May 2016 Monthly Market And Economic Outlook

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Continuing the rally that began in mid-February, risk assets posted modest gains in April, helped by more dovish comments from the Federal Reserve and further gains in oil prices. Expectations regarding the pace of additional rate hikes by the Fed have been tempered from where they started the year. Economic data releases were mixed, and while a majority of companies beat earnings expectations, earnings growth has been negative year over year.

The S&P 500 Index gained 0.4% for the month. Energy and materials were by far the strongest performing sectors, returning 8.7% and 5.0% respectively. On the negative side was technology and the more defensive sectors like consumer staples, telecom and utilities. U.S. small and micro-cap companies outpaced large caps during the month, and value continued to outpace growth.

International equity markets outperformed U.S. equity markets in April, helped by further weakness in the U.S. dollar. Developed international markets, led by solid returns from Japan and the Eurozone, outpaced emerging markets. Within emerging markets, strong performance from Brazil was offset by weaker performance in emerging Asia.

The Barclays Aggregate Index return was in line with that of the S&P 500 Index in April. Treasury yields were relatively unchanged, but solid returns from investment grade credit helped the index. High-yield credit spreads continued to contract throughout the month, leading to another month of strong gains for the asset class.

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: The Fed’s approach to tightening monetary policy 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, while China may require additional support.

Stable U.S. growth and tame inflation: U.S. economic growth has been modest but steady. While first quarter growth was muted at an annualized rate of +0.5%, we expect to see a bounce in the second quarter as has been the pattern. 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.

Constructive 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. An event that brings into question central bank credibility could weigh on markets.

Slower global growth: Economic growth outside the U.S. is decidedly weaker, and while China looks to be improving, a significant slowdown remains 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. This could also trigger further weakness in the high yield credit markets, which have recovered since oil bottomed in February.

Presidential Election Uncertainty: The lack of clarity will likely weigh on investors leading up to November’s election. Depending on the rhetoric, certain sectors could be more impacted.

The technical backdrop of the market has improved, as have credit conditions, while the macroeconomic environment leans 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; but our view on risk assets still 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.

February 2016 Monthly Market And Economic Outlook

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

It was a rough start to 2016 for investors. Fears of weaker growth in the U.S. and China and volatile oil prices weighed on global equity markets. With signs of slower growth in the U.S., investors began to worry about the impact of additional tightening moves by the Federal Reserve. Global equities and commodities experienced mid-single digit declines and high-yield credit spreads widened further. U.S. Treasuries benefited from the flight to safety and yields declined. After strong gains in 2015, the strength in the U.S. dollar moderated to start the year.

The S&P 500 Index declined -5% in January. The more defensive sectors – telecom, utilities and consumer staples – were able to produce gains against the backdrop of weaker economic data, but all other sectors were negative on the month. Small caps lagged large caps, while microcaps experienced double-digit declines. Growth lagged value across all market caps, due to the underperformance of the healthcare, consumer discretionary and technology sectors.

International equity markets were in line with U.S. markets in local terms, but lagged slightly in U.S. dollar terms. Emerging markets finished slightly ahead of developed markets in January, despite continued weakness in the equity markets of China and Brazil. The equity markets of both Europe and Japan fell during the month; however, Japan was able to erase some losses on the last trading day of the month when the Bank of Japan moved to implement a negative interest rate policy on excess reserves held at the central bank.

Yields fell across the curve in January as investors preferred the safety of government bonds. The 10-year Treasury note fell 39 basis points to end the month at a level of 1.88%. The decline was felt in both real yields and inflation expectations, and long duration assets benefited. The yield curve flattened marginally. Municipal bonds continued their solid performance run with a 1% gain. Investment grade credit spreads widened, but the asset class was still able to eke out a gain. The high-yield index, on the other hand, experienced another 80 basis points of spread widening and declined -1.6% for the month. Technical pressures still weigh on the high-yield market; however, we have yet to see a meaningful decline in fundamentals outside of the energy sector, at an absolute yield above 9% today, we view the asset class as attractive.

We remain positive on risk assets over the intermediate-term as we view the current market environment as a correction period rather than the start of a bear market. The worst equity market declines are typically associated with recessions, which are preceded by aggressive central bank tightening or accelerating inflation, factors we do not believe are present today. 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, and, while a recession 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 accommodation: Despite the Federal Reserve beginning to normalize monetary policy with a first rate hike in December, their approach should be patient and data dependent. More signs point to the Fed delaying the next rate hike in March. 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.
  • U.S. growth stable and inflation tame: U.S. economic growth has been modest but steady. Payroll employment growth has been solid and the unemployment rate has fallen to 4.9%. Wage growth has been tepid at best despite the tightening labor market, and reported inflation measures and inflation expectations remain below the Fed’s target.
  • Washington: With the new budget fiscal policy is poised to become modestly accommodative, helping offset more restrictive monetary policy.

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

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

On the balance the technical backdrop of the market is weak, but valuations are back to more neutral levels and investor sentiment, a contrarian signal, reached extreme pessimism territory. Investors continue to pull money from equity oriented strategies. We expect a higher level of volatility as markets digest the Fed’s actions and assess the impact of slower global growth; however, our view on risk assets leans positive over the near term. Increased volatility creates opportunities that 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

Monthly Market and Economic Outlook: March 2014

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

The U.S. equity market suffered a mild pullback in the second half of January, but resumed its trend higher in early February. The S&P 500 Index gained 4.3% in February to close at a record-high level. The consumer discretionary (+6.2%) and healthcare (+6.2%) sectors led during the month, while telecom (-1.8%) and financials (+3.1%) lagged. From a style perspective, growth continues to lead value across all market caps.

International equity markets edged out U.S. markets in February, helped by a weaker U.S. dollar. Performance on the developed side was mixed. Japan suffered a decline for the month (-0.5%), but Europe posted solid gains (+7.3%).  Emerging markets bounced back (+3.3%) as taper fears eased somewhat; however, they remain negative for the year.

Interest rates were unchanged in February and all fixed income sectors posted small gains. The 10-year Treasury ended the month at 2.66%, 34 basis points lower than where it started the year. Credit, both investment grade and high yield, continues to perform very well as spreads grind lower. High yield gained over 2% for the month. Municipal bonds have started the year off very strong gaining more than 3% despite concerns over Puerto Rico. Flows to the asset class have turned positive again, and fundamentals continue to improve.

While we believe that the bias is for interest rates to move higher, it will likely be a choppy ride. Despite an expectation of rising rates, fixed income still plays an important role in portfolios as a hedge to equity-oriented assets, just as we saw in January. 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 or stable interest rate environment.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into 2014, with a number of factors supporting the economy and markets over the intermediate term.

  • Monetary policy remains accommodative: Even with the Fed tapering asset purchases, short-term interest rates should remain near zero until 2015. Federal Reserve Chair Yellen wants to see evidence of stronger growth. In addition, the European Central Bank stands ready to provide support, and the Bank of Japan has embraced an aggressive monetary easing program.
  • Global growth stable: U.S. economic growth has been slow and steady. While momentum picked up in the second half of 2013, the weather appears to have had a negative impact on growth to start 2014. Outside of the U.S. growth has not been very robust, but it is still positive.
  • Labor market progress: The recovery in the labor market has been slow, but stable. The unemployment rate has fallen to 6.6%.
  • Inflation tame: With the CPI increasing just +1.6% over the last 12 months, inflation in the U.S. is running below the Fed’s target.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets 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 turned positive: 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 has been some movement in Washington. Fiscal drag will not have a major impact on growth this year. All parties in Washington were able to agree on a two-year budget agreement, averting another government shutdown, and the debt ceiling was addressed.

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

  • Fed tapering/exit: The Fed began reducing the amount of their asset purchases in January, and should they continue with an additional $10 billion at each meeting, quantitative easing 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 this time, and the withdrawal is more gradual. The reaction of emerging markets to Fed tapering is cause for concern and will contribute to higher market volatility.
  • 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.

Risk assets should continue to perform if real growth continues to recover; 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. There are even pockets of attractive valuations, such as certain emerging markets. After the near 6% pullback in late January/early February, investor sentiment is now elevated again.

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.

Magnotta_MonthlyUpdate_3.4.14

Data points above compiled from FactSet, Standard & Poor’s, MSCI, and Barclays. The views expressed are those of Brinker Capital and are for informational purposes only. Holdings subject to change.

U.S. Policy Update: Key Dates Ahead

Magnotta @AmyLMagnotta, CFA, Brinker Capital

I recently attended Strategas Research Partners’ public policy conference in Washington, D.C. It was hard to not come away with the feeling that our government will remain dysfunctional for the foreseeable future. But there is still hope. If we could just put politics aside, there are many smart, reasonable people on both sides of the aisle that could come together to devise an acceptable solution for our fiscal problems that does not stifle economic growth.

In the near term, policy uncertainty remains. The deal to avoid the fiscal cliff dealt primarily on the tax side, making the lower rates permanent except for those in the top tax bracket. However, they continued to kick the can down the road on the spending side. While Congress has agreed on a short-term extension of the debt ceiling, the issue will return mid-year. Washington will continue to be a focus for markets this year.

Below are some key items to watch for on the policy front:

  • The sequester, which consists $1.2 trillion of mandatory spending cuts over 10 years, half of which coming from the defense budget, is set to go into effect on March 1. At this point there is a high probability the cuts will happen. This will result in immediate negative headlines, but the impact of these spending cuts will not be felt for a few more months. Sequestration will also put some pressure on state and local governments as $37 billion of federal aid will be cut. A couple of months of cuts may force President Obama into a deal with the Republicans that would include some entitlement reform.
  • The continuing resolution that currently funds the government expires on March 27. No resolution could result in a complete or partial shutdown of the federal government.
  • The debt ceiling was extended until May 19, but the Treasury could stretch it out until July or August with extraordinary measures. Also included in the legislation is a requirement that both the House and the Senate produce a budget in April or their pay will be withheld.
  • The CBO will release their outlook on February 4.
  • Momentum is building for tax reform as Chairmen of the House Ways and Means Committee (Camp-R) and the Senate Finance Committee (Baucus-D) have hired dedicated staff. However, there is a lack of consensus on why we should do tax reform.
  • Ratings agencies are looking for a plan to stabilize our debt to GDP ratio at 70%. To do this we would need spending cuts closer to $2 trillion over ten years.

Weaker Earnings Outlook Weighs on Stocks

Amy Magnotta, CFA, Brinker Capital

I wrote last week about the shaky start to the earnings season. That trend has continued this week and it is weighing on equity prices. Companies are beating on the earnings side (over 60% have beat earnings estimates), but revenue growth has been disappointing. As of October 19, only 42% of companies were beating sales estimates, the lowest percentage since the first quarter of 2009 (Source: FactSet).

Source: FactSet

In addition, forward guidance has been abysmal. Large companies, such as Caterpillar, DuPont and United Technologies, have been cautious on growth looking forward, both in the U.S. and abroad.* The number of companies delivering negative guidance is multiples of those offering positive guidance. Coming into 2012 companies had relied on margin expansion to grow earnings, but with margins at peak levels, revenue growth must follow in order to meet consensus growth expectations. This will be difficult to accomplish in this sluggish growth environment.

Source: Strategas Research Partners

While the Fed has tried to boost liquidity and asset prices with more quantitative easing, investors seem to now be focusing on the fundamentals. The uncertain macro environment, including risks surrounding the U.S. fiscal cliff, Europe, and a slowdown in China, is beginning to flow through and impact company earnings. We expect growth estimates for 2013 to be downgraded in response.

*Individual securities listed are shown for illustrative purposes only.

Economic Headwinds and Tailwinds

Amy Magnotta, CFA, Brinker Capital

We continue to approach our macro view as a balance between
cyclical tailwinds and more structural headwinds. While we have
seen some cyclical improvement in the economy, helped by easy
monetary policy, we continue to face global macro risks and
uncertainties. The unresolved macro risks could result in bouts of
market volatility and as a result portfolios have a modest defensive
bias, and are focused on high conviction opportunities within asset classes.

Tailwinds
Accommodative monetary policy: The Fed has become even more accommodative with the announcement of further quantitative easing, an open-ended mortgage-backed securities purchase program, and they seem determined to continue until growth picks up. In addition, the Fed has pledged to keep interest rates low into 2015. The European Central Bank has also pledged support to defend the Euro and has committed to sovereign bond purchases of countries who apply for aid. Emerging economies have room to ease further if growth slows to an unacceptable level. There is the expectation that China will ease further to attempt to engineer a soft landing.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be put to work through M&A, capital expenditures or hiring, or returned to shareholders in the form of dividends or share buybacks. While estimates are coming down, profits are still at high levels.

Housing market improvement: There is evidence that the housing market has bottomed and could soon be in a position to contribute to economic growth. Prices have stabilized and sales have increased over last year. Homebuilder confidence is at levels last seen in 2007. Housing inventories have fallen. Low mortgage rates and rising rents have driven affordability to record levels; however, credit remains tight.

Headwinds
U.S. fiscal cliff / U.S. election / U.S. fiscal situation: The current U.S. political environment does not inspire confidence. We face a significant fiscal cliff in 2013 due to expiring tax cuts and spending measures. With economic growth in the U.S. at stall speed, the size of the fiscal cliff could tip us into recession territory. There will be no resolution of the fiscal cliff until after the election is decided, which will result in greater uncertainty. We hope for a short-term extension of some of the measures, setting up for a larger tax and entitlement reform package to be debated in 2013. Fiscal policy uncertainty has led U.S. companies to put plans for additional hires and/or capital expenditures on hold until it is clear what the rules are.

European sovereign debt crisis and recession: While the ECB and EU leaders have pledged support to the Euro, actions need to follow words. Bond purchases by the ECB will not solve the problems in Europe, but it can buy policymakers time to make real reforms. However, growth will continue to weaken in the region. High unemployment combined with planned austerity measures have led to more social unrest.

Global growth slowdown: There is evidence of a slowdown in growth not only in developed markets, but also in emerging markets. Growth in the U.S. continues to be sluggish, leaving the economy susceptible to shocks. Europe is in recession territory. Growth in China has slowed and continues to show signs of further weakening.

Tensions in the Middle East: Geopolitical risks in the Middle East are cause for concern. A sharp rise in oil prices will be a negative shock to the global economy.

This commentary is intended to provide opinions and analysis of the market and economy, but is not intended to provide personalized investment advice. Statements referring to future actions or events, such as the future financial performance of certain asset classes, market segments, economic trends, or the market as a whole are based on the current expectations and projections about future events provided by various sources, including Brinker Capital’s Investment Management Group. These statements are not guarantees of future performance, and actual events may differ materially from those discussed. Diversification does not ensure a profit or protect against a loss in a declining market, including possible loss of principal. This commentary includes information obtained from third-party sources. Brinker Capital believes those sources to be accurate and reliable; however, we are not responsible for errors by third party sources on which we reasonably rely.

Quantitative Easing Ad Infinitum?

Amy Magnotta, CFA, Brinker Capital

The Federal Open Market Committee (FOMC) launched an open-ended quantitative easing program yesterday. The Fed will purchase $40 billion of Agency mortgage-backed securities (MBS) per month with no specified end date. The Fed will continue its Operation Twist program through December, which includes the purchase of $45 billion per month of longer-dated Treasuries.

The MBS purchases will continue indefinitely until the outlook for the labor market improves “substantially,” which is a different approach than previous easing programs. The Fed also used a communication tool, stating that short-term rates will remain zero-bound until at least mid-2015 (instead of late-2014).

The Fed did not express any concern with inflation, stating it will likely run at or below its 2% objective over the medium term. However, the market is not convinced and inflation expectations moved up significantly after the announcement.

U.S. 5-Year Breakeven Inflation Rate (Source: Bloomberg)U.S. 5-Year Breakeven Inflation Rate

Gold (white) and Silver (orange) Prices (Source: Bloomberg)

The equity markets reacted positively, with the S&P 500 Index gaining +1.6% on the day. An open-ended quantitative easing program may be even more supportive for equities. It is clear the Fed is not ready to stop easing until they see more meaningful and sustainable growth. They want to see more of an improvement in the housing and labor markets. Low rates are here to stay. While the Fed’s actions will increase the risk appetite of investors, we still need help from fiscal policy before year end.

The full FOMC statement can be found here and their updated economic projections here.

Have the Odds of More Quantitative Easing Increased?

Amy Magnotta, CFA, Brinker Capital

Last Friday’s disappointing employment report raises the odds of more quantitative easing by the Fed. Payroll employment increased by only 96,000, and the increases reported in prior months were revised lower. The unemployment rate fell, but only due to a decline in the labor force. The labor force participation rate has fallen to 63.5%, the lowest level since September 1981. With GDP growth of just +1.7%, the U.S. economy is not growing at a pace sufficient to create needed job gains. The chart below shows just how weak job creation has been compared to previous recoveries. (Bureau of Labor Statistics).

Job Creation

This employment report did not offer the Federal Reserve evidence of a “substantial and sustainable strengthening in the pace of the economic recovery”[1] that they are seeking.  As a result, the odds that the Federal Open Market Committee (FOMC) will announce further easing at their meeting on September 12/13 have increased.  Consensus seems to expect additional easing, and a lack of announcement to that effect could disappoint the markets.  There has been talk of an open-ended buying program of U.S. Treasuries and/or mortgage-backed securities.  The FOMC could also extend their rate guidance, perhaps pledging low rates into 2015.

Inflation remains within the Fed’s target level, so they still have room to ease; however, the effectiveness of further monetary policy easing is diminishing.  While the Fed feels obligated to act to fulfill their mandate of economic growth, the bigger problems facing the U.S. economy – the fiscal cliff, the Eurozone crisis and slower growth in China – are outside the Fed’s control.  More certainty surrounding fiscal policy would allow businesses pick up the pace of hiring and investment, boosting economic growth


[1] Ben Bernanke, Federal Reserve Chairman.

An Update on Greece

With the recent headlines coming out of Greece this week, Brinker Capital’s Senior Investment Manager and International Strategist, Stuart Quint, shares a few quick points.

  • Greek elections on June 18 raise the risk of Greek default sooner rather than later, leading to some uncertainty. However, risks of Greece have been known for a while by the markets. The question is whether we see bank deposit runs out of other weaker European economies (Spain, Italy) and into stronger ones.
  • European Central Bank liquidity measures and hopeful, but inconsistent, fiscal progress in Ireland, Portugal, and Italy could cushion the downside and show commitment to keeping the Euro around in the near term.
  • Economic growth and European equities, primarily, are likely to take the pain until we get further clarity on the issues listed above. U.S. equities and other risk assets will also be affected in the near term due to concerns on slower global growth, although the U.S. is less affected by global growth than other markets.