May 2016 Monthly Market And Economic Outlook

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Continuing the rally that began in mid-February, risk assets posted modest gains in April, helped by more dovish comments from the Federal Reserve and further gains in oil prices. Expectations regarding the pace of additional rate hikes by the Fed have been tempered from where they started the year. Economic data releases were mixed, and while a majority of companies beat earnings expectations, earnings growth has been negative year over year.

The S&P 500 Index gained 0.4% for the month. Energy and materials were by far the strongest performing sectors, returning 8.7% and 5.0% respectively. On the negative side was technology and the more defensive sectors like consumer staples, telecom and utilities. U.S. small and micro-cap companies outpaced large caps during the month, and value continued to outpace growth.

International equity markets outperformed U.S. equity markets in April, helped by further weakness in the U.S. dollar. Developed international markets, led by solid returns from Japan and the Eurozone, outpaced emerging markets. Within emerging markets, strong performance from Brazil was offset by weaker performance in emerging Asia.

The Barclays Aggregate Index return was in line with that of the S&P 500 Index in April. Treasury yields were relatively unchanged, but solid returns from investment grade credit helped the index. High-yield credit spreads continued to contract throughout the month, leading to another month of strong gains for the asset class.

We remain positive on risk assets over the intermediate-term; however, we acknowledge that we are in the later innings of the bull market that began in 2009 and the second half of the business cycle. The worst equity market declines are typically associated with recessions, which are preceded by aggressive central bank tightening or accelerating inflation, factors which are not present today.  While our macro outlook is biased in favor of the positives and a near-term end to the business cycle is not our base case, the risks must not be ignored.

A number of factors we find supportive of the economy and markets over the near term.

Global monetary policy remains accommodative: The Fed’s approach to tightening monetary policy is patient and data dependent.  The Bank of Japan and the ECB have been more aggressive with easing measures in an attempt to support their economies, while China may require additional support.

Stable U.S. growth and tame inflation: U.S. economic growth has been modest but steady. While first quarter growth was muted at an annualized rate of +0.5%, we expect to see a bounce in the second quarter as has been the pattern. Payroll employment growth has been solid and the unemployment rate has fallen to 5.0%. Wage growth has been tepid at best despite the tightening labor market, and reported inflation measures and inflation expectations, while off the lows, remain below the Fed’s target.

U.S. fiscal policy more accommodative: With the new budget, fiscal policy is poised to become modestly accommodative in 2016, helping offset more restrictive monetary policy.

Constructive backdrop for U.S. consumer: The U.S. consumer should see benefits from lower energy prices and a stronger labor market.

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

Risk of policy mistake: The potential for a policy mistake by the Fed or another major central bank is a concern, and central bank communication will be key. In the U.S. the subsequent path of rates is uncertain and may not be in line with market expectations, which could lead to increased volatility. Negative interest rates are already prevalent in other developed market economies. An event that brings into question central bank credibility could weigh on markets.

Slower global growth: Economic growth outside the U.S. is decidedly weaker, and while China looks to be improving, a significant slowdown remains a concern.

Another downturn in commodity prices: Oil prices have rebounded off of the recent lows and lower energy prices on the whole benefit the consumer; however, another significant leg down in prices could become destabilizing. This could also trigger further weakness in the high yield credit markets, which have recovered since oil bottomed in February.

Presidential Election Uncertainty: The lack of clarity will likely weigh on investors leading up to November’s election. Depending on the rhetoric, certain sectors could be more impacted.

The technical backdrop of the market has improved, as have credit conditions, while the macroeconomic environment leans favorable. Investor sentiment moved from extreme pessimism levels in early 2016 back into more neutral territory. Valuations are at or slightly above historical averages, but we need to see earnings growth reaccelerate. We expect a higher level of volatility as markets assess the impact of slower global growth and actions of policymakers; but our view on risk assets still tilts positive over the near term. Higher volatility has led 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. 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. Brinker Capital Inc., a Registered Investment Advisor.

January 2016 Monthly Market And Economic Outlook

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After three years of strong market returns, 2015 performance was relatively flat combined with higher volatility across most asset classes. Sluggish global economic growth, concerns over a hard landing in China, a further decline in oil prices, and the anticipation of the Federal Reserve’s first interest rate hike since 2006 weighed on markets. The U.S. dollar was a top performing asset class, gaining more than 9%, while commodity-related assets were the worst performers. Large cap U.S. equities outpaced small cap and international equities, fixed income delivered lackluster returns, and alternative strategies generally underperformed expectations, resulting in a difficult year for diversified investors.

Despite a robust fourth quarter, U.S. equity markets ended the year with a small gain on a total return basis. There was also wide dispersion across sectors. Consumer discretionary dominated with a double-digit gain, followed by healthcare and technology. Energy experienced a greater than -20% loss for the year. With sluggish economic growth as the backdrop, investors significantly favored growth over value from a style perspective across all market capitalizations, but particularly in the large cap space where the spread was more than 900 basis points. Small caps faded after a strong start to the year, with the Russell 2000 Index declining more than -4%.

BRICDeveloped international equity markets performed in line with U.S. markets in local terms during 2015, but lagged in U.S. dollar terms. Unlike in the U.S., small caps outpaced large caps in international markets. Japan was the strongest performing market with a gain of almost 10%. Emerging markets significantly underperformed developed markets. The weakest performer was Brazil, with a decline of more than -40% in U.S. dollar terms. Of the BRIC countries, only Russia was able to deliver a positive return.

Longer-term U.S. Treasury yields moved slightly higher in 2015, with the 10-year rising 10 basis points to end the year at a level of 2.27%. The shorter-end of the curve moved higher, resulting in a modest flattening of the yield curve. Even with the Fed’s actions, we expect longer-term rates to remain range-bound in the intermediate term. All investment-grade fixed income sectors except for corporate credit delivered modest gains, and municipal bonds outperformed taxable fixed income. High-yield credit spreads widened meaningfully throughout 2015 and the asset class declined more than -4%. Technical pressures, including increased supply and meaningful outflows, weighed on the high-yield market with the most impact on lowest-rated credits; however, we have yet to see a meaningful decline in fundamentals.

The global macro backdrop keeps us positive on risk assets over the intermediate term as we move through the second half of the business cycle. However, we acknowledge that we are in the later innings of the bull market that began in 2009, and the risks must not be ignored. We find a number of factors supportive of the economy and markets over the near term.

  • Fed_OutlookGlobal monetary policy accommodation: Despite the Fed beginning to normalize monetary policy with the initial rate hike in December, their approach should be patient and data-dependent. The European Central Bank (ECB) and the Bank of Japan have been more aggressive with easing measures in an attempt to support their economies. China is likely going to require additional support.
  • U.S. growth stable and inflation tame: U.S. economic growth has been modest but steady. Payroll employment growth has been solid, and the unemployment rate has fallen to 5%. Wage growth has been tepid at best despite the tightening labor market, and reported inflation measures and inflation expectations remain below the Fed’s target.
  • Deal Activity: Mergers and acquisitions (M&A) deal activity continues to pick up as companies seek growth.
  • Washington: With the new budget, fiscal policy is poised to become modestly accommodative, helping offset more restrictive monetary policy.

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

  • Policy mistake: The potential for a policy mistake by the Fed or another major central bank is a concern, and central bank communication will be key. In the U.S., the subsequent path of rates is uncertain and may not be in line with market expectations, which could lead to increased volatility.
  • Slower global growth: Economic growth outside the U.S. is decidedly weaker, and a significant slowdown in China is a concern.
  • Wider credit spreads: While overall credit conditions are still accommodative, high-yield credit spreads have moved significantly wider, and weakness has spread outside of the commodity sector.
  • Commodity price weakness: Weakness in commodity-related sectors has begun to spill over to other areas of the economy, and earnings have weakened as a result.
  • Geopolitical risks could cause short-term volatility.

Market technicals remain weak, but valuations are back to more neutral levels. Investor sentiment, a contrarian signal, is near extreme pessimism territory. We expect a higher level of volatility as markets digest the Fed’s actions and we move through the second half of the business cycle; however, our view on risk assets remains positive over the near term. Increased volatility creates opportunities that we may 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. 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. Brinker Capital, Inc., a Registered Investment Advisor.

Early Concern in 2016 Yields Opportunity

Miller_HeadshotBill Miller, Chief Investment Officer

Overall global economic concerns and yesterday’s market events present a great opportunity to remind investors to stay focused on their goals. To that end, we highlight two performance metrics:

First, as illustrated below, some asset classes, including gold, U.S. Treasury bonds, TIPs and pipeline Master Limited Partnerships, finished up yesterday in the face of poor global equity performance. In some cases, this is the opposite of last year’s performance. Such a flip-flop in performance across asset classes only serves to highlight the value of Brinker Capital’s multi-asset class investment philosophy. A commitment to diversification can help calm investors on bad days and moderate enthusiasm on good days.

Performance Across Asset Classes

Source: Brinker Capital, FactSet

Second, big drops in the S&P are infrequent but certainly not an unfamiliar occurrence on an absolute basis. There have been single-day dips of 2% or greater in the S&P 500 a total of 222 times in the trailing 20 years, or just slightly under 5% of the total number of trading days.

More importantly, following these dips the median S&P return in the following month (2.44% over the subsequent 20 trading days) has been more than double that of the median 20-day S&P return over the period on a non-conditional basis (1.01%).

Over the last 20 years, a strategy that fled to cash for 20-day periods following those 2% S&P 500 declines would have fared 2% worse on an annualized basis than staying 100% invested in equity. That’s a cumulative return difference of 151%.

S&P 500 Performance

Source: Brinker Capital, FactSet

Again, yesterday’s volatility presents a great opportunity early in 2016 to remind investors that it’s not time to panic–it’s important to stay focused on their goals. While we can’t predict what specifically may happen in the future, Brinker Capital has been identifying trends and leveraging our six-asset class philosophy when positioning our portfolios to anticipate a period of increased market volatility in many of our strategic and tactical portfolios.

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 “Don’ts” for Periods of Market Volatility

Crosby_2015Dr. Daniel Crosby, Founder, Nocturne Capital

Having checked in this week with many of our advisors and the clients they serve, we know that this has been a stressful week for everyone involved in the market. On Monday, we wanted to provide a few proactive starting points and created a list of “do’s” for volatile markets. However, at times like this, knowing what not to do can be just as important as knowing what to do. With that, we present a list of things you should absolutely not be doing in periods of market volatility.

  • Don’t lose your sense of history – The average intrayear drawdown over the past 35 years has been just over 14%. The market ended the year higher on 27 of those 35 years. A relatively placid six years has lulled investors into a false reality, but nothing that we have experienced this year is out of the average by historical measures.
  • Don’t equate risk with volatility – Repeat after me, “volatility does not equal risk.” Risk is the likelihood that you will not have the money you need at the time you need it to live the life you want to live. Nothing more, nothing less. Paper losses are not “risk” and neither are the gyrations of a volatile market.
  • Don’t focus on the minute to minute – Despite the enormous wealth creating power of the market, looking at it too closely can be terrifying. A daily look at portfolio values means you see a loss 46.7% of the time, whereas a yearly look shows a loss a mere 27.6% of the time. Limited looking leads to increased feelings of security and improved decision-making.
  • Don’t forget how markets work – Do you know why stocks outperform other asset classes by about 5% on a volatility-adjusted basis? Because they can be scary at times, that’s why! Long term investors have been handsomely rewarded by equity markets, but those rewards come at the price of bravery during periods short-term uncertainty.
  • Don’t give in to action bias – At most times and in most situations, increased effort leads to improved outcomes. Want to lose weight? Start running! Want to learn a new skill set? Go back to school. Investing is that rare world where doing less actually gets you more. James O’Shaughnessy of “What Works on Wall Street” fame relates an illustrative story of a study done at Fidelity. When they surveyed their accounts to see which had done best, they uncovered something counterintuitive. The best-performing accounts were those that had been forgotten entirely. In the immortal words of Jack Bogle, “don’t do something, just stand there!”

Views expressed are for illustrative purposes only. The information was created and supplied by Dr. Daniel Crosby of Nocturne Capital, an unaffiliated third party. Brinker Capital Inc., a Registered Investment Advisor

Monthly Market and Economic Outlook: July 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Uncertainty over the start of the Federal Reserve’s rate hike campaign, the possibility of a default in Greece and Puerto Rico, and the drop in China shares each weighed on financial markets in June, resulting in a quarter of flat to negative performance across most asset classes. The increased volatility and higher level of dispersion across and within asset classes has benefited active management.

The S&P 500 Index fell almost -2% in June but was able to eke out a small gain for the quarter, despite the negative headlines. The healthcare and consumer discretionary sectors continued to lead, while bond proxies like dividend-paying stocks and REITs struggled. Energy stocks continued to lose ground as well despite a stabilization in crude oil prices. From a market cap perspective, small caps are leading large and mid caps, but the margin isn’t as wide as it is between growth and value. Through the first half of the year, all style boxes are positive except for large cap value, which is modestly negative. However, dispersion is wide, with small cap growth outpacing large cap value by more than 900 basis points over that time period.

Greece_OutlookThe rally in international equities slowed in the second quarter as fears surrounding Greece prompted a sharper sell-off in June; however, international markets still ended the quarter ahead of U.S. markets and continue to have a sizeable lead through the first half of the year. The U.S. Dollar Index (DXY) was weaker in the second quarter, but has still posted gains of more than 5% in the first half, dampening international equity returns for U.S. investors.

In developed markets, Japan, fueled by its expansive quantitative easing program, has been the top performer year to date, gaining almost 14%. Europe, despite a weaker second quarter, has gained more than 4%. Emerging markets soared in April, but gave most of the gains back in May and June to end the quarter in line with developed international markets. June’s significant decline in the Chinese local stock market, which had gained more than 110% since November, prompted a number of policy responses. However, for investors the vast majority of exposure is gained through listings on the more open Hong Kong exchange, which has not experienced gains and losses of even close to the same magnitude.

Anticipation of a Fed rate hike in the fall incited a rise in long-term U.S. Treasury yields, with yield on the 10-year note climbing 41 basis points during the quarter to 2.35%. As a result, the Barclays Aggregate declined -1.7% in the second quarter and is slightly negative through the first six months of the year. All fixed income sectors were negative for the quarter, led by U.S. Treasuries. The macro concerns caused both investment grade and high-yield credit spreads to widen, but due to its yield cushion, the high-yield index was flat for the quarter and remains the strongest fixed income sector year to date with a gain of +2.5%. Despite the recent widening, spreads are still at levels below where we started the year. Municipal bonds finished the quarter ahead of taxable bonds, but are still flat year to date. Increased supply weighed on the municipal market in the second quarter.

Our outlook remains biased in favor of the positives, but recognizes that risks remain. We’re solidly in the second half of the business cycle, but the global macro backdrop keeps us positive on risk assets over the intermediate term. As a result, our strategic portfolios are positioned with a modest overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

  • Global monetary policy accommodation: Despite the Fed heading toward monetary policy normalization, their approach will be cautious and data dependent. The ECB and the Bank of Japan have both executed bold easing measures in an attempt to support their economies.
  • U.S. growth stable and inflation tame: Despite a soft patch in the first quarter, U.S. economic growth is forecast to be positive in the second quarter and the labor market continues to show steady improvement. While wages are showing signs of acceleration, reported inflation measures and inflation expectations remain below the Fed’s target.
  • U.S. companies remain in solid shape: M&A activity has picked up and companies also are putting cash to work through capex and hiring. Earnings growth outside of the energy sector is positive, 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; however, Congress will still need to address the debt ceiling before the fall. Government spending has shifted to a contributor to GDP growth in 2015 after years of fiscal drag.

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

  • Fed tightening: The Fed has set the stage to commence rate hikes later this year. Both the timing of the first rate increase, and the subsequent path of rates is uncertain, which could lead to increased market volatility.
  • Slower global growth: Economic growth outside the U.S. is decidedly weaker. It remains to be seen whether central bank policies can spur sustainable growth in Europe and Japan. Growth in emerging economies has slowed as well.
  • Contagion risk relating to the situations in Greece and China must continue to be monitored.
  • Geopolitical risks could cause short-term volatility.

Despite higher than average valuations, neutral investor sentiment and a weaker technical backdrop, we believe the macro picture supports additional market gains over the intermediate-term. However, with headline risk of events in Greece and the Fed set to normalize monetary policy, a larger pull-back is not out of the question. The S&P 500 Index has gone more than 900 days without a 10% correction, the third longest period on record (Source: Ned Davis Research). However, because of our positive macro view, we’d view a pull-back as a buying opportunity and would expect the equity market to continue its uptrend.

Fed_OutlookWe expect U.S. interest rates to continue to normalize; however, U.S. Treasuries still offer relative value over sovereign bonds in other developed markets, which could keep a ceiling on long-term rates in the short-term. With the Fed set to increase the federal funds rate this year, we should see a flattening of the yield curve. Our portfolios are positioned in defense of rising interest rates, with a shorter duration and yield cushion versus the broader market.

As we operate without the liquidity provided by the Fed and move through the second half of the business cycle, we expect higher levels of both equity and bond market volatility. We expect this volatility and dispersion of returns to lead to more attractive opportunities for active management across and within asset classes. 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 Outlook Comments
U.S. Equity + Quality bias
Intl Equity + Neutral vs. US
Fixed Income +/- Favor global high yield
Absolute Return + Favor fixed income AR, event driven
Real Assets +/- Favor global natural resources
Private Equity + Later in cycle

Source: Brinker Capital

Brinker Capital, Inc., a Registered Investment Advisor. 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. 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.

Monthly Market and Economic Outlook: January 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Despite geopolitical tensions in Russia and the Middle East, the end of the Federal Reserve’s quantitative easing program, weakness in growth abroad, and a significant decline in oil prices, U.S. large cap equities posted solid double-digit gains in 2014. International equity markets lagged U.S. markets, and the spread was exacerbated by the major strength in the U.S. dollar. Despite consensus calling for higher interest rates in 2014, yields fell, helping long-term Treasuries deliver outsized returns of more than 25%. The weakness in energy prices weighed on markets in the fourth quarter, with crude oil prices falling by almost 50%, the type of move we last saw in 2008. However, it wasn’t enough to prevent the S&P 500 from hitting all-time highs again in December. Volatility remained relatively low throughout the year. We did not see more than three consecutive down days for the S&P 500, the fewest on record (Source: Ned Davis Research).

In the U.S., the technology and healthcare sectors were the largest contributors to the S&P 500 return; however, utilities posted the biggest return, gaining more than 28%. Large caps significantly outperformed small caps for the year, despite a big fourth quarter for small caps. The spread between the large cap Russell 1000 Index and small cap Russell 2000 Index was 760 basis points. Growth outperformed value in large caps and small caps, but value outperformed in mid caps due to the strong performance of REITs.

BRICU.S. equities outperformed the rest of the world in 2014. The S&P 500 Index led the MSCI EAFE Index by more than 1,800 basis points, the widest gap since 1997. In local terms, international developed markets were positive, but the strength of the dollar pushed returns negative for U.S. investors. Emerging markets led developed international markets, but results were mixed. Strength in India and China was offset by weakness in Brazil and Russia.

As the Fed continued to taper bond purchases and eventually end quantitative easing in the fourth quarter, expectations were for interest rates to move higher. We experienced the opposite; the yield on the 10-year U.S. Treasury note fell 80 basis points during the year, from 3.0% to 2.2%. Despite a pick-up in economic growth, inflation expectations moved lower. In addition, U.S. sovereign yields still look attractive relative to the rest of the developed world. As a result of the move lower in rates, duration outperformed credit within fixed income. All sectors delivered positive returns for the year, including high-yield credit, which sold off significantly in the fourth quarter due to its meaningful exposure to energy credits.

Our macro outlook remains unchanged. When weighing the positives and the risks, we continue to believe the balance is shifted 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 accommodation: We anticipate the Fed beginning to raise rates in mid-2015, but at a measured pace as inflation remains contained. The ECB is expected to take even more aggressive action to support the European economy, and the Bank of Japan’s aggressive easing program continues.
  • Pickup in U.S. growth: Economic growth improved in the second half of 2014. A combination of strengthening labor markets and lower oil prices are likely to provide the stimulus for stronger-than-expected economic growth.
  • Inflation tame: Inflation in the U.S. remains below the Fed’s 2% target, and inflation expectations have been falling. Outside the U.S., deflationary pressures are rising.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. Earnings growth has been solid 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. Government spending will shift to a contributor to GDP growth in 2015 after years of fiscal drag.
  • Lower energy prices help consumer: Lower energy prices should benefit the consumer who will now have more disposable income.

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

  • Timing/impact 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, which should provide the Fed more runway.
  • Slower global growth; deflationary pressures: While growth in the U.S. has picked up, growth outside the U.S. is decidedly weaker. The Eurozone is flirting with recession, and Japan is struggling to create real growth, while both are also facing deflationary pressures. Growth in emerging economies has slowed as well.
  • Geopolitical risks: The geopolitical impact of the significant drop in oil prices, as well as issues in the Middle East and Russia, could cause short-term volatility.
  • Significantly lower oil prices destabilizes global economy: While lower oil prices benefit consumers, significantly lower oil prices for a meaningful period of time are not only negative for the earnings of energy companies, but could put pressure on oil dependent countries, as well as impact the shale revolution in the U.S.

While valuations are close to long-term averages, investor sentiment is in neutral territory, the trend is still positive, and the macro backdrop leans favorable, so we remain positive on equities. 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. However, we expect higher levels of volatility in 2015.

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 Outlook Comments
U.S. Equity + Quality bias; overweight vs. Intl
Intl Equity + Country specific
Fixed Income +/- Actively managed
Absolute Return + Benefit from higher volatility
Real Assets +/- Oil stabilizes in 2H15
Private Equity + Later in cycle

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. 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. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

 

Yale Endowment Proves, Once Again, That A Free Lunch is Not a Thing of the Past

Sue BerginSue Bergin, President, S Bergin Communications

In 1952, Harry Markowitz, an unknown 25-year old graduate student at the University of Chicago, defined risk mathematically for the first time. He also explained how investors could lower volatility while preserving expected returns if they incorporated different investments that are not highly correlated. He went on to explain, “diversification is a kind of free lunch at which you can combine a group of risky securities with high expected returns into a relatively low-risk portfolio, so long as you minimize the covariances, or correlations, among the returns of the individual securities.”

YaleThe most prominent institutional investor in developing the multi-asset class investment model was, and remains, David Swensen, chief investment officer of the Yale University Investment Office. The power of diversification to act as a free lunch is described in his book Pioneering Portfolio Management. Swensen, the long-term Chief Investment Officer at Yale University and father of the Yale Endowment Model, believed in avoiding liquidity rather than seeking it, since it comes at a cost of lower returns. The Yale Endowment Model emphasizes broad diversification and makes the case for allocating only a small amount to traditional U.S. equities and bonds and more to alternative investments.

Today, multi-class investing means different things to different people. Initially the Yale Model was based on an asset class composition that included six asset classes. It currently uses seven asset classes: domestic equity, foreign equity, fixed income, absolute return, natural resources, real estate, and private equity.

When it comes to achieving purity of asset class composition, Swensen had to say this:

Purity of asset class composition represents a rarely achieved ideal. Carried to an extreme, the search for purity results in dozens of asset classes, creating an unmanageable multiplicity of alternatives. While market participants disagree on the appropriate number of asset classes, the number should be large enough so that portfolio commitments make a difference, yet small enough so that portfolio commitments do not make too much of a difference. Committing less than 5 percent or 10 percent of a fund to a particular type of investment makes little sense; the small allocation holds no potential to influence overall portfolio results. Committing more than 25 percent or 30 percent to an asset class poses danger of overconcentration. Most portfolios work well with around a half a dozen of asset classes [1].

Swensen’s views on diversification and asset allocation continue to pay off. According to the preliminary 2014 results of the NACUBO-Commonfund Study of Endowments, larger, better-diversified endowments have outperformed their smaller, equity heavy peers.

On average, the 426 university and college endowments in the study returned 15.8%, while endowments with more than $1 billion returned on average 16.8%, and endowments with between $500 million and $1 billion, saw investment returns of 16.2%.

Free LunchYale University led the group, posting 20.2% gains. Further proof that the free lunch concept is alive in well in 2014.

The principles and benefits of diversification are well supported by academic thought. When selecting an investment manager, advisors and investors should consider a firm that believes in the value of the free lunch by taking a multi-asset class investment approach.

[1] Swensen, D. (2009). Asset Allocation. In Pioneering Portfolio Management (p. 101). New York: Simon and Schuster.

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

Monthly Market and Economic Outlook: November 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After a pullback that began in mid-September, the equity markets bounced back sharply in the last two weeks of October. The equity markets shrugged off the end of the Fed’s quantitative easing program and slower economic growth outside of the U.S., viewing the weakness as a buying opportunity. After being down -7% during the correction, the S&P 500 ended the month at a new high. Utilities and healthcare were the top performing sectors, while energy and materials were negative on the month. Small caps bounced back even harder than large caps with the Russell 2000 gaining +6.6% in October, yet small caps have not yet eclipsed their July highs. Year to date through October, mid cap value has been the best performing style, gaining +11.9% due to the strong performance of REITs and utilities.

International equity markets were mixed in October. Developed markets, including Europe and Japan, were generally negative, while emerging markets ended the month in positive territory, led by strong performance in India and China. The U.S. exhibited further strength versus both developed and emerging market currencies. International equity markets have significantly lagged the U.S. markets so far this year; the spread between the S&P 500 Index and MSCI ACWI ex USA Index is 1200 basis points through October.

During the equity market sell-off U.S. Treasury yields declined. The yield on the 10-year note fell almost 50 basis points to a low of 2.14% on October 15, then moved slightly higher to end the month at 2.35%. It was a good month for the fixed income asset class, with all sectors posting positive returns led by corporate credit. High-yield credit spreads widened out 100 basis points in the equity market sell-off, but recaptured 75% of that move in the last two weeks of October. High-yield spreads still remain 100 basis points wider than the low reached in June, and the fundamental backdrop is positive. Municipal bonds had another solid month, benefiting from a continued supply/demand imbalance and improving credit fundamentals.

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 flush 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:

  • Fed’s withdrawal of stimulus: Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, tapering was gradual and the economy is on more solid footing this time. Should inflation measures pick up, market participants will quickly shift to concern over the timing of the Fed’s first interest rate hike. However, the core Personal Consumption Expenditure Price (PCE) Index, the Fed’s preferred inflation measure, is up only +1.4% over the last 12 months and we have not yet seen the improvement in the labor market translate into a level of wage growth that is worrisome.
  • Global growth: While growth in the U.S. has picked up recently, concerns remain surrounding growth in continental Europe, Japan and some emerging markets. Both the OECD and IMF have downgraded their forecasts for global growth.
  • Geopolitical risks: The events in the Middle East and Ukraine, as well as Ebola fears could have a transitory impact on markets.

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.

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 Outlook Favored Sub-Asset Classes
U.S. Equity + Large caps growth
Intl Equity + Emerging and frontier markets, small cap
Fixed Income - Global high-yield credit
Absolute Return + Closed-end funds, global macro
Real Assets +/- Natural resources equities
Private Equity + Diversified

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. 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. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

 

Monthly Market and Economic Outlook: July 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Equity markets continued to grind higher in the second quarter despite continued tapering by the Federal Reserve, a negative GDP print, and rising geopolitical tensions. All asset classes have delivered positive returns in the first half of the year, led by long-term U.S. Treasury bonds. There has been a lack of volatility across all asset classes; the CBOE Volatility Index (VIX) fell to its lowest level since February 2007.

Year to date the U.S. equity markets are slightly ahead of international markets. All S&P sectors are positive year to date, led by utilities and energy. Mid cap value has been the best performing style, helped by the double-digit performance of REITs. U.S. large caps have outperformed small caps, but after experiencing a drop of more than -9%, small caps rebounded nicely in June. Value leads growth across all market capitalizations.

Despite concerns surrounding the impact of Fed tapering on emerging economies, emerging market equities outperformed developed markets in the second quarter, and have gained more than 6% so far this year, putting the asset class ahead of developed international equities. Small cap emerging markets and frontier markets have had even Magnotta_Market_Update_7.09.14_1stronger performance. The dispersion of performance within emerging markets has been high, with India, Indonesia and Argentina among the top performers, and China, Mexico and Chile among the laggards. On the developed side, performance from Japan has been disappointing but a decent rebound in June bumped it into positive territory for the year-to-date period.

Despite a consensus call for higher interest rates in 2014, U.S. Treasury yields moved lower. The 10-year Treasury Note is currently trading at 2.6% (as of 7/7/14), still below the 3.0% level where it started the year. While sluggish economic growth and geopolitical risks could be keeping a ceiling on U.S. rates, technical factors are also to blame. The supply of Treasuries has been lower due to the decline in the budget deficit, and the Fed remains a large purchaser, even with tapering in effect. At the same time demand has increased from both institutions that need to rebalance back to fixed income after experiencing strong equity markets returns, and investors seeking relative value with extremely low interest rates in Japan and Europe.

With the decline in interest rates and investor risk appetite for credit still strong, the fixed income asset class has delivered solid returns so far this year. Both investment grade and high yield credit spreads continue to grind tighter. Emerging market bonds, both sovereign and corporate, have also experienced a nice rebound after a tough 2013. Municipal bonds benefited from a positive technical backdrop with strong demand for tax-free income being met with a lack of new issuance.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, with a number of factors supporting the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even with quantitative easing slated to end in the fall, U.S. short-term interest rates should remain near-zero until 2015 if inflation remains contained. The ECB and the Bank of Japan are continuing their monetary easing programs.
  • Global growth stable: We expect a rebound in U.S. growth in the second quarter after the polar vortex helped to contribute to a decline in economic output in the first quarter. 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 we have continued to add jobs. The unemployment rate has fallen to 6.1%.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. M&A deal activity has picked up this year. Corporate profits remain at high levels and margins have been resilient.
  • Less Drag from 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 in 2014, and the budget deficit has also declined significantly.

Risks facing the economy and markets remain, including:

  • Fed Tapering/Tightening: If the Fed continues at the current pace, quantitative easing will end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual and the economy appears to be on more solid footing this time. Should inflation pick up, market participants will shift quickly to concern over the timing of the Fed’s first interest rate hike. Despite the recent uptick in the CPI, the core Personal Consumption Expenditure Price Index (PCE), the Fed’s preferred inflation measure, is up only +1.5% over the last 12 months.
  • Election Year: While we noted there has been some progress in Washington, we could see market volatility pick up later this year in response to the mid-term elections.
  • Geopolitical Risks: The events surrounding Iraq, as well as Russia/Ukraine are further evidence that geopolitical risks cannot be ignored.

Risk assets should continue to perform if we experience the expected pickup in economic growth; however, we could see increased volatility and a shallow correction as markets digest the end of the Federal Reserve’s quantitative easing program. Economic data, especially inflation data, will be watched closely for signs that could lead the Fed to tighten monetary policy earlier than expected. Equity market valuations look elevated, but not overly rich relative to history, and maybe even reasonable when considering the level of interest rates and inflation. Investor sentiment remains overly optimistic, but the market trend remains positive. In addition, credit conditions still provide a positive backdrop for the markets.

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

Outlook

Favored Sub-Asset Classes

U.S. Equity

+

Large cap bias, dividend growers

Intl Equity

+

Emerging and Frontier markets, small cap

Fixed Income

-

Global high yield credit, short duration

Absolute Return

+

Closed-end funds, event driven

Real Assets

+/-

MLPs, natural resources equities

Private Equity

+

Diversified

 

Source: Brinker Capital

Brinker Capital, Inc., a Registered Investment Advisor. 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. 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. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

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