March 2016 Monthly Market And Economic Outlook

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

February was a fragmented month. Equity markets were down mid- to high-single-digits for the first half of the month but rebounded off the February 11 bottom to end the month relatively flat. While fears of slower growth in U.S. and China as well as volatile oil prices continued to serve as negative catalysts to equity markets in the beginning of the month, positive reports of strong consumer spending and  employment as well as signs of stabilization in oil prices helped dissipate fears. In response, the market rallied during the second half of the month, finishing in neutral territory.

The S&P 500 Index ended slightly negative with a return of -0.1% for February. Sector performance was mixed with more defensive sectors – telecom, utilities and consumer staples – posting positive returns. Underperformance of health care and technology sectors caused growth to lag value for the month. Small caps continued to lag large caps, and micro caps had a particularly challenging month, underperforming all market caps.

International equity markets lagged U.S. markets in both local and in U.S. dollar terms for the month. Weak economic data coupled with concerns over the effectiveness of monetary policy response in both Europe and Japan caused investor confidence to drop, negatively impacting developed international markets. Emerging markets were relatively flat on the month, remaining ahead of developed international markets as these export heavy countries benefited from more stable currencies and an upturn in oil prices.

U.S. Treasury yields continued to fall in the beginning of the month, bottoming at 1.66%, before bouncing back to end the month at 1.74% as equities rebounded. The yield curve marginally flattened during the month. All investment grade sectors were positive for the month and municipal bonds also posted a small gain. High yield credit gained 0.6% as spreads contracted 113 basis points after reaching a high of 839 basis points on February 11th. We remain positive on this asset class due to the underlying fundamentals and attractive absolute yields.

We remain positive on risk assets over the intermediate-term as we believe we remain in a correction period rather than the start of a bear market. The worst equity market declines are typically associated with recessions, which are preceded by aggressive central bank tightening or accelerating inflation, factors we do not believe are present today. 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, and, while a recession 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 accommodation: Despite the Federal Reserve beginning to normalize monetary policy with a first rate hike in December, their approach should be patient and data dependent.  More signs point to the Fed delaying the next rate hike in March. The Bank of Japan and the ECB have been more aggressive with easing measures in an attempt to support their economies, and China is likely going to require additional support.
  • U.S. growth stable and inflation tame: U.S. economic growth has been modest but steady. GDP estimates are running at 2.2% for the first quarter (Source: Federal Reserve Bank of Atlanta). Payroll employment growth has been solid and the unemployment rate has fallen to 4.9%. 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.
  • Washington: The new budget fiscal policy is poised to become modestly accommodative, helping offset more restrictive monetary policy.vola

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 remain wide, and weakness is widespread.
  • Another downturn in commodity prices: Oil prices have rebounded off of the recent lows; however, another significant leg down in prices could become destabilizing.

On the balance, the technical backdrop of the market remains on the weaker side, but valuations are at more neutral levels. We expect a higher level of volatility as markets digest the Fed’s actions and assess the impact of slower global growth; however, our view on risk assets tilts positive over the near term. Higher volatility has led to attractive pockets of opportunity that as active managers we can take advantage of.

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.

60% of the Time, It Works Every Time

Solomon-(2)Brad Solomon, Junior Investment Analyst

“Bonds Show 60% Odds of Recession.”

It was a bold, slightly jarring headline to an article I happened across one recent morning. I had done a solid minute of skimming before I scrolled back to the top and noticed the published date—October 22, 2011.  If the models cited in the article had bet their chips on red, so to say, then the U.S. economy continued to hit black for some time.  Over the next four years, the domestic unemployment rate nearly halved while the S&P 500 returned a cumulative 84%.  Say what you want about much of that return being multiple expansion (84% total return on cumulative earnings per share growth of 16%)—it would’ve been a tough four years for investors to sit on the sidelines.

I’m writing this from an investment perspective rather than an academic one, but it is still a preoccupation for both fields to monitor to the economy.  Why?—because, as quantified by Evercore ISI, S&P 500 bear markets have been more severe (-30%) when they predate what actually morphs into an economic recession versus times when dire signs of economic stress do not ultimately turn up (-15%).

The world is once again on “recession watch” in 2016; signs of financial strain include the offshore weakening of China’s yuan, widening credit spreads, an apparent peak in blue chip earnings per share, and spiking European bank credit default swaps (CDSs).  One telling recession indicator, yield curve inversion, has seemingly not reared its head.  As measured through the difference between 10-year and 3-month Treasury yields, the spread today stands around 150 basis points, while it has fallen like clockwork to zero or below prior to each U.S. recession since 1956. (Recessions are indicated by the shaded grey areas below, as defined by the NBER.)

Source: The Federal Reserve, Brinker Capital

Source: The Federal Reserve, Brinker Capital

A number of commentators have raised concerns that the statistics above should not warrant an “all clear” sense of thinking there won’t be a recession.  In full awareness of the folly of claiming that “this time is different”—well, this time may be different.  Breaking down the term spread into its two components—the yield on a shorter-dated bill and longer-dated bond—the short rates have been artificially held down by a zero-bound federal funds rate for the past six years, while the feature of positive convexity that is inherently more pronounced for long rates means that it is, in theory, very tough to close the gap” on the remaining 150 basis point spread that would indicate an inverted yield curve mathematically.  (A convexity illustration is shown below—the takeaway is that the yield-price relationship becomes asymptotic at high prices, meaning that the 10-year note would need to be exorbitantly bid up to bring its yield down to equate with much shorter maturities.)

Source: Brinker Capital

Source: Brinker Capital

So, what are the odds of a recession?  If it’s not clear yet, I’m not writing this to assign a current probability but rather to warn against viewing such a figure in isolation.  Following the logic illustrated in papers such as this one, statistical programs make it possible to truly fine-tune a model: plug in any number of explanatory vectors (time series variables such as industrial production or unemployment claims) and “fit” the historical data to the response variable, which is essentially a switch that is “on” during a recession” and “off” when not.  But as calibrated as the model becomes, there is still subjectivity involved: what is the proper “trigger” for alarm?  Should your reaction to a 70% implied probability be different from your reaction to a 60% reading?  An important consideration is the objective behind such a model in the first place—to create a continuous distribution (infinite number) of outcomes and assign a probability to a discrete event (red or black, recession or no recession).  When framed this way, often it is the unquantifiable, intangible narratives and examination of what’s different this time (rather than what looks “the same”) that can create a fuller picture.

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.

Has Quantitative Easing Worked? A Two-Part Blog Series Perspective (Part II)

Solomon-(2)Brad Solomon, Junior Investment Analyst

Part two in a two-part blog series discussing quantitative easing measures on a domestic and global scale. Part one published last week.

Transmission to Main Street has been dubious.

The Fed’s FRB/US model, which is the workhorse behind quantifying QE’s transmission mechanisms into the general economy, forecasted a 0.2 percentage-point drop in unemployment over a 2-year time horizon as a result of a $500 billion LSAP, according to then-Fed governor Stein in 2012. Given that the cumulative scale of QE in the U.S. totaled around $4 trillion over about 4.4 years, excluding intermittent periods between buying sprees, the FRB/US model would then forecast a reduction in unemployment of 1.6 percentage points. (This assumes that there are no marginally diminishing returns to QE dollars.) Building in a “lag” of six months, the actual U.S. unemployment rate fell by 4.0 percentage points during this period and currently hovers near 5%, right above what is often pegged as the natural rate of unemployment. To what extent that reduction is due to QE, though, is very difficult to answer—there is no “control subject” in real-world experiments. The next-best-option is the event study that looks at variables prior to and following some stimulus, although this risks blending the effect with some other variable. While unemployment has fallen near its natural rate, anecdotal evidence speaks to widespread underemployment

Other metrics look either ambiguous or decidedly impressive. Across the U.S., U.K., Eurozone, and Japan, industrial production growth has been significantly more volatile than it was pre-recession; unemployment has fallen, with exception of the Eurozone where it has marched further upward after a double-dip recession in 2013; household saving as a percent of disposable income has come down substantially. Lack of healthy inflation has proven to be the fly in the ointment. Nearly 30 countries have explicitly adopted inflation targeting (around half of those in the last 15 years), but the majority continue to be plagued by nagging disinflation or outright deflation. Consider the poster child Japan who pioneered QE over the 2001-2006 period in its commitment to purchase $3-6 trillion in Japanese government bonds (JGBs) per month until core CPI became “stably above zero.” While the Bank of Japan wrapped up with the program in March 2006 after witnessing year-over-year core CPI in Japan clock in just above zero for three consecutive months, this was more of a mathematical win. Headline inflation over the period picked up solely due to a rapid rise in the price of crude oil, which arguably has little connection to monetary policy. This is not to say that some commentators have not already called for an indefinite deflationary environment, or that QE’s effects on the money supply don’t appear ambiguous.

Getting back to using the U.S. as an example, income growth has not followed the drop in unemployment, and inequality has persisted. Annualized growth rates since 2010 have been near zero and well below their long-term averages, and the lack of growth is particularly pronounced in the lower income quintiles.

Solomon_QE_4

On another front, record-low mortgage rates are undoubtedly a product of QE but have not translated into pre-2008 home buying, even in the presence of rising FICO scores and real home prices that are hovering around their 10-year trailing average. In fairness to QE, though, there simply seems to be a lack of a relationship between the cost of borrowing money to buy a home, and the demand for borrowing that money, as evidenced by the chart below.

Solomon_QE_5

QE’s efficacy seems to have varied case-by-case, and there is a growing consensus that there are diminishing marginal returns to QE.

Of this last point, Japan and the ECB should take note. While the Bank of Japan refrained from expanding its QE program at its meeting this past Friday above the current $670 billion p.a. rate, such expansion remains on the table for its November and December meetings. A similar decision faces the ECB in December, and the rhetoric of ECB President Mario Draghi has been mostly dovish in tone. (The annual rate of asset purchases by the ECB currently stands at about $816 billion.) While both banks will ultimately adhere to their mandates in trying to combat deflation and negative export growth, perhaps expectations should be set low for how effective further QE will be in meeting those mandates.

Proponents of real business cycle theory would not be surprised at much of the above—that is, that aggressive monetary policy has failed to override a general shift in appetites for home-buying, tepid supply-glut disinflation, reduced appetite by banks to lend, and the preference by businesses towards doing nothing productive with bond issuance besides repurchasing their own equity. These “exogenous” factors may overpower the stimulatory nature of QE, or the problem may be one of model specification. (Getting back to the home sales/mortgage rate example, QE may do its job of lowering borrowing rates, but this may not ultimately stoke home-buying appetites, which is a failure of the assumed indirect transmission mechanism that underlies QE’s founding.) Whatever the case, while it has helped solve short-run liquidity problems by injecting cash into the financial system, QE has proven sub-optimal in terms of being a cure-all to the woe of general economic lethargy.

Further reading

  1. Fawley, Brett & Christopher Neely. “Four Stories of Quantitative Easing.” (2013)
  2. Krishnamurthy, Arvind & Annette Vissing-Jorgensen. “The Ins and Outs of LSAPs.” (2013)
  3. Klyuev, Vladimir et. al. “Unconventional Choices for Unconventional Times.” (2009)
  4. McTeer, Robert. “Why Quantitative Easing May Not Work the Same Way in Europe as in the U.S.” (2015)
  5. Raab, Carolin et. al. “Large-Scale Asset Purchases by Central Banks II: Empirical Evidence.” (2015)
  6. Schuman, Michael. “Does QE Work? Ask Japan.” (2010)
  7. Stein, Jeremy. “Evaluating Large-Scale Asset Purchases.” (2012)
  8. Williams, John. “Monetary Policy at the Zero Lower Bound.” (2014)
  9. Williamson, Stephen D. “Current Federal Reserve Policy Under the Lens of Economic History.” (2015)
  10. Yardeni, Edward & Mali Quintana. “Global Economic Briefing: Central Bank Balance Sheets.” (2015)

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.

Monthly Market And Economic Outlook: September 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Global growth concerns, specifically the impact of a slowdown in China, and the anticipation of Fed tightening beginning in the fall prompted a spike in volatility and a sell-off in risk assets in August. The decline occurred despite decent U.S. economic data. U.S. equity markets held up slightly better than the rest of the developed world while emerging markets fared worse. U.S. Treasury yields were unchanged on the month, but credit spreads widened in response to the risk-off environment. Crude oil prices hit another low in late August, also weighing on global equity and credit markets.

The S&P 500 Index ended the month down -6%, but experienced a peak to trough decline of -12%. Prior to that it had been more than 900 trading days since we last experienced a 10% correction. All sectors were negative on the month, with healthcare and consumer discretionary, which had been leading, experiencing the largest declines. Small caps experienced a -6% decline as well, while mid caps held up slightly better. Growth meaningfully lagged value in small caps, but style performance was less differentiated in the large cap space.

International developed equity markets lagged U.S. markets in August, despite a slightly weaker U.S. dollar. Japan edged out European markets. After leading through the first seven months of the year, international developed equity markets are now behind the S&P 500 U.S. equity markets year to date. Emerging market equities have experienced a steep decline, down more than -15% so far in the third quarter, amid the volatility in China and continued economic woes in Brazil and broad currency weakness.

August wasn’t a typical risk-off period as longer-term U.S. Treasury yields were unchanged on the month and yields on the short end of the curve rose slightly. The Barclays Aggregate Index declined -0.14% in August. Treasuries and mortgage-backed securities were flat for the month, but spread widening in both investment grade and high yield led to negative returns for corporate credit, with lower quality credits experiencing the largest declines. Municipal bonds were slightly ahead of taxable bonds in August and lead year to date.

Our outlook remains biased in favor of the positives, but recognizing risks remain. The global macro backdrop keeps us positive on risk assets over the intermediate-term, even as we move through the second half of the business cycle. 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, 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: U.S. GDP growth rebounded in the second quarter and consensus expectations are for 2.5% growth moving forward. Employment growth is solid, with an average monthly gain of 243,000 jobs during the past year. While wages are showing beginning 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. However, weakness due to low commodity prices could begin to spread to sectors.
  • 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.

However, risks facing the economy and markets remain:

  • Fed tightening: The Fed has set the stage to commence rate hikes in the coming months. 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. A significant slowdown in China is a concern, along with slower growth in other emerging economics like Brazil.
  • Geopolitical risks could cause short-term volatility.

While the recent equity market drop is cause for concern, we view the move as more of a correction than the start of a bear market. The worst equity market declines are associated with recessions, which are preceded by substantial central bank tightening or accelerating inflation. As described above, we don’t see these conditions being met yet today. The trend of the macro data in the U.S. is still positive, and a significant slowdown in China, which will certainly weigh on global growth, is not likely enough to tip the U.S. economy into contraction. Even if the Fed begins tightening monetary policy in September, the pace will be measured as inflation is still below target. However, we would not be surprised if market volatility remains elevated and we re-tested the August 25 low as history provides many examples of that occurrence. Good retests of the bottom tend to occur with less emotion and less volume as the weak buyers have already been washed out.

As a result of this view that we’re still in a correction period and not a bear market, we are seeking out opportunities created by the increased volatility. We expect volatility to remain elevated as investors position for an environment without Fed liquidity. However, such an environment creates greater dislocations across and within asset classes that 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.

 

Investment Insights Podcast – August 21, 2015

miller_podcast_graphicBill Miller, Chief Investment Officer

On this week’s podcast, we focus on two important areas of the economy as noted by Economist Don Rissmiller (recorded August 19, 2015):

 

  • Employment:
    • Labor Force Participation Rate (LFPR) often used as a technicality with good or bad unemployment rates
    • However, there’s nothing actually nefarious about the number and (because it is falling) is more a function of baby boomers aging
    • Despite falling, the LFPR does not diminish the success we’re seeing in getting people back to work
  • Interest Rates
    • Fed has interest rates at 0%, so may see a gradual increase up to somewhere around 2%
    • If interest rates do in fact rise, it would behoove the Fed to have them match the inflation rate as to not damage the economy

Overall, the economy feels mid-cycle, people are going back to work, and appear to be in a position to handle slightly higher interest rates.

Click here to listen to the 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.

 

Investment Insights Podcast – March 12, 2015

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded March 9, 2015):

What we like: Global economic growth; Europe QE policy under way

What we don’t like: Valuations have moved higher; interest rates may be moving up; size of stock market compared to the economy at a high level

What we’re doing about it: Taking a little risk off the table; intermediate and long-term outlook is good for economy and stock markets; keeping an eye out for currency weakness in emerging markets

Click here to listen to the 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.

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.

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Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class Returns:12.13.13_Magnotta_MarketOutlook

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.”

Market Commentary: Liquidity

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The powerful figure of the Federal Reserve Bank of the United States (Fed) continues to hold sway over the global landscape, as the collective eyes of investors around the world watch intently for any discernible hint of a shift in policy, which when detected, has radiated across the marketplace. During the course of the past five weeks, the American Central Bank has launched a veritable public relations barrage in an effort to stave off the steep sell-off in risk assets that accompanied comments issued by Chairman Ben Bernanke following the conclusion of a meeting of the Federal Open Market Committee on June 19.  During the ensuing press conference, Mr. Bernanke suggested that if the economic data from the U.S. continued in its current pattern of improvement, the time may be near for a measure of the support the Fed has provided to the U.S. economy. namely the $85 billion per month of asset purchases currently being made, to be curtailed.

7.26.13_Preisser_Liquidity_2Market participants reacted to the Chairman’s comments by throwing what has been called the “taper tantrum”(Bloomberg News), which culminated in a 4.8% decline in the Standard & Poor’s 500 over the course of five trading days, and a .35% rise in yields on the 10-year U.S. Treasury note during the same time frame.  The Central Bank’s officials, and especially the Chairman himself, have proven themselves particularly deft at quelling the market’s concerns in the day’s since, and in so doing have provided a catalyst that has sent stocks rallying around the world, and those listed in the United States to record highs. The volatility witnessed over recent weeks highlights the market’s continued dependence on the liquidity provided by the Fed, and further illustrates the difficulties surrounding its eventual removal, which may begin as early as September.

Reassurances from Fed officials—that the Central Bank remains committed to the continuity of its current accommodative stance for the foreseeable future—poured forth into the mainstream media as the selling pressure built within the marketplace. Beginning on June 25, the President of the Federal Reserve Bank of Dallas, Richard Fischer, and Minneapolis Fed President, Narayana Kocherlakota both issued comments designed to emphasize the fact that the Central Bank would keep in place its support of the economic recovery in the U.S. Mr. Kocherlakota was quoted by Bloomberg News on the 25th as saying, “The committee should continue to buy assets at least until the unemployment rate has fallen below 7 percent.  The purchases should continue as long as the medium-term outlook for the inflation rate remains below 2.5 percent and longer-term inflation expectations remain well anchored.” What have been categorized as unusually direct statements, of these two, non-voting members of the Committee (Bloomberg News), served to soothe concerns among investors, and were followed in short order by those of Richmond Fed President, Jeffery Lacker, who helped to further assuage any lingering uncertainty.  Mr. Lacker reiterated the fact that continued, substantive labor market improvement was necessary for the tapering of asset purchases to commence, and noted his confidence that deflation was not an issue (Bloomberg News), which helped to accelerate the rebound in risk assets.

7.26.13_Preisser_Liquidity_3The highly anticipated release of the June employment report was well received by the market. Although it revealed the creation of 195,000 jobs within the United States, which exceed the consensus estimate of 165,000 (New York Times), it fell short of the whisper number of 200,000 that had circulated, and the unemployment rate remained stagnant at 7.6%. The report buoyed the belief that the Fed would need to maintain its current pace of asset purchases for a longer period of time than many had feared as the pace of job creation, although improving, does not warrant tapering.  Jan Hatzius, the chief economist at Goldman Sachs, was quoted in the New York Times on July 5—“Beyond the headline numbers for job growth, it gets a little more mixed. There is still a lot of slack in the labor market.”

Stocks received a further lift from Chairman Bernanke who, in answering audience questions following a speech he delivered at the National Bureau of Economic Research conference on July 10, made an effort to stress the fact that the Central Bank remained committed to furthering the economic recovery.  Mr. Bernanke was quoted by the Wall Street Journal—“There is some perspective, gradual and possible change in the mix of instruments.  But that shouldn’t be confused with the overall thrust of policy, which is highly accommodative.” The Chairman once again reiterated this pledge in testimony before Congress on July 17—“Our intention is to keep monetary policy highly accommodative for the foreseeable future, and the reason that’s necessary is because inflation is below our target and unemployment is still quite high” (New York Times). These statements served to further the belief that has come to be known as the, Bernanke Put for the Chairman’s willingness to intercede when financial market’s struggle, which has been perceived to offer protection to investors, remains in place and provided further support to risk assets.

7.26.13_Preisser_Liquidity

Although benchmark indices in the United States have risen to record levels, a measure of uncertainty lingers beneath the surface as the inevitability of the scaling back of the Fed’s asset purchases remains, along with the question of who will succeed Mr. Bernanke as the next Chairman of the American Central Bank.  Despite no official word having been offered that his tenure atop the Federal Reserve will come to an end in January, this is widely considered to be the case.

Speculation as to who will replace Mr. Bernanke has risen to the fore with the two perceived leading candidates appearing to be the Fed’s current No. 2, Janet Yellen, and former Treasury Secretary, Larry Summers. According to the Wall Street Journal—“The race to become the next leader of the Federal Reserve looks increasingly like a contest between two economists: Lawrence Summers and Janet Yellen.”  In addition to the questions surrounding the identity of the next head of the Central Bank, a recent poll of economists, conducted by Bloomberg News, revealed the belief among a majority of those queried that the Federal Reserve would in fact begin tapering in September. With summer’s effusive glow illuminating Wall Street and the record gains of its equity markets, the cool winds of fall hold within them the possibility of bringing the unwelcome specter of volatility as these issues seek resolution.