Monthly Market and Economic Outlook: December 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Global equity markets were positive in November, helped by optimism over the prospect of additional monetary policy easing in Japan and Europe. U.S. equity markets posted another solid monthly gain, led by large and mid cap growth companies. The energy sector was down more than -8% due to the collapse in oil prices after OPEC decided not to cut output. However, the expectation of higher disposable incomes as a result of lower gasoline prices helped push the consumer sectors higher in November.

International equities lagged U.S. equity markets again in November. The S&P 500 Index has gained almost 14% year to date through November, while the MSCI All Country World ex USA Index is flat. The U.S. dollar, which has gained over 10% so far this year, has also been a contributor. Developed market equities fared better than emerging markets in November. European equities reacted positively to the expectation that the ECB would soon announce a full scale quantitative easing program. Within emerging markets, equity market gains in China and India were offset by weak performance in Brazil and Russia.

outlook_chartDespite stronger economic data, longer-term U.S. Treasury yields continue to move lower, while rates on the shorter end of the curve were unchanged to slightly higher, resulting in a flattening yield curve. From the beginning of November through December 12, the yield on the 10-year note fell 25 basis points to 2.10% and the yield on the 30-year bond fell 32 basis points to 2.75%. The yield on the 2-year note rose 6 basis points over that same period. The Barclays Aggregate Index was up +0.7% for the month, led by government bonds.

The negative sentiment surrounding the energy sector has weighed significantly on the high yield asset class. Energy represents 13% of the Barclays High Yield Index, up from 6% of the index in 2008. The credit issues outside of the energy sector have been limited, and should the economy continue to grow, current spread levels (525 basis points above Treasuries which we last saw in December 2012) look more attractive.

Our macro outlook has not changed. When weighing the positives and the risks, we continue to believe the balance is shifted even more in favor of the positives over the intermediate-term and the global macro backdrop is constructive for risk assets. As a result our strategic portfolios are positioned with an overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even with QE complete Fed policy is still accommodative. U.S. short-term interest rates should remain near-zero until mid-2015 if inflation remains contained. The ECB stands ready to take even more aggressive action to support the European economy, and the Bank of Japan expanded its already aggressive easing program.
  • Pickup in U.S. growth: Economic growth in the U.S. has picked up. Companies are starting to spend on hiring and capital expenditures. Both manufacturing and service PMIs remain in expansion territory. Housing has been weaker, but consumer and CEO confidence are elevated.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are with cash. M&A deal activity has picked up this year. Earnings growth has been ahead of expectations 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. Fiscal drag will not have a major impact on growth this year, and the budget deficit has also declined significantly. Government spending will again become a contributor to GDP growth in 2015.

Risks facing the economy and markets remain, including:

  • Timing of Fed tightening: QE ended without a major impact, so concern has shifted to the timing of the Fed’s first interest rate hike. While economic growth has picked up and the labor market has shown steady improvement, inflation measures and inflation expectations remain contained.
  • Global growth: While growth in the U.S. has picked up more recently, growth outside the U.S. is decidedly weaker. Both the OECD and IMF have downgraded their forecasts for global growth.
  • Geopolitical risks: The geopolitical impact of the significant drop in oil prices, as well as issues in the Middle East and Ukraine, could cause short-term volatility.

Despite levels of investor sentiment that have moved back towards optimism territory and valuations that are close to long-term averages, we remain positive on equities for the reasons previously stated. In addition, seasonality and the election cycle are in our favor. The fourth quarter tends to be bullish for equities, as well as the 12-month period following mid-term elections.

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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.

 

A Mixed Start to 2014

Ryan Dressel Ryan Dressel, Investment Analyst, Brinker Capital

With 2013 in the rear view mirror, investors are looking for signs that the U.S. economy has enough steam to keep up the impressive growth pace for equities set last year.  This means maintaining sustainable growth in 2014 with less assistance from the Federal Reserve in the form of its asset purchasing program, quantitative easing.  Based on economic data and corporate earnings released so far in January, investors have had a difficult time reaching a conclusion on where we stand.

To date, 101 of the S&P 500 Index companies have reported fourth quarter 2013 earnings (as of this writing).  71% have exceeded consensus earnings per share (EPS) estimates, yielding an aggregate growth rate 5.83% above analyst estimates (Bloomberg).  The four-year average is 73% according to FactSet, indicating that Wall Street’s expectations are still low compared to actual corporate performance.  Information technology and healthcare have been big reasons why, with 85% and 89% of companies beating fourth quarter EPS estimates respectively.

Despite these positive numbers, two industries that are failing to meet analyst estimates are consumer discretionary and materials.  Both of these sectors tend to outperform the broad market during the recovery stage of a business cycle, which we currently find ourselves in.  If they begin to underperform or are in line with the market, then it could indicate the beginning of a potential short-term market top.

S&P500 Index - Earnings Growth vs. Predicted

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There has been mixed data on the macro front as well:

Positive Data

  • Annualized U.S. December housing starts were stronger than expected (999,000 vs. Bloomberg analyst consensus 985,000).
  • U.S. Industrial production rose 0.3% in December, marking five consecutive monthly increases.[1]
  • U.S. December jobless claims fell 3.9% to 335,000; the lowest total in five weeks.
  • The HSBC Purchasing Managers’ Index (PMI) was above 50 for most of the developed and emerging markets.  An index reading above 50 indicates expansion from a production standpoint.  This data supports a broad-based global economic recovery.

Negative Data:

  • The Thomson Reuters/University of Michigan index of U.S. consumer confidence unexpectedly fell to 80.4 from 82.5 in December.
  • The average hourly wages of private sector U.S. works (adjusted for inflation) fell -0.03% compared to a 0.3% increase in CPI for December, 2013.  Wages have risen just 0.02% over the last 12 months indicating that American workers have not been benefiting from low inflation.
  • Preliminary Chinese PMI fell to 49.6 in January, compared to 50.5 in December and the lowest since July 2013.
S&P Performance Jan 2014

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The mixed corporate and economic data released in January has led to a sideways trend for the S&P 500 so far in 2014.  We remain optimistic for the year ahead, but are managing our portfolios with an eye on the inherent risks previously mentioned.


[1]  The statistics in this release cover output, capacity, and capacity utilization in the U.S. industrial sector, which is defined by the Federal Reserve to comprise manufacturing, mining, and electric and gas utilities. Mining is defined as all industries in sector 21 of the North American Industry Classification System (NAICS); electric and gas utilities are those in NAICS sectors 2211 and 2212. Manufacturing comprises NAICS manufacturing industries (sector 31-33) plus the logging industry and the newspaper, periodical, book, and directory publishing industries. Logging and publishing are classified elsewhere in NAICS (under agriculture and information respectively), but historically they were considered to be manufacturing and were included in the industrial sector under the Standard Industrial Classification (SIC) system. In December 2002 the Federal Reserve reclassified all its industrial output data from the SIC system to NAICS.