Investment Insights Podcast – Japan: Sunset on the Horizon?

Stuart Quint, Investment Insights PodcastStuart P. Quint, CFA, Senior Investment Manager & International Strategist

On this week’s podcast (recorded April 29, 2016), Stuart puts the focus on Japan and their struggling economy especially on the current political climate and its economic impact.

Why talk about Japan?

  • It’s the third largest economy in the world.
  • It’s one of the world’s leading lenders to the rest of the world, including the U.S.
  • Political fallout and economic downside loom if monetary easing policy is not accompanied with fiscal progress.

What’s the latest?

  • On April 27, the Bank of Japan decided not to add to currently high quantitative easing, greatly disappointing the markets.
  • The Japanese Yen appreciated over 2% (versus the U.S. dollar), that’s a negative given that two-thirds of the equity market is based towards overseas earnings.

How did Japan get here?

  • Back in 2013, Shinzo Abe inspired hope to reinvigorate the economy through the three arrows: monetary policy, fiscal stimulus, and structural reform.
  • The reality is there has been little-to-no follow through on fiscal policy or structural reform.
  • Bank of Japan has created a massive QE program, owning one out of every three long-duration government bonds.

Japan_Chart_1

So, did the quantitative easing measures work?

  • QE helped asset prices, but did not reset inflationary expectations nor economic growth (GDP around 1%).
  • Japanese corporations aren’t investing back into Japan, but rather overseas.
  • Negative interest rates have resulted in a deceleration in bank lending.

That’s not great, but what does that mean exactly?

  • Failure in Japan could also have implications for global markets.
  • Despite stagnant growth for parts of the last three decades, Japan remains the third largest economy and second largest equity market.
  • Japan is also one of the largest holders of U.S. Treasuries.

Shoot me straight here, has Japan entered into the “sunset” phase?

  • It appears likely that Japan still has liquidity to muddle through its problems for now, but one cannot rule out a more negative scenario with the latest inaction and failure to improve the economy.
  • Fiscal stimulus could come in light of the recent earthquake, but progress on tax code reform and increased spending would provide longer-lasting relief.
  • One potentially negative scenario could come in July if a larger-than-expected victory for the opposition happens–this could lead to general elections and the departure of Abe causing policy uncertainty and higher volatility.

Please click here to listen to the full 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, a Registered Investment Advisor.

International Insights Podcast – Elections, Opportunity, and Risk in Japan

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

This audio podcast was recorded November 24, 2014:

Stuart’s International Insights Podcast focuses in specifically on the elections and economics in Japan.

Highlights of the discussion include:

  • Early parliamentary elections this December will be a key signpost.
  • Central bank policy is aggressive, while structural reform needs improvement.
  • Opportunities arise in the forms of deflation changing to inflation, valuation, and flow of funds.
  • Risks include sustainability and investment.

Click here to listen to the full 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, a Registered Investment Advisor.

 

Monthly Market and Economic Outlook: February 2014

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

After such a strong move higher in 2013, U.S. equity markets took a breather in January as the S&P 500 Index fell -3.5%. Volatility returned to the markets as concerns over the impact of Fed tapering and emerging economies weighed on investors. Investor sentiment, a contrarian indicator, had also climbed to extreme optimism levels, leaving the equity markets ripe for a short-term pullback.

In U.S. equity markets, the utilities (+3%) and healthcare (+1%) sectors delivered gains, while energy and consumer discretionary each declined -6%. Mid caps led both small and large caps in January, helped by the strong performance of REITs. Fourth quarter 2013 earnings season has been decent so far. Of the one-third of S&P 500 companies reporting, 73% have beat expectations.

U.S. equity markets led international markets in January, helped by a stronger currency. Performance within developed markets was mixed, with peripheral Europe outperforming (Ireland, Italy, Spain, Portugal), while Australia, France and Germany lagged.

Emerging markets equities significantly lagged developed markets in January, as the impact of Fed tapering, slower economic growth and higher inflation weighed on their economies. Countries with large current account deficits have seen their currencies weaken significantly. Latin America saw significant declines, with Argentina down -24%, Chile down -12% and Brazil down -11%. Asia fared slightly better, with the region down less than -5%. Emerging Europe was dragged lower with double-digit losses in Turkey.

Fixed income had a solid month of performance as interest rates fell across the yield curve. The 10-year Treasury note is now trading around 2.6%, 40 basis points lower than where it started the year. The Barclays Aggregate Index gained +1.5% in January, its best monthly return since July 2011. All major sectors were in positive territory for the month; however, higher-quality corporates led high yield. Municipal bonds edged out taxable bonds and continue to benefit from improving fundamentals.

We believe that the bias is for interest rates to move higher, but it will likely be choppy. 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 as experienced 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 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 into 2014, with a number of factors supporting the economy and markets over the intermediate term.

  • Monetary policy remains accommodative: Even with the Fed beginning to taper asset purchases, short-term interest rates should remain near zero until 2015. In addition, the ECB 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 picked up in the second half of 2013. 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. Monthly payroll gains have averaged more than 200,000, and the unemployment rate has fallen to 7%.
  • Inflation tame: With the CPI increasing +1.5% 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 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 turned 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. 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 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 emerging markets. We are not surprised that we have experienced a pull-back in equity markets to start the year as investor sentiment was elevated and it had been an extended period of time since we last experienced a correction. However, we expect it to be more short-term in nature and maintain a positive view on equities for the year.

Magnotta_Market_Update_2.7.14

We feel that 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

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

Monthly Market and Economic Outlook: December 2013

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

U.S. equities continued to climb higher in November, with major indexes gaining between 2% and 4% for the month. Year to date through November, the S&P 500 Index has posted an impressive gain of 29.1%, while the small cap Russell 2000 Index has fared even better with a return of 36.1%. The last five years have proved to be a very good time to be invested in equity markets, with a cumulative return of 125% for the S&P 500 Index.

International developed equity markets posted small gains in November, and have failed to keep up with U.S. equity markets this year. In Japan, Prime Minister Abe’s policies have spurred risk taking, but the currency has also weakened. The European equity markets have benefited from economies and a financial system that are on the mend. Emerging markets continued to struggle in November and are negative year to date. Concerns over the impact of Fed tapering on emerging economies, as well as slower economic growth, have weighed on the asset class this year.

Interest rates have remained range-bound after the spike in the summer in response to Bernanke’s initial talk of tapering. The 10-year Treasury ended November at a level of 2.75%, just 10 basis points higher than where it began the month. Fixed income is still negative for the year-to-date period; the Barclays Aggregate was down -1.5% through November. However, high-yield credit has had a solid year so far, gaining close to 7%. We believe that the bias is for interest rates to move higher, but it will likely come in fits and starts.

12.13.13_Magnotta_MarketOutlook_2The Fed will again face the decision to taper asset purchases at their December meeting, and we expect volatility in risk assets and interest rates surrounding this decision, just as we experienced in the second quarter.  The recent economic data has surprised to the upside; however, inflation remains below the Fed’s target level. Despite their decision to reduce or end asset purchases, the Fed has signaled short-term rates will be on hold for some time. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome.

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 into 2014, with a number of factors supporting the economy and markets.

  • Monetary policy remains accommodative: The Fed remains accommodative (even with the eventual end of asset purchases, short-term interest rates will remain near-zero until 2015), the European Central Bank has provided additional support through a rate cut, 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 steady and recently showing signs of picking up. The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S., growth has not been very robust, but it is 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 declined.
  • Inflation tame: With the CPI increasing only +1% over the last 12 months, inflation in the U.S. has been running below the Fed’s target level.
  • 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 or returned to shareholders. 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 two months while fixed income funds have experienced significant outflows, a reversal of the patter 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. It looks like Congress may sign 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 markets are anxiously awaiting the Fed’s decision on tapering asset purchases, prompting further volatility in asset prices and interest rates. 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 expect continued volatility in the near term as we await the Fed’s decision on the fate of quantitative easing. Despite the strong run, valuations for large cap U.S. equities still look reasonable on a historical basis by a number of measures. Valuations in international developed markets look relatively attractive as well, while emerging markets are more mixed. Momentum remains strong; the S&P 500 Index has spent the entire year above its 200-day moving average. However, investor sentiment is elevated, which could provide ammunition for a short-term pull-back surrounding the Fed’s tapering decision.

12.13.13_Magnotta_MarketOutlook_1

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 Returns:12.13.13_Magnotta_MarketOutlook

Decoding the G7 Statement

Andy RosenbergerAndy Rosenberger, CFA, Senior Investment Manager

Earlier this week, members of the seven richest countries met for the official G7 conference. Center to the assembly were discussions surrounding the recent actions by Japan to stimulate their economy through currency devaluation and higher inflation targets. Investors, hungry for a green light by the G7 that Japanese policies are warranted, were disappointed and confused as conflicting statements were issued. The official statement read:

“We, the G7 Ministers and Governors, reaffirm our longstanding commitment to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets. We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates. We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability. We will continue to consult closely on exchange markets and cooperate as appropriate.”

Confused by the statement? You weren’t alone. The statement, although obscure, was initially seen by the market as a green light. Specifically, market participants focused on the following sentence:

“We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments…”

However, only hours later, an unnamed “official” was quoted in a Reuters article as saying:

“The G7 statement signaled concern about excess moves in the yen.” and “The G7 is concerned about unilateral guidance on the yen. Japan will be in the spotlight at the G20 in Moscow this weekend.”

G7

The unnamed “official” was enough to stop the yen’s depreciation; at least temporarily. Investors’ eyes will now turn to the G20 meeting this weekend for further clarification. However, the reality of all of this is that it’s more noise than news.

Japan has started down a path with which there’s no turning back. Too many failed stimulus attempts have been one of the major reasons as to why Japan hasn’t been able to escape its two-decade long deflationary spiral. Reversing course now would be disastrous for the Japanese economy, and more importantly, Japan’s newly elected Prime Minster Shinzo Abe. Prime Minster Abe has only months to establish his Liberal Democratic Party’s (LDP) credibility before another round of elections determine the party’s fate. Turning back now would surely cost the party its ruling power. Ultimately, it seems hard to believe that newly elected officials would side with six members from other countries over that of the voters and ultimately their political careers.

A Tale of Two Currencies

Joe PreisserJoe Preisser, Brinker Capital

As the global marketplace continues to recover from the worst financial crisis since the Great Depression, two of the world’s major currencies, the yen and the euro, have embarked on remarkably different paths of late in a reflection of the efforts of the Central Bank’s, which guard the levers of these economies, to achieve growth and stability. The responses of the nations ‘ respective policy makers has led directly to a steep decline in the value of the Japanese Yen, while the European continent has seen its common medium of exchange rise to heights unreached since 2011. Although the nature of the challenges facing what are two of the largest economies in the world differ significantly, the efficacy of the monetary policies employed to combat them will have a profound effect on markets across the globe.

In Japan, newly elected Prime Minister, Shinzo Abe, has grabbed headlines after only a few weeks in office, through his advocacy of aggressive measures designed to foster growth within a nation that has been mired in stagnation. Dubbed “Abenomics”, the plan is a multifaceted approach to economic stimulus whose centerpiece is a desire to devalue the nation’s currency, in an effort to support its exporters by rendering the goods and services they provide less expensive on the world stage. According to the Wall Street Journal, on February 6th, “Analysts at Goldman Sachs Inc. estimate that for every 10 yen the currency weakens against the dollar, profits of exporters would rise by 7% to 10%.” Mr. Abe has professed his aim to achieve this through a controversial limiting of a measure of the Bank of Japan’s (BOJ) autonomy in an effort to effectively force the reflation of the economy through a program of unlimited monetary easing and large scale stimulus. In addition, the Prime Minister has pledged to fill the recently vacated position at the helm of the BOJ with an appointee who shares his commitment to revitalizing the country’s economy through all available means (The Economist, Jan 26th). The efforts undertaken thus far, combined with Mr. Abe’s emphatically-stated focus on combatting the deflation that has plagued Japan for more than a decade, have resulted in a sharp fall in the value of the yen, and a steep rise in equity prices listed on the nation’s exchange, which should be sustained as long as this endeavor proves successful. “The Nikkei has surged 32% since mid-November…The yen has declined 14% against the dollar over the same period…The gains in Tokyo have made Japan the world’s best-performing major stock market over the past three months ”(The Wall Street Journal, February 6th).2.8.13_Preisser_Currencies

On the Continent, the nearly four-year-old struggle to maintain its union in the face of a perilous debt crisis that threatened the world economy, has led to an unprecedented effort by the European Central Bank (ECB) to support the common currency. The fear of a possible dissolution of this unique collection of countries led directly to the widespread selling of the euro, as well as large scale liquidations of bonds issued by its sovereign members. As the cost of repaying the debt of a host of the European Union’s members rose to unsustainable levels the President of the ECB, Mario Draghi elected to act pledging to do, “whatever it takes to preserve the euro”(Bloomberg News July 26,2012). This statement manifested itself in a series of massive sovereign debt purchases by The Central Bank in September of 2012 which was dubbed, “Outright Monetary Transactions.” Mr. Draghi’s effort brought stability back to the euro-zone, and as a result led to an appreciation of its currency. As investors have become more confident that the worst of the crisis has been averted, the euro has risen further, and is now back to levels untested in two years. The sequence of events on the Continent stands in stark contrast to those in Japan, as Europe’s exporters have seen the cost of their products increase, thus making it more difficult for them to compete in the global marketplace. The threat that this state of affairs poses to the recovery of the region’s economy is such that it was directly and repeatedly addressed by Mr. Draghi this week during a press conference in which he suggested that the Central Bank may take steps to counter the effects of the currency’s rise. The ECB President was quoted by Bloomberg News as saying on Feb 7th, “The exchange rate is not a policy target, but it is important for growth and price stability…We want to see if the appreciation is sustained, and if it alters our assessment of the risks to price stability.”

The historic measures undertaken by both the European Central Bank, and the Bank of Japan in the interest of maintaining stability and fostering growth have thus far been largely successful, however it will be the ongoing maintenance of the consequences of this success that will ultimately determine the fate of these economies.