The Impact of Brexit

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

An overview of highlights from our Investment Team on the impact of Brexit on markets and Brinker Capital portfolios.

Key Highlights:

  • Today is largely a retracement of last week’s market action. Over the last week, the MSCI EAFE Index was up over 7% and the Russell 3000 Index almost 2% as the market anticipated a “remain” vote. We’ve retraced that rally today, but global markets are only marginally down from levels seen a week ago.
  • Brinker Capital portfolios have generally been underweight to international markets, specifically developed international markets.
  • This vote is a political event, not an economic event. It marks the coming end of the UK’s trade agreement with the EU, but the process is one that will likely take years. What it has done immediately is increased the level of uncertainty in markets. We will likely see additional global central bank liquidity and easing in an effort to support economies and markets.
  • Emotional trading can create opportunities, so our focus over the coming weeks and months will be to identify and take advantage of these opportunities.

Brexit’s Impact on Global Economies and Markets

  • The economic and political impact on the UK is decidedly negative, but the degree of which is uncertain. The currency and equity markets will be weaker in the near term while the long-term outlook is unclear given the politics involved.
  • The negative economic impact on Europe is less, but still meaningful. From a political perspective, the departure highlights the rising risk of populism and becomes another distraction for the EU from much-needed reforms. We expect a weaker euro and European risk assets in the near term; the central bank could try to cushion some impact.
  • International markets will experience the indirect effects of lower global growth and general risk aversion.
  • We do not see it as having a significant direct impact on the U.S. economy; however, a strengthening U.S. dollar as a result will be a headwind for U.S. companies with significant international business.
  • Expectations for additional interest rate hikes by the Federal Reserve have plummeted. Today, the futures curve is predicting a zero chance of a rate hike in September (down from 31% yesterday) and a 14% chance in December (down from 50%).

How Brinker Capital is Positioned in Strategic Portfolios

  • Portfolios have been positioned with a meaningful underweight to international equity markets in favor of domestic equity markets.
  • The underweight has been concentrated in developed international markets, due to concerns over long-term structural issues in their economies that have an impact on economic growth.
  • We don’t anticipate any immediate changes to the portfolios as a result of these events as we feel we were well positioned ahead of the news, and we expect to reallocate portfolios in late July.

Overall Summary

  • We think this is an extended process that will develop over the coming months and years. Today, the market is pricing in the uncertainty, but this will be a fluid and evolving process.
  • The market selloff today has been relatively orderly and largely a retracement of the gains of the last week.
  • Our portfolios were well positioned in advance of the vote with an underweight to international markets.
  • We expect the uncertainty to result in higher levels of volatility, which creates opportunities for active management.

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.

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.

Monthly Market and Economic Outlook: June 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Financial markets in May were mixed with modestly positive returns in U.S. equity markets (+1.3% for the S&P 500), modestly negative returns for international equity markets (-1.5% for the MSCI ACWI ex USA), and flat returns in U.S. fixed income markets (-0.2% for the Barclays Aggregate). U.S. economic data was on the weaker side, generally attributed to bad weather; however, the labor market continues to show improvement. The expectation is still for the Fed to commence rate hikes later this year.

In U.S. equity markets all sectors were positive for the month except for Energy and Telecom. The healthcare sector led with gains of more than 4%. Small caps led large caps for the month, and growth led value except in the mid cap segment.

International equity markets delivered a small gain in local terms, but the stronger dollar weighed on returns for U.S. investors. Japan gained more than 5% in local terms amid stronger economic data, while Europe gained less than 1% in local terms. Emerging market equities lagged developed markets in May, declining -4% in US dollar terms. China and Brazil were particularly weak performers. Despite weaker performance in May, both developed international and emerging markets lead U.S. equity markets so far this year by a sizeable margin.

The 10-year U.S. Treasury yield ended the month 10 basis points higher at a level of 2.13% and so far in June 10-year yields have backed up another 25 basis points (through June 5). However, because of the small coupon cushion in U.S. Treasuries today, only a small increase in yields can lead to a negative total return for investors. The credit sector was mixed in May, with investment grade experiencing declines and high yield delivering small gains. Municipal bonds continued to underperform taxable bonds. Year to date high yield leads all fixed income sectors.

Our outlook remains biased in favor of the positives, but recognizing risks remain. 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 and inflation tame: Despite a soft patch in the first quarter, U.S. economic growth is expected to turn positive in the second quarter and the labor market has markedly improved. Reported inflation measures and inflation expectations remain below the Fed’s target.
  • U.S. companies remain in solid shape: U.S. companies are beginning to put cash to work through capex, hiring and M&A. 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:

  • 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: 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.
  • Geopolitical risks: Could cause short-term volatility.

Despite higher than average valuations and neutral investor sentiment, the trend is still positive and the macro backdrop leans favorable, so we believe there is the potential for additional equity market gains. The quantitative easing programs of the European Central Bank and the Bank of Japan, 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 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.

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. This volatility should lead to more attractive opportunities 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 + Neutral vs. U.S.
Fixed Income +/- High-yield favorable
Absolute Return + Benefit from higher volatility
Real Assets +/- Favor global natural resources
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.

Monthly Market and Economic Outlook: May 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

In April we saw a reversal of some of what occurred in the first quarter. U.S. large cap equities were positive on the month (S&P 500 Index gained +1.0%); however, U.S. mid and small cap stocks experienced declines of -0.9% and -2.6% respectively. International developed equity markets continued to outperform U.S. markets (MSCI EAFE gained +4.2%), led by strong gains in Europe. The Euro strengthened 4.5% against the dollar during the month. Emerging markets led developed markets (MSCI EM gained +7.7%), helped by double-digit gains in China and Brazil. In the real assets space, crude oil soared +25% in April after an -11% decline in the first quarter, while REITs experienced modest declines.

Global sovereign yields moved higher in April. The yield on the 10-year Treasury climbed 11 basis points and as a result the Barclays Aggregate Index fell -0.4%. While investment-grade credit was negative on the month, high-yield credit gained +1.2% as spreads tightened. Municipal bonds underperformed taxable bonds during the month.

Our outlook remains biased in favor of the positives, but recognizing risks remain. 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 and inflation tame: Despite a soft patch in the first quarter, U.S. economic growth remains solidly in positive territory and the labor market has markedly improved. Reported inflation measures and inflation expectations are moving higher but remain below the Fed’s target.
  • U.S. companies remain in solid shape: U.S. companies are beginning to put cash to work through capex, hiring and M&A. 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:

  • 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. 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.
  • Geopolitical risks: Issues in the Middle East, Greece and Russia, could cause short-term volatility.

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 normalize, but remain range-bound and 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.

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 + Neutral vs. U.S.
Fixed Income +/- HY favorable after ST dislocation
Absolute Return + Benefit from higher volatility
Real Assets +/- Favor global natural resources
Private Equity + Later in cycle

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.

Monthly Market and Economic Outlook: April 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After 2014 was dominated by the strong performance of the narrow S&P 500 Index, the first quarter of 2015 showed better results for diversified portfolios and higher levels of volatility across and within asset classes—both positive developments for active management.

The focus remained on the Federal Reserve and the timing of the initial interest rate hike despite U.S. economic data coming in below expectations. The S&P 500 gained just 1% for the quarter, while mid caps and small caps fared better, gaining 4%. Growth outperformed value across all market caps, and high-dividend-paying stocks lagged amid concern of higher interest rates. The strong dollar also hurt U.S. multinationals as a high percentage of their profits are derived from overseas. Despite a strong February, commodity prices fell again in March and were the worst performing asset class for the quarter.

shutterstock_28211977While the anticipation of tighter monetary policy may have weighed on U.S. equity markets in the first quarter, looser monetary policy helped to boost asset prices in international developed markets. The MSCI EAFE Index surged 11% in local terms, but the stronger dollar dampened returns in U.S. dollar terms to 5%, still 400 basis points ahead of the S&P 500 Index. The euro fell -11% versus the dollar, the largest quarterly decline since its inception in 1999. Japan also benefited from central bank policy, gaining 10%.

Emerging market equities outpaced U.S. equities for the quarter, gaining 2.3%; however, dispersion was quite wide. All emerging regions delivered positive returns in local currency terms, although weaker currencies in Latin America had a significant impact for U.S. investors. For example, Brazil’s equity market gained 3% in local terms, but fell -15% in U.S. dollar terms. China and India posted solid gains of 5-6% for the quarter.

The 10-year U.S. Treasury yield bounced around in the first quarter, first declining 49 basis points in January, then climbing 56 basis points in February before declining again to end the first quarter at a level of 1.94%, 23 basis points lower than where it started. The Barclays Aggregate Index outperformed the S&P 500 Index for the quarter, with all sectors in positive territory. Credit spreads tightened modestly during the quarter and the high-yield sector outperformed investment grade. Municipal bonds were slightly behind taxable bonds as the market had to digest additional supply.

Our outlook remains biased in favor of the positives but recognizes that risks remain. We feel we have entered the second half of the business cycle and 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: U.S. economic growth remains solidly in positive territory and the labor market has markedly improved.
  • 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 through capex, hiring and M&A. Earnings growth outside of the energy sector is 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 initial 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. 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.
  • Geopolitical risks: Issues in the Middle East, Greece 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 normalize, but remain range-bound, and 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.

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 + Neutral vs. U.S.
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.

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.

International Insights Podcast – Implications of Major Central Bank Moves in Switzerland and India

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

This audio podcast was recorded January 15, 2015:

Stuart’s International Insights Podcast focuses on small markets potentially creating big implications for global markets.

Highlights of the discussion include:

Switzerland:

  • Central bank cut interest rates and removed the link of the Swiss franc to the euro
  • Background discussion and what it means for global currencies
  • Losers: carry trades, mortgage holders in Eastern Europe, Austrian banks

India:

  • Central bank cut interest rates modestly, but still sent a major global signal
  • Falling inflation and government reform both key for future cuts
  • Major emerging market able to stimulate growth while others are doing the opposite

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.

 

Eurozone Crisis Report Card

Ryan DresselRyan Dressel, Investment Analyst, Brinker Capital

In January 2013 Amy Magnotta wrote in detail about how the actions of the European Central Bank (ECB) finally gave the markets confidence that policy makers could get their sovereign debt problems under control.[1] The purpose of this blog is to measure the progress of the ECB’s actions, as well as other critical steps taken to resolve the Eurozone crisis.

Maintaining the Euro: A+
The markets put a lot of faith in the comments made by the head of the ECB Mario Draghi in July, 2012. Draghi stated that he would “Pledge to do whatever it takes to preserve the euro.” These words have proven to be monumental in preserving the euro as a currency. Following his announcement, the ECB still had to put together a plan that would be approved by the ECB’s governing council (comprised of banking representatives from each of the 18 EU countries)[2]. The politics of the approval essentially boiled down to whether or not each council member supported the euro as a currency. Draghi’s plan ultimately passed when Germany’s Chancellor, Angela Merkel, endorsed it in September 2012.[3] The stabilization of the euro boosted lending and borrowing for European banks, and allowed governments to introduce necessary economic reforms outlined in the plan.

Since the plan was approved, the euro’s value versus the U.S. Dollar has continued to rise; reaching levels last seen in 2011. There is still some debate as to whether or not the currency will last over the long term, but for now its stability has helped avoid the worst possible outcome (financial collapse). There are several key elections coming up over the next month, which could renew the threat of breaking up the currency if anti-EU officials are elected.

Government Deficit Levels: B
The average Eurozone government deficit came in at 3.0% in 2013, which was down from 3.7% in 2012. Budgets will need to remain tight for years to come.

Corporate Earnings: B
The MSCI Europe All Cap Index has returned 27.46% in 2013 and 5.01% so far in 2014 (as of last week). The Euro area also recorded first quarter 2014 GDP growth at +0.2% (-1.2% in Q1 2013).[4] This indicates that companies in Europe have established some positive earnings growth since the peak of the crisis. On a global scale, Europe looks like an attractive market for growth.

Dressel_EuroZone_ReportCard_5.30.14

Unemployment: C
Unemployment in the Eurozone has stabilized, but has not improved significantly enough to overcome its structural problems. The best improvements have come out of Spain, Ireland and Portugal due to a variety of reasons. In Ireland, emigration has helped reduce jobless claims while a majority of economic sectors increased employment growth. In Spain, the increased competitiveness in the manufacturing sector has been a large contributor. Portugal has seen a broad reduction in unemployment stemming from the strict labor reforms mandated by the ECB in exchange for bailout packages. These reforms are increasing worker hours, cutting overtime payments, reducing holidays, and giving companies the ability to replace poorly performing employees.[5]

Dressel_EuroZone_ReportCard_5.30.14_1[6]

There are also some important fundamental factors detracting from the overall labor market recovery. The large divide between temporary workers and permanent workers in many Eurozone countries has made labor markets especially difficult to reform. This is likely due to a mismatch of skills between employers and workers. High employment taxes and conservative decision-making by local governments and corporations have also created challenges for the recovery.

Additional Reading: Euro Area Labor Markets

Debt Levels: D
Total accumulated public debt in the Eurozone has actually gotten worse since the ECB’s plan was introduced. In 2013 it was 92.6% of gross domestic product, up from 90.7% in 2012. The stated European Union limit is 60%, which reflects the extremely high amount of government borrowing required to stabilize their economies.

Overall Recovery Progress: B-
On a positive note, governments are finally able to participate in bond markets without the fear of bankruptcy looming. Banks are lending again. Unemployment appears to have peaked and political officials recognize the importance of improving economic progress.

Unlike the 2008 U.S. recovery however, progress is noticeably slower. The social unrest, slow decision making, low confidence levels, and now geopolitical risks in Ukraine have hampered the recovery. When you consider the financial state of Europe less than two years ago, you have to give the ECB, and Europe in general, some credit. Things are slowly heading in the right direction.

The views expressed are those of Brinker Capital and are for informational purposes only. Holdings are subject to change.

[1] January 4, 2013. “Is Europe on the Mend?” http://blog.brinkercapital.com/2013/01/04/is-europe-on-the-mend/
[2]
European Central Bank. http://www.ecb.europa.eu/ecb/orga/decisions/govc/html/index.en.html
[3] September 6, 2012. “Technical features of Outright Monetary Transactions. European Central Bank.” http://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html
[4] Eurostat
[5] August 6, 2012. “Portugal Enforces Labour Reforms but More Demanded.” http://www.wsws.org/en/articles/2012/08/port-a06.html
[6] Eurostat (provided by Google Public Data)

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.

A Tale of Two Currencies

Joe PreisserJoe Preisser, Brinker Capital

As the global marketplace continues to recover from the worst financial crisis since the Great Depression, two of the world’s major currencies, the yen and the euro, have embarked on remarkably different paths of late in a reflection of the efforts of the Central Bank’s, which guard the levers of these economies, to achieve growth and stability. The responses of the nations ‘ respective policy makers has led directly to a steep decline in the value of the Japanese Yen, while the European continent has seen its common medium of exchange rise to heights unreached since 2011. Although the nature of the challenges facing what are two of the largest economies in the world differ significantly, the efficacy of the monetary policies employed to combat them will have a profound effect on markets across the globe.

In Japan, newly elected Prime Minister, Shinzo Abe, has grabbed headlines after only a few weeks in office, through his advocacy of aggressive measures designed to foster growth within a nation that has been mired in stagnation. Dubbed “Abenomics”, the plan is a multifaceted approach to economic stimulus whose centerpiece is a desire to devalue the nation’s currency, in an effort to support its exporters by rendering the goods and services they provide less expensive on the world stage. According to the Wall Street Journal, on February 6th, “Analysts at Goldman Sachs Inc. estimate that for every 10 yen the currency weakens against the dollar, profits of exporters would rise by 7% to 10%.” Mr. Abe has professed his aim to achieve this through a controversial limiting of a measure of the Bank of Japan’s (BOJ) autonomy in an effort to effectively force the reflation of the economy through a program of unlimited monetary easing and large scale stimulus. In addition, the Prime Minister has pledged to fill the recently vacated position at the helm of the BOJ with an appointee who shares his commitment to revitalizing the country’s economy through all available means (The Economist, Jan 26th). The efforts undertaken thus far, combined with Mr. Abe’s emphatically-stated focus on combatting the deflation that has plagued Japan for more than a decade, have resulted in a sharp fall in the value of the yen, and a steep rise in equity prices listed on the nation’s exchange, which should be sustained as long as this endeavor proves successful. “The Nikkei has surged 32% since mid-November…The yen has declined 14% against the dollar over the same period…The gains in Tokyo have made Japan the world’s best-performing major stock market over the past three months ”(The Wall Street Journal, February 6th).2.8.13_Preisser_Currencies

On the Continent, the nearly four-year-old struggle to maintain its union in the face of a perilous debt crisis that threatened the world economy, has led to an unprecedented effort by the European Central Bank (ECB) to support the common currency. The fear of a possible dissolution of this unique collection of countries led directly to the widespread selling of the euro, as well as large scale liquidations of bonds issued by its sovereign members. As the cost of repaying the debt of a host of the European Union’s members rose to unsustainable levels the President of the ECB, Mario Draghi elected to act pledging to do, “whatever it takes to preserve the euro”(Bloomberg News July 26,2012). This statement manifested itself in a series of massive sovereign debt purchases by The Central Bank in September of 2012 which was dubbed, “Outright Monetary Transactions.” Mr. Draghi’s effort brought stability back to the euro-zone, and as a result led to an appreciation of its currency. As investors have become more confident that the worst of the crisis has been averted, the euro has risen further, and is now back to levels untested in two years. The sequence of events on the Continent stands in stark contrast to those in Japan, as Europe’s exporters have seen the cost of their products increase, thus making it more difficult for them to compete in the global marketplace. The threat that this state of affairs poses to the recovery of the region’s economy is such that it was directly and repeatedly addressed by Mr. Draghi this week during a press conference in which he suggested that the Central Bank may take steps to counter the effects of the currency’s rise. The ECB President was quoted by Bloomberg News as saying on Feb 7th, “The exchange rate is not a policy target, but it is important for growth and price stability…We want to see if the appreciation is sustained, and if it alters our assessment of the risks to price stability.”

The historic measures undertaken by both the European Central Bank, and the Bank of Japan in the interest of maintaining stability and fostering growth have thus far been largely successful, however it will be the ongoing maintenance of the consequences of this success that will ultimately determine the fate of these economies.