Investment Insights Podcast – Why So Shaky, Markets?

miller_podcast_graphicBill Miller, Chief Investment Officer

On this week’s podcast (recorded January 7, 2016), Bill lends some insight into why markets have started the year so volatile, and what that means for the long-term outlook.

Two themes are at the heart of the current market weakness: (1) Chinese government has meddled too much with its market and currency and (2) Central banks have kept interest rates too low for too long.

China

  • Stock prices are two to three times more expensive relative to Germany, U.S., Japan and others
  • China halted trading (twice) so investor’s couldn’t get to their investments, causing panicked behavior among investors
  • Officials manipulated down the value of the yuan in an effort to stimulate exports, creating more fear in investors
  • Things must be weak enough where officials think that they have to stimulate exports

Central Banks

  • Central banks around the world have kept interest rates near zero, but now that is shifting
  • U.S. has raised rates and there is talk of raising them again in 2016; but Europe and Japan remain at near-zero levels, creating a credibility issue
  • Investors now questioning why U.S. is going in one direction and Europe and Japan in another, and what that means to their investments

The combination of Chinese market manipulation and central bank credibility is surely causing fear, and perhaps some irrational investing, but it’s important to temper those voices. While the current volatility may take some time to pass, it feels more like a market correction and less of a large-scale economic issue.

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

It’s Official: China’s Currency Admitted to IMF Major Leagues

Stuart QuintStuart P. Quint, CFA, Senior Investment Manager & International Strategist

Here are the quick takes:

  • The IMF formally approved inclusion of the Chinese renminbi (RMB) into Special Drawing Rights (SDR)
  • Chinese RMB will not replace the U.S. dollar (USD) in the near term
  • Impact more symbolic near term, but progress will be measured over many years

The IMF formally indicated on November 30 it would include the Chinese RMB into its basket of approved reserve currencies. As stated in a previous blog, the inclusion of the RMB would appear to have limited near-term economic impact to the U.S. dollar.

Even with limited economic near-term impact, the inclusion of the RMB certainly has symbolic significance. Clearly, there is political benefit to the IMF’s recognition of the RMB in terms of enhancing China’s global prestige. The inclusion of the RMB might also serve as a carrot to deepen further structural reform as evidenced by China’s promise to have fully open capital accounts by 2020.[1]   Other countries hostile to the U.S., such as Russia and Iran, might view RMB investment as a way to hedge themselves against the risk of U.S.-led economic sanctions by conducting more trade away from the U.S. dollar.

However, the overall effects of the IMF SDR should not be overstated. The SDR is akin to a “recommended list” that cannot be enforced on central banks or markets. As an example, the weight of the USD was basically held flat at around 41%. (The new RMB weight was added at the expense mostly of the EUR). Furthermore, current holdings of central bank reserves deviate quite a bit from the SDR, with USD comprising 60% of total reserves (vs. 41% weight in the IMF SDR).[2] For comparison, central banks hold roughly 20% of reserves in EUR (vs. 31% weight in the IMF SDR). Some central banks hold currencies such as the Australian dollar (AUD) that are not in the IMF SDR.

Major potential shifts into the RMB will take place over a protracted period of years, but here are some milestones to watch:

  • Progress on further structural reform
  • Deeper liquidity in local Chinese bonds
  • Longer track record on responsible governance.

[1] http://www.bloomberg.com/news/articles/2015-10-22/china-said-to-weigh-pledge-for-opening-capital-account-by-2020-ig1sbvez .

[2] http://www.wsj.com/articles/proportion-of-euros-held-in-foreign-exchange-reserves-declines-1435686071

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.

China Currency Admitted to IMF Major Leagues: The End of U.S. Dollar Supremacy?

Stuart QuintStuart P. Quint, CFA, Senior Investment Manager & International Strategist

On November 13, the International Monetary Fund (IMF) gave a preliminary indication that it would include the Chinese currency, the RMB, for the first time in its basket of approved reserve currencies, or Special Drawing Rights (“SDRs”). Undoubtedly, China has gained international prestige due to its partial liberalization of its capital accounts as well as its position as the second largest economy in the world after the U.S.

Does this mean the end of the supremacy of the U.S. Dollar?

60% of reserves of foreign central banks are held in U.S. Dollars.[1] Chinese RMB comprise less than 1%. While foreign central banks are likely to accumulate more RMB over time, there remains some questions as to how quickly it could rise in the near term.

First, Chinese bond markets would need to develop deeper liquidity. In order to invest in a currency, central banks would demand liquid investments denominated in the currency. Today, the U.S. bond market is magnitudes deeper than that in China.[2]

Second, it’s not in China’s best interest to immediately go to fully-free capital accounts. Exports are in decline due in part to weak global demand. The last thing the Chinese government would want to do is to put further pressure on exporter margins with a strong currency buttressed by sudden foreign capital inflows. One case in point is the August devaluation of the Chinese RMB that spooked financial markets.

While China has made progress in financial reform—partial liberalization of interest rates and opening up access to its stock markets—China has not opened up its currency to full convertibility and free capital flows.

Furthermore, recent government intervention in the stock market and economy does not provide investors assurance on long-term governance. Neither the Chinese nor the IMF can simply legislate a track record of responsible governance overnight. Time and consistency are needed to win investor confidence.

[1] http://worldif.economist.com/article/6/what-if-the-yuan-competes-with-the-dollar-clash-of-the-currencies , accessed on November 13, 2015.

[2] See http://www.wsj.com/articles/why-investors-shy-away-from-chinas-6-4-trillion-bond-market-1437593482?alg=y , accessed on November 16, 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, a Registered Investment Advisor.

Investment Insights Podcast – November 6, 2015

miller_podcast_graphicBill Miller, Chief Investment Officer

On this week’s podcast (recorded November 5, 2015):

What we like: Clearer reasoning into why the economy was weak during summer months; inventories were too high, so businesses (smartly) quit building inventory allowing a drawdown; final demand for goods and services was positive; ultimately, slowdown seems temporary, lending itself to a positive outlook for fourth quarter; Central banks supporting economic growth via quantitative easing measures.

What we don’t like: Janet Yellen stated that she may in fact raise interest rates (by December); spooked the bond market as it seemed unlikely until 2016.

What we’re doing about it: Evaluating the soon-to-be-released employment report and its impact on Yellen’s potential decision.

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

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

Solomon-(2)Brad Solomon, Junior Investment Analyst

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

As policy rates hover near (or below) zero, the focus has been on the timing and magnitude of rate hikes by the Fed and other central banks. Don’t worry, I’m not here to add my speculative voice to that crowded discussion. Instead, I want to provide a quick ex-post assessment of another tool that has left the spotlight after being largely phased out by the Fed. I’m talking about quantitative easing (QE)—the buying of massive amounts of financial assets—or large-scale asset purchases (LSAPs) as they are termed by some economists.

At its core, QE attempts to influence the supply and demand for financial assets, thereby shifting preferences towards spending and investment and away from saving. (For those interested in getting further into the weeds on QE’s theoretical underpinnings, check out Ben Bernanke’s 2012 Jackson Hole speech, Jeremy Stein’s remarks that same year, or this release by the IMF.) Among the U.S., U.K., Japan, and the ECB, the scope of QE to date has amounted to around 10-20% of 2014 nominal GDP. To put that into perspective for the U.S.’s case, that is about the magnitude of U.S. total federal discretionary spending over the trailing four years.

Solomon_QE_1

So, with the Bank of Japan and ECB contemplating expanding quantitative easing at their upcoming meetings, does the existing research generally conclude that QE globally has been a few trillion dollars well spent? Let’s take a closer look.

LSAPs have seemed to benefit U.S. equities unequivocally well, and international equities less so. Evidence on financial system vitality is mixed.

The algebraic explanation is relatively straightforward: the yield on risk-free securities is an element of the discount rate used to value stocks and other assets. Artificially keeping this rate low, as well as creating expectations that it will stay that way, increases the discounted present value of other financial assets. However, only in the U.S. has the annualized return of that country’s respective MSCI index over the past five years exceeded the return required by a general equity risk premium of 5.57% (from Fama & French, 2002) and country risk premiums as computed by Aswatch Damodaran of NYU (2015).

Solomon_QE_2

Evidence on QE’s ability to reduce stress within the financial system is mixed. Event studies show that QE announcements were followed by sharp reductions in financial stress indicators, which consist of variables including the TED spread, corporate bond spreads, and beta of banking stocks. However, some studies on Japan’s experience with QE assert that it took a substantial amount of time for bank lending to improve, as banks were burdened by nonperforming loans and uneasiness towards extending credit.

Solomon_QE_3

Furthermore, QE may have also distorted asset prices (some have gone far enough to use the term bond bubble) while creating “price-insensitive buyers,” a term used by Ben Inker of GMO to describe an investor for whom the expected return on the asset does not dictate their decision to purchase.

Look for part two of this blog series later in the week.

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: An Update on The Current Market Environment

Magnotta-Audio-150x126Amy Magnotta, CFASenior Investment Manager, Brinker Capital

On this week’s podcast (recorded September 2), Amy takes the mic to provide an update on the current market environment and how the recent volatility can create opportunity. Highlights include:

  • S&P 500 finished month down 6%; international markets in worse shape
  • 12% correction from high reached in May
  • Still viewing the environment as a correction, not start of a bear market
  • Bear markets typically caused by recessions and tend to be preceded by central bank tightening or accelerating inflation—these conditions aren’t being met yet
  • U.S. growth still positive
  • If Fed begins to tighten in September, the pace will be measured as inflation is still below target
  • Looking for opportunities created by market volatility

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.

The Future of the Yuan and its Impact on the Dollar

Stuart QuintStuart P. Quint, CFA, Senior Investment Manager and International Strategist

The consideration of adding the yuan, or as others may refer to it more formally as renminbi (RMB), as the fifth member to the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) list has been debated for many years. However, while it is expected that China will eventually have its currency recognized by the (IMF), the question is timing of this conversion.

The recent crash of China’s stock market, combined with strong state intervention of measures that go against the grain of market liberalization, has the potential to delay acceptance of the yuan. That’s not to say that the central bank won’t want to proceed as proposed, but competing forces might gain strength in calling for a go-slow approach in making the decision.

In the near term, the adoption of the yuan would likely prompt U.S. dollar selling. China is experiencing weaker growth, and monetary policy is easing while the U.S. is stable to getting tighter. The appetite of central banks to dump dollars in favor of yuan will take time. However, over the long term, the yuan could be the major competing currency to the U.S. dollar–if China can conduct further structural reform that restores confidence in more sustainable growth.

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, a Registered Investment Advisor.

Monthly Market and Economic Outlook: April 2015

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After 2014 was dominated by the strong performance of the narrow S&P 500 Index, the first quarter of 2015 showed better results for diversified portfolios and higher levels of volatility across and within asset classes—both positive developments for active management.

The focus remained on the Federal Reserve and the timing of the initial interest rate hike despite U.S. economic data coming in below expectations. The S&P 500 gained just 1% for the quarter, while mid caps and small caps fared better, gaining 4%. Growth outperformed value across all market caps, and high-dividend-paying stocks lagged amid concern of higher interest rates. The strong dollar also hurt U.S. multinationals as a high percentage of their profits are derived from overseas. Despite a strong February, commodity prices fell again in March and were the worst performing asset class for the quarter.

shutterstock_28211977While the anticipation of tighter monetary policy may have weighed on U.S. equity markets in the first quarter, looser monetary policy helped to boost asset prices in international developed markets. The MSCI EAFE Index surged 11% in local terms, but the stronger dollar dampened returns in U.S. dollar terms to 5%, still 400 basis points ahead of the S&P 500 Index. The euro fell -11% versus the dollar, the largest quarterly decline since its inception in 1999. Japan also benefited from central bank policy, gaining 10%.

Emerging market equities outpaced U.S. equities for the quarter, gaining 2.3%; however, dispersion was quite wide. All emerging regions delivered positive returns in local currency terms, although weaker currencies in Latin America had a significant impact for U.S. investors. For example, Brazil’s equity market gained 3% in local terms, but fell -15% in U.S. dollar terms. China and India posted solid gains of 5-6% for the quarter.

The 10-year U.S. Treasury yield bounced around in the first quarter, first declining 49 basis points in January, then climbing 56 basis points in February before declining again to end the first quarter at a level of 1.94%, 23 basis points lower than where it started. The Barclays Aggregate Index outperformed the S&P 500 Index for the quarter, with all sectors in positive territory. Credit spreads tightened modestly during the quarter and the high-yield sector outperformed investment grade. Municipal bonds were slightly behind taxable bonds as the market had to digest additional supply.

Our outlook remains biased in favor of the positives but recognizes that risks remain. We feel we have entered the second half of the business cycle and 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: U.S. economic growth remains solidly in positive territory and the labor market has markedly improved.
  • 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 through capex, hiring and M&A. Earnings growth outside of the energy sector is 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 initial 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. 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.
  • Geopolitical risks: Issues in the Middle East, Greece 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 normalize, but remain range-bound, and 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.

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.

Asset Class Outlook Comments
U.S. Equity + Quality bias
Intl Equity + Neutral vs. U.S.
Fixed Income +/- HY favorable after ST dislocation
Absolute Return + Benefit from higher volatility
Real Assets +/- Oil stabilizes; interest rate sensitivity
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.

International Insights Podcast – Implications of Major Central Bank Moves in Switzerland and India

Stuart Quint, Investment Insights PodcastStuart P. Quint, CFA, Senior Investment Manager and International Strategist

This audio podcast was recorded January 15, 2015:

Stuart’s International Insights Podcast focuses on small markets potentially creating big implications for global markets.

Highlights of the discussion include:

Switzerland:

  • Central bank cut interest rates and removed the link of the Swiss franc to the euro
  • Background discussion and what it means for global currencies
  • Losers: carry trades, mortgage holders in Eastern Europe, Austrian banks

India:

  • Central bank cut interest rates modestly, but still sent a major global signal
  • Falling inflation and government reform both key for future cuts
  • Major emerging market able to stimulate growth while others are doing the opposite

Click here to listen to the full 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. Brinker Capital, a Registered Investment Advisor.

 

International Insights Podcast – Greek Tragedy Revisited

Stuart Quint, Investment Insights PodcastStuart P. Quint, CFA, Senior Investment Manager and International Strategist

This audio podcast was recorded December 30, 2014:

Stuart’s International Insights Podcast focuses on Greece.

Three-point summary:

  1. Greece has reemerged in world headlines, although it might be more bark than bite (but with risks to the downside for Europe). Important to keep an eye on general elections in Spain later in 2015.
  2. Greek government collapsed as they failed to elect a new president by December 29. General elections set for January 25. Anti-austerity party leads polls, but markets seem to mostly understand current issues and that debt is held mainly by multilateral institutions–not private banks.
  3. Impact on Europe is small and does not hurt prospects for full-blown QE. However, Greece highlights the toll that comes with a lack of structural reform (and divided popular support) on sagging growth prospects in the EU.

Click here to listen to the full 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. Brinker Capital, a Registered Investment Advisor.