April 2017 market and economic review and outlook

lowmanLeigh Lowman, Investment Manager

Risk assets finished the quarter in strong positive territory but experienced a pullback in March after notably strong performance for the first two months of the year. In a widely anticipated move, the Fed increased interest rates by 25 basis points on March 15 and rhetoric alluded to the possibility of an additional 2-3 rate hikes this year. However, headlines during the quarter were dominated by speculation surrounding the Trump administration economic plan. After initially surging in the post-election market, investor confidence began to wane as pro-growth policies have yet to come to fruition. Efforts to reform Obamacare were thwarted just prior to the Congress vote on March 24, but uncertainty still remains on the future of healthcare. Overall, economic data remains positive with low unemployment and positive earnings reports and we continue to see signs of improved global growth.

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The S&P 500 Index was flat for the month but finished the quarter up 6.1%. Sector performance was mixed with the technology sector (+12.6%) posting double-digit returns for the quarter. Likewise, healthcare (+8.4%) posted strong quarter returns, a sharp reversal from the sector’s poor performance last year. Energy was negative for both the month (-1.0%) and the quarter (-6.7%). Financials lagged in March (-2.8%) but remained positive for the quarter (+2.5%). Growth outperformed value and large cap led both mid and small cap.

Developed international equity outperformed domestic equity for both the month and quarter, up 2.9% in March and 7.4% for the first quarter. Economic data leaned positive for the European Union and Japan as both regions experienced a pick-up in global earnings and nominal growth. Recent outcomes of European regional elections may also have signaled a weakening in the populist movement, but political uncertainty is still apparent as upcoming elections begin to unfold.

Emerging markets were up 2.6% for the month and 11.5% for the quarter. The region rebounded from a difficult fourth quarter as fears of US protectionism began to dissipate.

The Bloomberg Barclays US Aggregate Index was flat for the month and up 0.8% for the quarter. During the month, the 10 year Treasury yield rose as high as 2.6% in anticipation of the Fed raising interest rates, but finished the quarter at 2.4%, slightly lower than where it started in 2017. After steadily contracting during the first two months of the year, high yield spreads slightly widened in March but still remain at relatively low levels. Municipal bonds outperformed taxable bonds during the quarter, largely due to limited supply and solid demand.

We remain positive on risk assets over the intermediate-term, although we acknowledge we are in the later innings of the bull market and the second half of the business cycle. While our macro outlook is biased in favor of the positives and recession is not our base case, especially considering the potential of reflationary policies from the new administration, the risks must not be ignored.

We find a number of factors supportive of the economy and markets over the near term.

  • Reflationary fiscal policies: With the new administration and an all-Republican government, we expect fiscal policy expansion in 2017, including tax cuts, repatriation of foreign sourced profits, increased infrastructure and defense spending, and a more benign regulatory environment.
  • Global growth improving: U.S. economic growth is ticking higher and there are signs growth outside of the U.S., in both developed and emerging markets, is improving.
  • Business confidence has increased:  Measures like CEO Confidence and NFIB Small Business Optimism have spiked since the election. This typically leads to additional project spending and hiring, which should boost growth.
  • Global monetary policy remains accommodative: The Federal Reserve is taking a careful approach to policy normalization. ECB and Bank of Japan balance sheets expanded in 2016 and central banks remain supportive of growth.

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

  • Administration unknowns: While the upcoming administration’s policies are currently being viewed favorably, uncertainties remain. The market may be too optimistic that all of the pro-growth policies anticipated will come to fruition. We are unsure how Trump’s trade policies will develop, and there is the possibility for geopolitical missteps.
  • Risk of policy mistake: The Federal Reserve has begun to slowly normalize monetary policy, but the future path of rates is still unclear. Should inflation move significantly higher, there is also the risk that the Fed falls behind the curve. The ECB and the Bank of Japan could also disappoint market participants, bringing the credibility of central banks into question.

The technical backdrop of the market is favorable, credit conditions are supportive, and we have started to see some acceleration in economic growth. So far Trump’s policies are being seen as pro-growth, and investor confidence has improved. We expect higher volatility to continue as we digest the onset of new policies under the Trump administration and the actions of central banks, but our view on risk assets remains positive over the intermediate term. Higher volatility can lead 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. Indices are unmanaged and an investor cannot invest directly in an index. 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.

Barclays Municipal Bond Index: A market-weighted index, maintained by Barclays Capital, used to represent the broad market for investment grade, tax-exempt bonds with a maturity of over one year. Such index will have different level of volatility than the actual investment portfolio. S&P 500: An index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Companies included in the Index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor’s. World Index Ex-U.S. includes both developed and emerging markets. Bloomberg Barclays U.S. Aggregate: A market capitalization-weighted index, maintained by Bloomberg Barclays, and is often used to represent investment grade bonds being traded in the United States.

Brinker Capital Inc., a Registered Investment Advisor.

Fed continues on road to interest rate normalization

lowmanLeigh Lowman, Investment Manager

In a widely anticipated move, the Fed increased interest rates by 25 basis points on March 15, 2017, the second interest rate hike in three months and there are talks of potentially two more raises this year. Positive economic data and a rise in business confidence served as a catalyst for the Fed to continue its interest rate normalization efforts with the possibility of as many as two additional rate increases later this year. However, recent rhetoric from the Fed reaffirmed their commitment to move at a cautious pace, supporting Brinker Capital’s view that the process of longer term rates will likely be prolonged and characterized in fits and starts, rather than linear, as the market adapts to the new normal.

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Source: FactSet, Federal Reserve, J.P. Morgan Asset Management. U.S. Data are as of February 28, 2017. Market expectations are the federal funds rates priced into the fed futures market as of the date of the December 2016 FOMC meeting. *Forecasts of 17 Federal Open Market Committee (FOMC) participants are median estimates. **Last futures market expectation is for November 2019 due to data availability.

Catalysts for higher interest rates

Many positive factors are currently present in the economy that point to a move toward interest rate normalization:

  • Stable U.S. economic growth. Economic growth in the U.S. has been modest but steady. The new administration and an all-Republican government will likely further stimulate the economy through reflationary fiscal policies including tax cuts, infrastructure spending and a more benign regulatory environment.
  • Supportive credit environment. High yield credit spreads have meaningfully contracted and are back to the tight levels we saw in 2014. Commodity prices have also stabilized.
  • Inflation expectations. Historically, there has been a strong positive correlation between interest rates and inflation. Many of the anticipated policies of the Trump administration are inherently inflationary. Inflation expectations have increased accordingly and headline inflation has been moving towards the Fed’s 2% long-run objective. In addition, we believe we are in the second half of the business cycle, typically characterized by wage growth and increased capital expenditures, both of which eventually translate into higher prices.
  • Unemployment levels. The labor market has become stronger and is nearing full employment. Unemployment has dropped to a level last seen in 2007.

Historical perspective

From 1965 to present, the Fed has implemented policy tightening a total of 15 times and the impact on the bond market has not always translated into longer rates rising. For example, back in 2004 the Fed began raising rates in response to beginning concerns of a housing bubble and the bond market did well as the yield on the 10-year Treasury fell.

More recently during the current market cycle, the Fed increased rates by 25 basis points in December 2015. The 10 year Treasury yield fell and the bond market generated a positive return while equities plummeted in the first quarter of 2016. A year later, the Fed increased rates by 25 basis points in December 2016. The impact on markets was minimal with both equities and fixed income generating strong positive returns in the two months that followed.

Fixed income allocation

Traditional fixed income has historically provided a hedge against equity market risk with substantially less drawdown than equities. Although a rising rate environment would suggest flat to negative returns for some areas of fixed income, the asset class still provides stability in portfolios when equities sell off. For example, fixed income provided an attractive safe haven during the market correction in the beginning of 2016.

In an environment of rising rates, Brinker Capital believes an allocation to traditional fixed income is still merited as we expect the asset class to provide a good counter to equity volatility.

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Source: Fact Set, Brinker Capital, Inc. Index returns are for illustrative purposes only. Investors cannot invest directly in an index. Past performance does not guarantee future results.

Overall, much uncertainty remains on the timing and trajectory of interest rate changes. Brinker Capital remains committed to helping investors navigate through a rising rate environment through building diversified portfolios across multiple asset classes.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a Registered Investment Advisor.

Investment Insights Podcast: A quick review of the markets last week and our outlook


Leigh Lowman
, Investment Manager

On this week’s podcast (recorded March 24, 2017), Leigh provides a quick review of the markets last week and reaffirms our outlook.

Quick hits:

  • After notably strong performance for the first two months of the year, risk assets sold off last week with the S&P 500 declining over 1% on Tuesday, the first 1% drop since October 2016.
  • Month to date through Thursday, March 23rd, the S&P 500 is down -0.6% and areas of the market are beginning to show signs of consolidation.
  • Despite the recent market pullback, we remain positive on risk assets over the intermediate term.
  • We expect higher volatility to continue as policies under the new administration and actions of central banks continue to unfold.

For Leigh’s full insights, click here to listen to the audio recording.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

Investment Insights Podcast: A quick review of January markets

Leigh Lowman, Investment Manager

On this week’s podcast (recorded February 10, 2017), Leigh provides a review of January markets. Quick hits:

  • Markets were overall off to a good start in 2017 as risk assets posted modest gains for the month.
  • The S&P 500 was up 1.9% for the month.
  • International equities were also a positive as economic data in the European Union pointed to signs of a modest recovery.
  • Fixed income ended the month slightly positive.
  • Overall, we remain positive on risk assets over the intermediate term as we find a number of factors currently supportive of the economy and markets.

For Leigh’s full insights, click here to listen to the audio recording.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

The road to interest rate normalization

lowmanLeigh Lowman, Investment Manager

“Lower for longer”; the motto heard repeatedly since the 2008 financial crisis may soon be irrelevant as interest rates have begun the much anticipated path of normalization. We believe interest rates are biased higher in the longer term as economic data leans positive, giving the green light for the Fed to resume its interest rate normalization efforts. As shown in the chart below, the recent December rate increase is likely the first in a series of hikes to occur over the next few years. However, the process of longer term rates moving higher will likely be prolonged and characterized in fits and starts, rather than linear, as the market adapts to the new normal.

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Source: FactSet, Federal Reserve, J.P. Morgan Asset Management. U.S. data are as of November 30, 2016. Market expectations are the federal funds rates priced into the fed futures market as of the date of the September 2016 FOMC meeting. *Forecasts of 17 Federal Open Market Committee (FOMC) participants are median estimates. **Last futures market expectation is for August 2019 due to data availability.

Many positive factors are currently present in the economy that point to a move toward interest rate normalization, including:

Stable U.S. economic growth – U.S. economic growth has been modest but steady.  The onset of the Trump administration will likely further stimulate the economy through reflationary fiscal policies including tax cuts, infrastructure spending and a more benign regulatory environment.

Supportive credit environment – Since the February 11, 2016 market bottom, high yield credit spreads contracted 431 basis points with most sector credit spreads now at or near one year market lows. Commodity prices have also stabilized.

Inflation expectations – Historically there has been a strong positive correlation between interest rates and inflation. Many of the anticipated policies of the Trump administration are inherently inflationary, and inflation expectations have increased accordingly. In addition, we believe we are in the second half of the business cycle, typically characterized by wage growth and increased capital expenditures, both of which eventually translate into higher prices.

Unemployment levels – The labor market has become stronger and is nearing full employment. Unemployment has dropped to a level last seen in 2007.

What does this mean for fixed income?

While a rising rate environment may suggest flat to even negative returns for some areas of fixed income, it still provides stability in the portfolio when equities sell off.  Historically, fixed income has had substantially less drawdown than equities. For example shown in the charts below, in the two days following the Brexit decision on June 23, 2016, equities sold off over 4% and fixed income was up sharply. Likewise fixed income provided an attractive safe haven during the market correction in the beginning of 2016. In an environment of rising rates, we expect fixed income to provide a good counter to equity volatility.

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Source: FactSet

Although uncertainty remains on the timing and trajectory of interest rates changes, we believe interest rates are poised higher for the longer term. Brinker Capital is committed to helping investors navigate through a rising rate environment. All of our products are based on a multi-asset class investment philosophy, a proven method of achieving meaningful diversification

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a Registered Investment Advisor.