Investment Insights Podcast – August 5, 2015

miller_podcast_graphic Bill Miller, Chief Investment Officer

On this week’s podcast (recorded August 4, 2015), Bill breaks away from the traditional format to provide context around the headline of Puerto Rico defaulting on some of their bonds.

Highlights include:

  • Puerto Rico’s debt is larger than every other state in the U.S. except for California and New York
  • They did not make payment on a specific type/class of bond
  • General obligations/revenue bonds are indeed still being paid, just specific class of bonds are in default (smaller of the classes)
  • Puerto Rican government has formal restructure plan to be announced early September; more bonds may be impacted
  • Believes bond holders should carry some of the burden, not just the citizens of Puerto Rico

Click here to listen to the 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

Investment Insights Podcast – July 10, 2015

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded July 7, 2015):

What we like: Harvard study shows when there’s debt relief as part of the solution, countries tend to recover and thrive more quickly

What we don’t like: The emotional impact the Greek crisis has on investors, chiefly contagion and anger

What we’re doing about it: Touting behavioral finance; investors shouldn’t allow this anger or fear to dictate their investment decisions; encouraging the themes found in Personal Benchmark: Integrating Behavioral Finance and Investment Management 

Click here to listen to the 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.

 

International Insights Podcast – Greece: How Bad Is It?

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

This audio podcast was recorded June 29, 2015:

Not surprisingly, Stuart’s podcast this week features the unnerving situation in Greece and the ripple effect it may have on a global scale.

Highlights of the discussion include:

In short…

  • The breakdown in negotiations between Greece and its creditors justifiably disappointed the markets.
  • Our sense is the end of the world has not come yet.
    • Primary links to Europe and world economy appear small and manageable.
    • Secondary links to Europe are murkier but not visible near term.
  • Watch economics and politics in peripheral Europe for further direction.

So, what about the near-term?

  • Do not underestimate Europe’s ability to prolong the agony (though it appears they are trying to force Greece’s hand even with the announced July 5 referendum).
  • Multiple scenarios could happen:
    • Best case is that Greece gets new government more willing to cut a deal
    • Worst case is Grexit and passive EU institutions

Does that mean it’s time to panic?

  • Primary links appear relatively minor and obvious
    • Most of Greece’s €340bn debt held by large government institutions (ECB, EU, IMF)
    • Direct trade links are small
    • Greek economy is small relative to Europe and the world
  • Secondary impacts less clear
    • Near-term hit to European confidence and economic growth
    • Medium-term credibility issue to the euro as a concept – in event of Grexit, should we worry about who is next?
      • Examples:
        • Italy – lower popular political support for euro (though ruling coalition supports Euro)
        • Spain – pending 4Q15 elections (one opposition party Podemos with minority of votes considers itself kindred to the ruling Greek Syriza party)
        • France – greater need for fiscal tightening, most popular anti-Euro populist party in LePen National Front

What to keep an eye on if things are getting worse or better

  • The euro
  • Peripheral bond spreads (Italy, Spain vs. Germany)
  • Greek referendum (Does it even happen? “Yes” a good result, but does it result in new negotiations and/or change of government?)
  • Popularity of other populist political parties in other parts of Europe (Spain, France, Italy)

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.

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.

High Profit Margins Outlook in 2014

Miller, Bill 2Bill Miller, Chief Investment Officer

Throughout this year, we have been in the camp that profit margins would not mean-revert.  Better measures of labor and manufacturing productivity, technology improvements and cheaper imports have all helped profits.  As the chart below shows, that was the case in the third quarter.  In 2014, we expect margins to remain persistently high.

The big three—productivity, technology and cheap imports—should help again next year.  Plus, we do not see excesses in business investment, inventory or debt (personal or commercial) in 2014.

Persistently high profit margins should help equities in 2014.

S&P 500 Operating Margins (Quarterly)

Source: International Strategy & Investment (ISI) Group LLC

The views expressed above are those of Brinker Capital and are not intended as investment advice.

Why Care About Housing Reform

QuintStuart Quint, Sr. Investment Manager & International Strategist, Brinker Capital

Housing is a major component of the U.S. economy and the largest source of wealth for many Americans. Despite the recent rebound, home prices in the U.S. have declined a cumulative -16% since 2006. That masks significant declines in Sunbelt markets hit by the housing bubble collapse (FL -37%, AZ -32%, CA -26%, NV -45%).
(Freddie Mac. September 2013)

Roughly 50% of the stock of housing in the U.S. is financed by mortgage debt. Consequently, the availability and cost of mortgage debt has a direct relationship on the value of housing. Indeed, the 2008 financial crisis exacerbated the downturn in housing as the financial system had sharply cut mortgage credit. The downturn in home prices also damaged consumer confidence for the two-thirds of Americans who owned their home. Many homeowners saw their savings reduced and consequently cut back on their consumption. Additionally, the housing downturn left nearly one out of five Americans underwater on their mortgage debt, (i.e. the resale value of their home in the current market would be less than the mortgage debt they owed). This resulted in higher credit losses for banks, which in turn reduced credit availability across the board.

One reason for sub-par economic growth following the 2008 financial crisis stems from the sub-par recovery in housing. Housing accounts for one out of every six dollars of economic output. (National Association of Home Builders)

9.27.13_QuintAdditionally, the housing downturn has impacted the job market. Approximately 2.5 million lost jobs between 2006 and 2013 were lost because of the housing downturn. Residential construction accounts for 1.5 million jobs including the financial sector and real estate. Housing-related employment amounts to as many as one out of every twelve jobs in the U.S. economy. (Bureau of Labor Statistics. September 6 and The Bipartisan Policy Center)

The issue of how to finance the largest asset for many Americans is of critical importance to future growth prospects for the U.S. economy.

Detroit Files for Bankruptcy

Magnotta@AmyMagnotta, CFA, Senior Investment Manager, Brinker Capital

On July 18, the City of Detroit filed for bankruptcy, becoming the largest American city to seek bankruptcy in court.  This course of action was anticipated by many market participants as Detroit’s fiscal situation has been deteriorating for some time. The city has accumulated more than $18 billion in debt, including $12 billion in unsecured obligations to lenders and retirees, over $6 billion in bonds secured by revenues, and has run operating deficits for a number of years. Detroit has suffered from a confluence of demographic and economic factors, including a significant loss of population and declining tax revenues, as described in the bankruptcy court declaration filed by Kevyn Orr, Detroit’s emergency financial manager (via Zero Hedge).

7.19.13_Magnotta_DetroitThis situation will be contentious as there are a number of parties involved, including bondholders, retirees, and other creditors that will seek recovery through the bankruptcy process.  Revenue bonds, which represent $6 billion of Detroit’s outstanding debt, have historically had high recovery values in bankruptcies.  The case will be watched very closely as the outcome could determine whether this type of restructuring becomes a model for other municipalities under significant fiscal pressure.

We do not view the actions of Detroit to signify broader credit weakness for U.S. municipalities.  Overall, municipal credit has been improving as revenues have rebounded.  The recent sell off in municipal bonds can be more attributed to the concern surrounding the Fed’s tapering of asset purchases and some technical pressures, not to underlying fundamentals.

At Brinker Capital, we favor active municipal bond strategies that draw on the resources of strong credit research teams and emphasize high quality issues and structures.  We have not felt it prudent to reach for yield in the current environment and will maintain our high quality bias.  With yields moving slightly higher, some value can be found in municipal bonds at the long end of the curve with yields at close to 5%.  Our municipal bond separate account strategies have no exposure to Detroit paper.  The mutual funds used within our discretionary products have very limited exposure to Detroit, the vast majority in bonds backed by revenues of the Detroit Water and Sewer Department.

Additional Links:

Trouble in the Mediterranean

Joe PreisserJoe Preisser, Investment Strategist, Brinker Capital

Blue-chip stocks listed in the United States stumbled on their quest to reclaim the historic heights they recently attained, as a renewal of concerns from the European continent served to unsettle investors. Proverbial wisdom contends that markets will climb a, “wall of worry”, and this statement has rung particularly true this year as the Dow Jones Industrial Average has marched steadily higher amid a torrent of potential pitfalls. Up until this week, market participants have largely disregarded the political gridlock ensnaring Washington, D.C. and the possibility of a resurgence of the European sovereign debt crisis, instead clamoring for risk assets, and in so doing, have driven stocks into record territory. The current rally has, however, paused for the moment with the increased possibility that Cyprus may become the first member of the Eurozone to exit the currency union, once again casting the shadow of doubt across the Mediterranean Sea and onto the sustainability of this collection of countries.

A decision rendered by leaders of the European Union last weekend—to attempt to impose a tax on bank deposits within the nation of Cyprus in exchange for the release of rescue funds the country desperately needs—sent tremors through global financial markets. Although the Cypriot population stands at slightly more than one million citizens, making it one of the smallest countries in the Eurozone, the repercussions of this decision were felt across continents. Policy makers representing the nations of their monetary union hastily gathered to decide what conditions would need to be met in order to disperse the necessary financial aid to Cyprus, totaling ten billion euros, and in so doing, made a significant policy error. According to The New York Times on March 19, “Under the terms of Cyprus’ bailout, the government must raise 5.8 billion euros by levying a one-time tax of 9.9 percent on depositors with balances of more than 100,000 euros. Those with balances below that threshold would pay 6.75 percent, an asset tax that would still hit pensioners and the lowest -income earners hard.” Although the intentions of the European leaders making this decision were to target large foreign depositors, who have historically used the country’s banks as a tax haven, the proposed inclusion of those on the lower end of the spectrum has created widespread uncertainty.

EurosThe imposition of a tax on deposits that would include those of 100,000 euros and less, which had been guaranteed by insurance provided by the European Union, has created concerns over the stability of the banking system in Cyprus and by extension, that of the Eurozone in its entirety. By negating the very guarantee that had been put in place to strengthen this vital portion of the Eurozone’s financial system, policy makers have increased the risk that large scale withdrawals will be taken across Cyprus, which is exactly the type of situation they had hoped to avoid. The New York Times quoted Andreas Andreou, a 26-year-old employee of a Cypriot trading company, who gave voice to the feelings of the populace when he said, “How can I trust any bank in the Eurozone after this decision? I’m lifting all my deposits as soon as the banks open. I’d rather put the money in my mattress.” In order to forestall such an event, and protect against the possibility of contagion to the other heavily indebted members of the currency union, the country’s banks have been shuttered and are scheduled to remain so until Tuesday.

Uncertainty continues to swirl in the warm Mediterranean air as the Cypriot Parliament on Wednesday rejected the original terms of the bailout, casting the nation’s leaders into direct conflict with those of the European Union. With the deadline for
the country to propose a viable plan to raise the requisite 5.8 billion euros,
set by the Continent’s Central Bank for Monday, fast approaching, the stakes of
this game of brinksmanship have been raised, as the possibility of the country
leaving the euro zone has been broached. Eric Dor, a French economist who is the head of research at the Iéseg School of Management in Lille, France offered his opinion on the rationale of Europe’s leaders in The New York Times on Thursday, “They are saying we can take the risk of pushing Cyprus out of the Eurozone, and that Europe can take the losses without going broke.” Although the raising of the possibility of Cyprus being expelled from the monetary union, is most likely a negotiating tactic designed to goad Cypriot leaders into adopting the reforms the E.U. has deemed necessary, with the more likely outcome of a compromise being reached, the current impasse serves as a reminder of the difficulties facing the Continent as it continues its unprecedented experiment in democracy.

Beginning of a ‘Great Rotation’?

Joe PreisserJoe Preisser, Brinker Capital

As the share prices of companies listed in the United States rose this week, to heights last seen in October of 2007, speculation has run rampant that a so called ‘Great Rotation’ from fixed income to equities may have commenced.

The continued easing of Europe’s sovereign debt crisis, combined with positive corporate earnings surprises and the temporary extension of our nation’s borrowing limit, has helped to quell a measure of the uncertainty that has plagued market participants during the course of the last few years. Tangible evidence of this phenomenon can be found in the marked decline of the Chicago Board Options Exchange Market Volatility Index (VIX), commonly referred to as the “fear gauge”, which is currently trading far below its historical average. The steep drop in expected market volatility suggests that investors believe to a large degree that many of the potential problems facing the global economy are already priced into current valuations, and as such have set expectations of the possibility of any external shocks to be quite low. This state of affairs has led directly to an increased appetite for risk within the market, which has culminated in strong inflows into equity funds. According to the Wall Street Journal, “For the week ended January 16, U.S. investors moved a net $3.8 billion into equity mutual funds. That followed the $7.5 billion inflows in the previous week, along with another $10.8 billion directed to exchange traded funds. Add it up and you’re looking at the biggest two-week inflow into stocks since April 2000” (January 24, 2013).

Although the movement of money into equities this year has been quite strong, whether or not this is the beginning of a significant reallocation from fixed income remains to be seen. Despite the flight of dollars into stocks, yields, which move inversely to price, on both U.S. Treasury and corporate debt have risen only moderately, and bond funds this year have not experienced the type of drawdowns that would be expected if investors were truly rotating from one asset class to another. In fact, what has transpired speaks to the contrary, as although inflows to the space have slowed from last year, they remain robust. According to an article in Barron’s published this week, “Bond funds, meanwhile, attracted $4.63 billion in net new cash. Bond mutual funds collected $4.21 billion of that sum, compared to the previous week’s inflows of $5.45 billion” (January 18, 2013). One possible explanation for the hesitation to exit the fixed income space is the lingering concern among investors over the looming fiscal fight in Washington D.C. and the potential damage to the global economy if common ground is not found. According to a recent Bloomberg News survey, “Global investors say the state of the U.S. government’s finances is the greatest risk to the world economy and almost half are curbing their investments in response to continuing budget battles” (January 22, 2013).

If begun in earnest, a rotation by investors from fixed income to equities would certainly present a powerful catalyst to carry share prices significantly higher; however caution is currently warranted in making such an assertion, as a potentially serious macro-economic risk continues inside the proverbial ‘beltway’. If the budget impasses in the United States is bridged in a responsible way, and the caustic partisanship currently gripping Washington broken, the full potential of the American economy may be realized and this reallocation truly undertaken. David Tepper, who runs the $15 billion dollar Apoloosa Management LP was quoted by Bloomberg News, “This country is on the verge of an explosion of greatness” (January 22, 2013).

One For The Muni

Magnotta@AmyLMagnotta, CFA, Brinker Capital

Municipal bonds have delivered very strong positive returns since Meredith Whitney famously predicted hundreds of billions in municipal defaults during a 60 Minutes interview in December 2010. Municipal bonds outperformed taxable bonds (Barclays Aggregate Index) by meaningful margins in both 2011 and 2012.

iShares S&P National AM T-Free Muni Bond Fund

Source: FactSet

Municipal bonds have benefited from a favorable technical environment. New supply over the last few years has been light, and net new supply has been even lower as municipalities have taken advantage of low interest rates to refinance existing debt. While supply has been tight, investor demand for tax-free income has been extremely strong. Investors poured over $50 billion into municipal bond funds in 2012 and added $2.5 billion in the first week of 2013 (Source: ICI). This dynamic has been driving yields lower. The interest rate on 10-year munis fell to 1.73%, the equivalent to a 2.86% taxable yield for earners in the top tax bracket. Similar maturity Treasuries yield 1.83% (Source: Bloomberg, as of 1/15). We expect new supply to be met with continued strong demand from investors.

*Excludes maturities of 13 months or less and private placements.  Source: SIFMA, JPMorgan Asset Management, as of November 2012

*Excludes maturities of 13 months or less and private placements. Source: SIFMA, JPMorgan Asset Management, as of November 2012

While technical factors have helped municipal bonds move higher, the underlying fundamentals of municipalities have also improved.  States, unlike the federal government, must by law balance their budget each fiscal year (except for Vermont).  They have had to make the tough choices and cut spending and programs.  Tax revenues have rebounded, especially in high tax states like California.  Last week California Governor Jerry Brown proposed a budget plan that would leave his state with a surplus in the next fiscal year, even after an increase in education and healthcare spending.  Stable housing prices will also help local municipalities who rely primarily on property tax revenues to operate.

While we think municipal bonds are attractive for investors with taxable assets to invest, the sector is still not without issues.  The tax-exempt status of municipal bonds survived the fiscal cliff deal unscathed, but the government could still see the sector as a potential source of revenue in the future which could weigh on the market.  Underfunded pensions – like Illinois – remain a long-term issue for state and local governments.  Puerto Rico, whose bonds are widely owned by municipal bond managers because of their triple tax exempt status, faces massive debt and significant underfunded pension liabilities and remains a credit risk that could spook the overall muni market.  As a result, in our portfolios we continue to favor active municipal bond strategies that emphasize high quality issues.