Amy Magnotta, CFA, Senior Investment Manager, Brinker Capital
Global equity markets delivered solid gains in February, helped by a stabilization in crude oil prices, signs of better economic growth in Europe, and a short-term resolution in Greece. It was a “risk-on” environment for U.S. equities, with the S&P 500 gaining 5.8%, despite more mixed economic data. Cyclical sectors, like consumer discretionary and information technology, posted gains of more than 8%, while the more defensive utilities sector fell more than -6% during the month. In the U.S. growth outpaced value, but there was little differentiation by size.
International developed equities were slightly ahead of U.S. equities in February despite continued U.S. dollar strength. European equities in particular exhibited strength ahead of the ECB’s quantitative easing program. Emerging market equities had positive returns in February, but lagged developed markets. Brazil, India and China were all relatively weak, while emerging European equities fared the best. A ceasefire agreement with Ukraine, as well as the stabilization in oil prices, helped boost Russia’s currency and their equity markets, which gained more than 22% in USD terms.
U.S. Treasury yields rose in February, with the yield on the 10-year Treasury note climbing 32 basis points to 2.0%. In her comments to Congress, Fed Chair Yellen laid the groundwork for the Fed’s first rate hike this year, which could come as early as June. All sectors in the Barclays Aggregate were negative in February, with Treasuries experiencing the largest decline. High yield credit spreads tightened meaningfully during the month and high yield bonds gained more than 2%. Municipal bonds were slightly behind taxable bonds for the month.
Our outlook remains biased in favor of the positives, while paying close attention to the risks. We feel we have entered the second half of the business cycle, but remain optimistic regarding the global macro backdrop and 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 Federal Reserve heading toward monetary policy normalization, the ECB and the Bank of Japan have both executed bold easing measures in an attempt to support their economies.
- U.S. growth stable: Economic growth has improved over the last few quarters. A combination of strengthening labor markets and lower oil prices are likely to provide the stimulus for stronger-than expected economic growth in the near-term.
- Inflation tame: Reported inflation measures and inflation expectations in the U.S. remain below the Fed’s 2% target.
- U.S. companies remain in solid shape: U.S. companies have solid balance sheets are beginning to put cash to work. Earnings growth has been decent 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:
- Timing/impact of 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: While growth in the U.S. is solid, growth outside the U.S. is decidedly weaker. The Eurozone is flirting with recession and Japan is struggling to create real growth. Growth in emerging economies has slowed as well.
- Geopolitical risks: Issues in Greece, the Middle East and Russia, could cause short-term volatility.
- Significantly lower oil prices destabilizes global economy: While lower oil prices benefit consumers, should oil prices re-test their recent lows and remain there for a significant period, it would be a negative not only for the earnings of energy companies, but also for oil dependent emerging economies and the shale revolution in the U.S.
While valuations have moved above long-term averages and investor sentiment is neutral, the trend is still positive and the macro backdrop leans favorable, so we remain positive on equities. The ECB’s actions, combined with signs of economic improvement, have us more positive in the short-term regarding international developed equities, but we need to see follow-through with structural reforms. We expect U.S. interest rates to remain range-bound, but the yield curve to flatten. Fed policy will drive short-term rates higher, but long-term yields should be held down by demand for long duration safe assets and relative value versus other developed sovereign bonds.
However, 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 market volatility. This volatility should lead to more opportunity for active management across 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.
||HY favorable after ST dislocation
||Benefit from higher volatility
||Oil stabilizes; interest rate sensitivity
||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.