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

Investment Commentary From Brinker’s Joe Preisser 6-11-12

As investors across the globe continued to grapple with the uncertainty on the European continent, the prospect of additional, accommodative monetary policies being enacted by several of the world’s major Central Banks sent share prices higher across indices this week.  In Europe, on Wednesday, stocks rallied to their best single day performance in more than seven months following a meeting of the European Central Bank(ECB).  Although the rate setting committee elected to maintain the current level, the President of the ECB, Mario Draghi signaled that measures designed to stimulate the euro-zone’s economy would be forthcoming if growth were to falter.  According to Bloomberg News, “Global stocks rallied the most this year, the euro strengthened and commodities jumped on speculation policy makers will take steps to revive the slowing economy.” Mr. Draghi’s sentiments were echoed on this side of the proverbial ‘pond’ by Federal Reserve Chairman Ben Bernanke in an appearance before a Congressional budget committee in which he reiterated that the Central Bank, “remains prepared to take action as needed to protect the U.S. financial system and economy” (New York Times).

Stocks rose across continent’s in the wake of an unexpected decision by the Central Bank of China on Thursday, to cut interest rates for the first time since 2008, in an attempt to stimulate growth in what has been a slowing economy.  According to the New York Times, “China cut its benchmark lending rate Thursday, for the first time in nearly four years, adding to efforts to reverse a sharp economic downturn.” The nation’s policy makers are once again demonstrating their continued resolve to act in an effort to thwart the negative effects of Europe’s sovereign debt crisis, which have rippled through the global economy. Dariusz Kowalczyk, an economist at Credit Agricole was quoted by the New York Times as saying, “The biggest impact of the move is likely to be on sentiment, both among businesses and consumers domestically by showing Beijing is bringing out the big guns to support growth…investors know that they have more ammunition if need be and a good track record in using it.”

Through the confusion the nations of the European Union face as a result of the precarious state of affairs in the nation of Greece, where the rapidly approaching national elections to be held on June 17th will serve as a referendum on the country’s membership in the euro zone, the Continent’s leaders have drawn closer to an accord on a rescue package for embattled Spanish financial institutions.  In an effort to halt the flight of capital still rattling the country and mitigate the dangers facing what is the fourth largest economy in Europe, the possibility that emergency funding could be made available to the banks themselves has come to the fore.   Throughout the current crisis Spain has strongly resisted attempts by its European partners to encourage the country to accept a rescue package, as the disbursement of these funds in the past has come laden with broad conditionality that has meant the need for additional austerity.  The most recent proposals, to lend directly to the troubled institutions themselves, have been designed with terms limited to the financial sector in an effort to make them more palatable to the government, thus displaying the resolve of Europe’s leaders to combat the current crisis and offering hope for a successful resolution.