significant slowdown in China is a concern.
  • Another downturn in commodity prices: Oil prices have rebounded off of the recent lows and lower energy prices on the whole benefit the consumer; however, another significant leg down in prices could become destabilizing.
  • Further weakness in credit markets: While high yield credit spreads have tightened from February’s wide levels, further weakness would signal concern regarding risk assets more broadly.

The technical backdrop of the market has improved, as have credit conditions, while the macroeconomic environment remains favorable. Investor sentiment moved from extreme pessimism levels in early 2016 back into more neutral territory. Valuations are at or slightly above historical averages, but we need to see earnings growth reaccelerate. We expect a higher level of volatility as markets assess the impact of slower global growth and actions of policymakers; however, our view on risk assets tilts positive over the near term. Higher volatility has led to attractive pockets of opportunity we can 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.

It’s Official: China’s Currency Admitted to IMF Major Leagues

Stuart QuintStuart P. Quint, CFA, Senior Investment Manager & International Strategist

Here are the quick takes:

  • The IMF formally approved inclusion of the Chinese renminbi (RMB) into Special Drawing Rights (SDR)
  • Chinese RMB will not replace the U.S. dollar (USD) in the near term
  • Impact more symbolic near term, but progress will be measured over many years

The IMF formally indicated on November 30 it would include the Chinese RMB into its basket of approved reserve currencies. As stated in a previous blog, the inclusion of the RMB would appear to have limited near-term economic impact to the U.S. dollar.

Even with limited economic near-term impact, the inclusion of the RMB certainly has symbolic significance. Clearly, there is political benefit to the IMF’s recognition of the RMB in terms of enhancing China’s global prestige. The inclusion of the RMB might also serve as a carrot to deepen further structural reform as evidenced by China’s promise to have fully open capital accounts by 2020.[1]   Other countries hostile to the U.S., such as Russia and Iran, might view RMB investment as a way to hedge themselves against the risk of U.S.-led economic sanctions by conducting more trade away from the U.S. dollar.

However, the overall effects of the IMF SDR should not be overstated. The SDR is akin to a “recommended list” that cannot be enforced on central banks or markets. As an example, the weight of the USD was basically held flat at around 41%. (The new RMB weight was added at the expense mostly of the EUR). Furthermore, current holdings of central bank reserves deviate quite a bit from the SDR, with USD comprising 60% of total reserves (vs. 41% weight in the IMF SDR).[2] For comparison, central banks hold roughly 20% of reserves in EUR (vs. 31% weight in the IMF SDR). Some central banks hold currencies such as the Australian dollar (AUD) that are not in the IMF SDR.

Major potential shifts into the RMB will take place over a protracted period of years, but here are some milestones to watch:

  • Progress on further structural reform
  • Deeper liquidity in local Chinese bonds
  • Longer track record on responsible governance.

[1] http://www.bloomberg.com/news/articles/2015-10-22/china-said-to-weigh-pledge-for-opening-capital-account-by-2020-ig1sbvez .

[2] http://www.wsj.com/articles/proportion-of-euros-held-in-foreign-exchange-reserves-declines-1435686071

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.

2013 Review and Outlook

Amy MagnottaAmy Magnotta, CFA, Senior Investment Manager, Brinker Capital

2013 was a stellar year for U.S. equities, the best since 1997. Despite major concerns relating to the Federal Reserve (tapering of asset purchases, new Chairperson) and Washington (sequestration, government shutdown, debt ceiling), as well as issues like Cyprus and Syria, the U.S. equity markets steadily rallied throughout the year, failing to experience a pullback of more than 6%.

Source: Strategas Research Partners, LLC

In the U.S. markets, strong gains were experienced across all market capitalizations and styles, with each gaining at least 32% for the year. Small caps outperformed large caps and growth led value. Yield-oriented equities, like telecoms and utilities, generally lagged as they were impacted by the taper trade. The strongest performing sectors—consumer discretionary, healthcare and industrials—all gained more than 40%. Correlations across stocks continued to decline, which is a positive development for active managers.

YenDeveloped international markets produced solid gains for the year, but lagged the U.S. markets. Japan was the top performing country, gaining 52% in local terms; however, the gains translated to 27% in U.S. dollar terms due to a weaker yen. Performance in European markets was generally strong, led by Ireland, Germany and Spain.  Australia and Canada meaningfully lagged, delivering only mid-single-digit gains.

Concerns over the impact of Fed tapering and slowing economic growth weighed on emerging economies in 2013, and their equity markets significantly lagged that of developed economies. The group’s loss of -2.2% was exacerbated due to weaker currencies, especially in Brazil, Indonesia, Turkey and India. Emerging market small cap companies were able to eke out a gain of just over 1%, while less efficient frontier markets gained 4.5%.

Fixed income posted its first loss since 1999, with the Barclays Aggregate Index experiencing a decline of -2%. The yield on the 10-year U.S. Treasury began rising in May, and moved significantly higher after then Federal Reserve Chairman Bernanke signaled in his testimony to Congress that tapering of asset purchases could happen sooner than anticipated. The 10-year yield hit 3% but then declined again after the Fed decided not to begin tapering in September. It climbed steadily higher in November and December, ending the year at 3.04%—126 basis points above where it began the year.

TIPS were the worst performing fixed income sector for the year, declining more than -8%, as inflation remained low and TIPS have a longer-than-average duration. On the other hand, high-yield credit had a solid year, gaining more than 7%. Across the credit spectrum, lower quality outperformed.

Magnotta_Client_Newsletter_1.7.13_5We believe that the bias is for interest rates to move higher, but it will likely come in fits and starts. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome. Despite rising rates, fixed income still plays a role in portfolios, as a hedge to equity-oriented assets if we see weaker economic growth or major macro risks. Our fixed income positioning in portfolios, which includes an emphasis on yield advantaged, shorter duration and low volatility absolute return strategies, is designed to successfully navigate a rising interest rate environment.

We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we begin 2014, with a number of factors supporting the economy and markets.

  • Monetary policy remains accommodative: Even with tapering beginning in January, short-term interest rates should remain near zero until 2015. In addition, the European Central Bank stands ready to provide support, and the Bank of Japan has embraced an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Global growth strengthening: U.S. economic growth has been slow and steady, but momentum has picked up (+4.1% annualized growth in 3Q). The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S., growth has not been very robust but is still positive.
  • Labor market progress: The recovery in the labor market has been slow, but stable. Monthly payroll gains have averaged more than 200,000 and the unemployment rate has fallen to 7%.
  • Inflation tame: With the CPI increasing only +1.2% over the last 12 months, inflation in the U.S. is running below the Fed’s target.
  • Increase in household net worth: Household net worth rose to a new high in the third quarter, helped by both financial and real estate assets. Rising net worth is a positive for consumer confidence and future consumption.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested, returned to shareholders, or used for acquisitions. Corporate profits remain at high levels and margins have been resilient.
  • Equity fund flows turn positive: Equity mutual funds have experienced inflows over the last three months while fixed income funds have experienced significant outflows, a reversal of the pattern of the last five years. Continued inflows would provide further support to the equity markets.
  • Some movement on fiscal policy: After serving as a major uncertainty over the last few years, there seems to be some movement in Washington. Fiscal drag will not have a major impact on growth next year. All parties in Washington were able to agree on a two year budget agreement, averting another government shutdown in January. However, the debt ceiling still needs to be addressed.

However, risks facing the economy and markets remain including:

  • Fed Tapering: The Fed will begin reducing the amount of their asset purchases in January, and if they taper an additional $10 billion at each meeting, QE should end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, the economy appears to be on more solid footing.
  • Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery. Should mortgage rates move higher, it could jeopardize the recovery in the housing market.
  • Sentiment elevated: Investor sentiment is elevated, which typically serves as a contrarian signal. The market has not experienced a correction in some time.

Risk assets should continue to perform if real growth continues to recover, even in a higher interest rate environment; however, we could see volatility as markets digest the slow withdrawal of stimulus by the Federal Reserve. Valuations have certainly moved higher, but are not overly rich relative to history. Markets rarely stop when they reach fair value. There are even pockets of attractive valuations, such as emerging markets. Momentum remains strong; the S&P 500 Index spent all of 2013 above its 200-day moving average. However, investor sentiment is elevated, which could provide ammunition for a short-term pull-back. A pull-back could be short-lived should demand for equities remain robust.

Asset Class Outlook

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 ReturnsAsset Class Returns