Investment Insights Podcast: September could be a grueling month in Washington

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Amy Magnotta, CFASenior Vice President, Brinker Capital

On this week’s podcast (recorded August 29, 2017), Amy discusses how the agenda in Washington, during the month of September, will be grueling.

Quick hits:

  • Lawmakers must deal with raising the debt ceiling, government funding to avoid a shutdown, and a new budget that will provide a reconciliation vehicle so that tax reform can pass with a simple majority vote.
  • We faced a similar situation in September 2013 when the government did shut down for sixteen days.
  • We believe that the Administration serves as both a positive tailwind for the economy and markets, as well as a significant risk.

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

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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.

When in Doubt, Blame the Weather

Ryan Dressel Ryan Dressel, Investment Analyst, Brinker Capital

The 2013-2014 winter has been nothing short of a worse-case scenario for the eastern half of the U.S. In Chicago, temperatures fell below zero an astounding 22 times (the Chicago record for a winter is 25), and let’s not forget the combined 67 inches of snow. In Atlanta, the city literally came to a halt during what became known as “Icepocalypse.” In Philadelphia, we’ve seen a total of 58 inches of snow (third highest on record) including 11 different snow storms dropping one inch or more.[1]

Source: TheAtlantic.com

Source: TheAtlantic.com

Those three locales give you a pretty good idea of just how wide spread the wrath of winter is this year. While it is difficult to measure the exact impact of the weather on the economy, we can conclude that economic activity will certainly lag in January, February and March. Despite the fact that most economic indices account for seasonal effects, they do not account for outlier years like this one. Weather has been blamed for poor economic reports ranging from job growth, to new housing starts, to manufacturing—but is it justified?

A 2010 study by the American Meteorological Society determined which U.S. states are most sensitive to extreme weather variability as it relates to economic output.[2]

Dressel_Weather_2.21.14_1The research concluded that the location with the most sensitive industries had the largest total economic effect. For example, agriculture is the most sensitive on an absolute basis, but the fact that agriculture makes up such a small percentage of most states’ Gross State Product (GSP) means that extreme weather has a small total effect on sensitivity. Conversely, manufacturing, financial services, and real estate have a large relative sensitivity because of their GSP impact. As you can see on the map, the states where these industries have a significant economic impact, translates in higher sensitivity to extreme weather.

The severity of winter in the states colored red and yellow justifies the weather-related hype, while the ones in blue can be ignored for economic purposes. If you include the effects of the Government shutdown, we’ve had four consecutive months of cloudy data that we can’t put into clear context!

[1] National Oceanic and Atmospheric Administration.
[2] U.S. Economic Sensitivity to Weather Variability. Jeffrey K. Lazo, Megan Lawson, Peter Larsen, Donald Waldman. December 28, 2010.

Monthly Market and Economic Outlook: October 2013

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

Developed market equities have had an impressive run so far in 2013, while fixed income, emerging markets and commodities have lagged. After telegraphing a tapering of asset purchases, the Fed surprised investors on September 18 with a decision to keep the quantitative easing program in place, wanting to see greater clarity on economic growth and a waning of fiscal policy uncertainty before reducing the level of asset purchases.

Asset prices moved immediately higher in response to the Fed’s decision; however that served to be the high-water mark for equities for the quarter.  Then concern over U.S. fiscal policy surfaced and has weighed on markets over the last few weeks. Unlike in previous years, deals to raise the debt ceiling and fund the government will result in limited fiscal drag; however, the headlines will serve to increase market volatility over the short term.

U.S. equity markets posted solid gains in the third quarter, led by small caps and growth-oriented companies.  High-yielding equities continue to lag. Developed international equity markets meaningfully outpaced U.S. markets in the quarter, with most countries generating double-digit returns.  As a result, the gap of outperformance for U.S. markets has narrowed for the year.  Emerging economies have been negatively impacted by the discussion of the Fed reducing liquidity, slower economic growth and weaker currencies.  While emerging markets equities rebounded in the third quarter, as a group they are still negative for the year with Brazil and India especially weak.

Interest rates continued their rise to start the quarter, with the 10-year Treasury note briefly hitting 3% in the beginning of September.  Rates then began to move lower, helped by an avoidance of conflict in Syria and the postponing of Fed tapering. All fixed income sectors were positive in the third quarter, led by high-yield credit.  Year to date through September, high yield has produced gains, while all other major fixed income sectors are negative. Outflows from taxable bond funds have slowed significantly in recent weeks, so the technical backdrop has improved somewhat.

We believe that interest rates have begun the process of normalization, and over the long term, the bias is for higher interest rates.  However, this process will be prolonged and likely characterized by fits and starts. The Fed will soon face the decision to taper asset purchases again later this year, with the earliest action in December.  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. Our fixed income allocation is well positioned with less interest-rate risk and a yield premium versus the broad market.

However, we continue to view a continued rapid rise in interest rates as one of the biggest threats to the U.S. economic recovery.  The recovery in the housing market, in both activity and prices, has been a positive contributor to growth this year.  Stable, and potentially rising, home prices help to boost consumer confidence and net worth, which impacts consumer spending in other areas of the economy.  Should mortgage rates move high enough to stall the housing market recovery, it would be a negative for economic growth.

We continue to approach our broad macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into the final months of the year, and a number of factors should continue to support 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 low for the foreseeable future), the ECB stands ready to provide additional support if necessary, and the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Global growth strengthening: U.S. economic growth has been sluggish, but steady.  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. China appears to have avoided a hard landing.
  • Labor market progress: The recovery in the labor market has been slow, but stable. Initial jobless claims, a leading indicator, have declined to a new cycle low.
  • Housing market improvement: The improvement in home prices, typically a consumer’s largest asset, boosts net worth, and as a result, consumer confidence.  However, another move higher in mortgage rates 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.

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

  • Fiscal policy uncertainty: After Congress failed to agree on a continuing resolution to fund the government, we entered shutdown mode on October 1.  While the economic impact of a government shutdown is more limited, the failure to raise the debt ceiling (which will be reached on October 17) would have a more lasting impact. A default remains unlikely in our opinion, and there will be little fiscal drag as a result of a deal, but the debate does little to inspire confidence. The Fed continues to provide liquidity to offset the impact.
  • Fed mismanages exit: The Fed will soon have to face the decision of whether to scale back asset purchases, which could prompt further volatility in asset prices and interest rates. If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.  The Fed will also be under new leadership next year, which could add to the uncertainty.  However, if the Fed does begin to slow asset purchases, it will be in the context of an improving economy.
  • Significantly higher interest rates: Rates moving significantly higher from here could stifle the economic recovery.
  • Europe: While the economic situation appears to be improving in Europe, the risk of policy error still exists.  The region has still not addressed its structural debt and growth problems; however, it seems leaders have realized that austerity alone will not solve its issues.

Risk assets should continue to perform if real growth continues to recover despite the higher interest rate environment; however, we expect heightened volatility in the near term. Valuations in the U.S. equity market remain reasonable while valuations abroad look more attractive. We continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Some areas of opportunity currently include:

  • Global Equity: Large-cap growth, dividend growers, Japan, frontier markets, international microcap
  • Fixed Income: MBS, global credit, short duration
  • Absolute Return: closed-end funds, relative value, long/short credit
  • Private Equity: company-specific opportunities

Asset Class Returns10.9.13_Magnotta_MarketOutlook

The views expressed above are those of Brinker Capital and are not intended as investment advice.

Stalemate

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The ongoing dysfunction in Washington D.C. reached a fever pitch this week, as the failure of lawmakers to agree on a bill to fund the Federal Government resulted in the President ordering its first shutdown since 1995.  The inability of Congress to effectively legislate has led to the furlough of more than 800,000 Federal workers, and a shuttering of all non-essential services.  Although equity markets around the world have remained relatively sanguine about the current state of affairs inside the beltway, the looming deadline to raise the debt ceiling, which the Treasury Department has declared to be no later than October 17, has heightened the stakes of the current impasse immeasurably, as a breach of this borrowing limit would have dire consequences not just for the United States, but for the global economy in aggregate.  It is the presence of this possibility that provides us with cautious optimism that a resolution might be forthcoming; as our belief is that the closure of the government and the subsequent pressure being applied by the electorate to end the stalemate has pulled forward the debt ceiling debate, which may result in a bargain that addresses both issues.  However, we intend to remain hyper-vigilant about the progress of these negotiations as we fully recognize the severity of the impact of a failure to honor our nation’s debts.

10.4.13_Preisser_Stalemate_1The current standoff has resulted from a multiplicity of factors, chief amongst which is a fundamental ideological difference between the parties over the Affordable Care Act, popularly known as “Obamacare”, which went into effect this week.  It is the vehemence of both sides in this debate combined with the extreme partisanship in the Capital that have made this situation particularly perilous.  Despite assertions to the contrary, the shuttering of the government comes at an exorbitant cost.  According to the New York Times, “ the research firm IHS Inc. estimates that the shutdown will cost the country $300 million a day in lost economic output…Moody’s Analytics estimated that a shutdown of three or four weeks would cut 1.4 percentage points from fourth-quarter economic growth and raise the unemployment rate.”  With consensus estimates for GDP currently at only 2.5% per annum, the present state of affairs, if not soon rectified will take an ever increasing toll on the nation’s economy.

Since 1970 there have been a total of 18 shutdowns of the Federal Government, including this most recent closure.  Although each situation was unique, what is common amongst them is that investors have, on average, approached them with relatively little trepidation.  According to Ned Davis Research, “during the six shutdowns that lasted more than five trading days, the S&P fell a median 1.7%.”In fact, optimism in the marketplace has tended to follow these periods of uncertainty.  Bloomberg News writes that, “the S&P has risen 11 percent on average in the 12 months following past government shutdowns, according to data compiled by Bloomberg on instances since 1976.  That compares with an average return of 9 percent over 12 months.”

Source: Ned Davis Research Group

Source: Ned Davis Research Group

There is one glaring difference between this year’s shuttering of the government and those of recent history, and that is the presence of the debt ceiling.  According to the New York Times, “the Treasury said last week that Congress had until Oct. 17 to raise the limit on how much the federal government could borrow or risk leaving the country on the precipice of default.”  Though we can look to the past as a guide to use to try and gauge the impact of a government shutdown, there is no way to accurately predict the effect of a failure of the United States government to fulfill its obligations, as this would be unprecedented. The need for Congress to raise the debt ceiling cannot be overstated, as the very sanctity of U.S. sovereign obligations depends upon it.  The importance of this faith to the global economy was captured by Nobel Prize winning economist, Paul Krugman, “Financial markets have long treated U.S. bonds as the ultimate safe asset; the assumption that America will always honor its debts is the bedrock on which the world financial system rests.”