Amy Magnotta, CFA, Senior Investment Manager, Brinker Capital
Developed equity markets rebounded in July amid easing of the debt crisis in Greece and improving U.S. economic data. However, concerns over a slowdown in China, renewed weakness in Brazil and a further sell‐off in commodity prices weighed on emerging market equities. Fixed income was the beneficiary of a flight to quality, with sovereign yields moving lower and the asset class delivering positive returns. The exception being high yield as credit spreads moved wider during the month. The default by Puerto Rico does not appear to have caused a broader sell‐off in the municipal bond market.
Year to date U.S. equity returns have been muted overall, but we have seen significant dispersion by style as growth has significantly outpaced value across market capitalizations. From a sector perspective, healthcare and consumer discretionary have led while energy, utilities and materials have lagged. U.S. equity markets have lagged developed international equity markets, despite continued strength in the U.S. dollar. Year to date the MSCI EAFE Index has gained more than 8%, boosted by strong gains in Japan and areas within the Eurozone. However, emerging market equities have posted broad‐based losses so far this year. The wider dispersion across and within asset classes has provided more attractive opportunities for active management.
Solid performance in July moved the fixed income asset class back into positive territory for the year to date period. All sectors with the exception of investment grade credit are in positive territory. The higher coupon has given high yield an edge year to date despite wider spreads. After a solid month, municipal bonds have pulled in line with taxable bonds year to date. With the expectation that the Fed will raise short‐term rates this year, our portfolios continue to be positioned in defense of rising interest rates, with a shorter duration and a yield advantage versus the broader market.
Our outlook remains biased in favor of the positives, but recognizing risks remain. We’ve entered 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 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 the labor market continues to show steady improvement. The slower recovery we’ve experienced following the financial crisis may lead to a longer period of expansion than in previous cycles. 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. Global M&A activity is up 41% from a year ago (Source: Thomson Reuters). 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 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. 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.
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. Concerns surrounding the risks outlined above could lead to a pull‐back in the markets; 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.
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.