The Future of the Yuan and its Impact on the Dollar

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

The consideration of adding the yuan, or as others may refer to it more formally as renminbi (RMB), as the fifth member to the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) list has been debated for many years. However, while it is expected that China will eventually have its currency recognized by the (IMF), the question is timing of this conversion.

The recent crash of China’s stock market, combined with strong state intervention of measures that go against the grain of market liberalization, has the potential to delay acceptance of the yuan. That’s not to say that the central bank won’t want to proceed as proposed, but competing forces might gain strength in calling for a go-slow approach in making the decision.

In the near term, the adoption of the yuan would likely prompt U.S. dollar selling. China is experiencing weaker growth, and monetary policy is easing while the U.S. is stable to getting tighter. The appetite of central banks to dump dollars in favor of yuan will take time. However, over the long term, the yuan could be the major competing currency to the U.S. dollar–if China can conduct further structural reform that restores confidence in more sustainable growth.

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 2013

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

Financial market performance diverged in May. Despite selling off in the second half of the month as investors began to worry about the Federal Reserve tapering its asset purchases, U.S. equity markets delivered solid returns, with the S&P 500 gaining +2.1%. In the equity markets, high dividend oriented sectors (utilities, telecom, staples) delivered negative returns, as did interest rate sensitive sectors like REITs and MLPs. International equity markets declined in May and were negatively impacted by a stronger U.S. dollar. Emerging markets continue to lag developed international markets.

Interest rates moved higher in May, attempting to return to more normal levels. In the U.S., both the 10-year Treasury note and 30-year bond climbed over 40 basis points resulting in negative returns for all major income sectors. Year to date, U.S. fixed income markets (Barclays Aggregate Index) have declined -0.9% while U.S. equity markets (S&P 500) have gained over 14%.

06.07.13_Magnotta_MarketOutlook_1The fear of the Fed tapering its stimulus as early as September has continued to weigh on investors as we move into June. While equity market indexes are just 3% off the recent highs, we’re experiencing more volatility. The last two occasions when the Fed has attempted to pare stimulus, the equity markets experienced double-digit declines. However, if the Fed does follow through with reducing the amount of asset purchases, it will do so in the context of an improving economy. More recent economic data has been mediocre, the recovery in employment will continue to be slow, and inflation is falling and now well below the Fed’s target. Market participants will be focusing on every data point in an effort to predict the Fed’s actions.

Interest rates have come down slightly from recent highs, but the 10-year note remains above 2%. We expect to see more bond market volatility as interest rates attempt to return to more normal levels. However, with growth still sluggish and inflation low, we expect interest rates to remain range-bound over the intermediate term.

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 move through the second quarter. A number of factors should continue to support the economy and markets for the remainder of the year:

  • 06.07.13_Magnotta_MarketOutlook_2Global Monetary Policy Accommodation: The Fed remains accommodative (even if they scale back on asset purchases), the ECB has pledged to support the euro, and now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. This liquidity has helped to boost markets.
  • Housing Market Improvement: An improvement in housing, typically a consumer’s largest asset, is a boost to net worth and, as a result, consumer confidence. However, a significant move higher in mortgage rates, which are now above 4%, could jeopardize the recovery.
  • U.S. Companies Remain in Solid Shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.
  • Equity Fund Flows Turn Positive: Equity mutual fund flows turned positive in 2013, and while muted compared to flows into fixed income funds, remain a tailwind after several years of outflows. Investors experiencing losses on their fixed income portfolios could also be a driver of flows to equity funds.

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

  • Europe: The risk of policy error in Europe still exists. While the ECB is willing to act as a lender of last resort, the region has still not addressed its debt and growth problems.
  • Sluggish Global Growth: Europe is in recession while Japan is using unconventional measures to create growth. China is showing signs of slowing further, as is Brazil.
  • U.S. Fiscal Drag: While we achieved some certainty on fiscal issues earlier this year, drag from higher taxes and the sequester will weigh on personal incomes and growth this year.

06.07.13_Magnotta_MarketOutlook_4Because of massive government intervention in the global financial markets, we will continue to be susceptible to event risk. Instead of taking a strong position on the direction of the markets, we continue to seek high conviction opportunities and strategies within asset classes. Some areas of opportunity currently include:

  • Domestic Equity: dividend growers, housing related plays
  • International Equity: Japan, small & micro-cap emerging markets, frontier markets
  • Fixed Income: non-Agency mortgage backed securities, emerging market corporates, global high yield, short duration strategies
  • Real Assets: REIT Preferreds
  • Absolute Return: relative value, long/short credit
  • Private Equity: company specific opportunities

06.07.13_Magnotta_MarketOutlook

Monthly Market and Economic Outlook – May 2013

Magnotta@AmyMagnotta, CFA, Brinker Capital

Risk assets continued their run in April, despite a small 3% pull-back mid-month. The easy monetary policies pursued by central banks in developed economies have forced investors out of cash and into higher yielding fixed income and equity strategies.  On May 3 the S&P 500 pushed above 1600 to an all-time high.  International equity markets outperformed U.S. equity markets in April, helped by continued strong performance from the Japanese equity markets, but U.S. markets continue to lead year to date. Even with stronger equity markets, the fixed income markets also rallied in April as interest rates moved lower and credit spreads tightened further.

After a near 20% move in the U.S. equity markets since November of last year, we may be susceptible to a pull-back in the near term; however, our longer-term view remains constructive. The market remains in a stronger fundamental position that at the 2007 high.

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 move through the second quarter. A number of factors should continue to support the economy and markets for the remainder of the year:

  • 5.6.13_Magnotta_MonthlyNewsletter_3Global Monetary Policy Accommodation: The Fed continues with their quantitative easing program, the ECB has pledged to support the euro, and now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. The markets remain awash in liquidity.
  • Housing Market Improvement: Home prices are increasing, helped by tight supply. Sales activity is picking up, and affordability remains at high levels. An improvement in housing, typically a consumer’s largest asset, is a boost to consumer confidence.
  • U.S. Companies Remain in Solid Shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Borrowing costs remain very low. Corporate profits remain at high levels and margins have been resilient.
  • Equity Fund Flows Turn Positive: After experiencing years of significant outflows, investors have begun to reallocate to equity mutual funds. Positive flows could provide a tailwind to the global equity markets.

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

  • 5.6.13_Magnotta_MonthlyNewsletter_2Europe: The ECB programs have bought time, but cannot solve the underlying problems in Europe. Austerity measures are serving only to weaken growth further and cause higher unemployment and social unrest. After how it dealt with Cyprus, there is risk of policy error in Europe once again.
  • U.S. Fiscal Policy: The automatic spending cuts will start to negatively impact growth in the second quarter, shaving an estimated 0.5% from GDP. In addition, the debt ceiling will need to be addressed again later this year.

Because of massive government intervention in the global financial markets, we will continue to be susceptible to event risk. Instead of taking a strong position on the direction of the markets, we continue to seek high conviction opportunities and strategies within asset classes. Some areas of opportunity currently include:

  • Domestic Equity: dividend growers, housing-related plays
  • International Equity: Japan, small and micro-cap emerging markets, frontier markets
  • Fixed Income: non-Agency mortgage backed securities, corporate credit, short duration strategies
  • Real Assets: REIT Preferreds, Master Limited Partnerships
  • Absolute Return: relative value, long/short credit
  • Private Equity: company specific opportunities
Annualized for periods greater than one year. Past performance is no guarantee of future results. Source: FactSet, Red Rocks Capital.

Annualized for periods greater than one year. Past performance is no guarantee of future results. Source: FactSet, Red Rocks Capital.

 

 

 

The views expressed by Brinker Capital are for informational purposes only. Brinker Capital, Inc. a Registered Investment Advisor.