Drivers of recent market volatility

Holland_F_150x150Tim Holland, CFA,
Senior Vice President, Global Investment Strategist

 

Throughout 2018, Brinker Capital has been optimistic about both the US economy and US stocks, however, recent market weakness and volatility beg two questions:

  • Is Brinker Capital still optimistic on the US economy and US equities?
  • If so, why?

To answer both questions, we remain optimistic on the US economy and markets into 2019. We are overweight US and emerging market equities and conservatively positioned within fixed income, as we continue to see interest rates biased higher. Additionally, we remain optimistic as the fundamental data continue to point us in that direction.

More specifically,

  • The US economy should grow north of 3% in 2018 and about 2.5% in 2019.  We see very little risk of a recession in the new year.
  • US corporate profits should grow north of 20% in 2018 and mid to high single digits in 2019.  Continued growth in earnings is important for a few reasons, including the fact that we haven’t had an economic recession without an earnings recession (e.g. when US corporate profits decline year-on-year) and that as earnings move higher and the market trades down, stocks become more attractively valued.
  • None of the classic indicators of a recession, including an inverted yield curve, restrictive monetary policy, or a rolling over of leading economic indicators are present today.  In fact, one could argue that the US economy is doing exceptionally well, with unemployment below 4%, GDP growth above 3% and inflation anchored near 2%. Also, the recent dramatic drop in the price of oil will translate into lower prices at the pump for US drivers, a powerful economic tailwind when considering our economy is 70% consumer driven.
  • Pivoting back to the US equities, not only is the market attractively valued at below 14x forward earnings, 2018 should see US companies pay a record amount of dividends and buy in a record amount of their own shares. Both are important pillars of support for stocks.
  • Many measures of Investor Sentiment are at or close to all-time high levels of pessimism. This indicated that many investors have capitulated and return expectations moving forward are very low. In this environment, news that is even incrementally positive can have a substantial upside impact on markets.

So, if the fundamental data is so robust, why has the market been so volatile and biased lower? We would point to two primary concerns. First, the US Federal Reserve (Fed) is pushing interest rates too high too quickly, which will ultimately lead to a slowing of corporate and consumer spending and a recession. Second, the US and China won’t be able to resolve their differences on trade, with escalating tariffs ultimately pushing the Chinese economy into a recession, which will pull down global growth and possibly cause a recession here at home.

We believe both risks are real and meaningful, however, we also continue to believe that the Fed will move quite slowly on interest rates next year and that cooler heads will prevail on trade.  In fact, the Fed has made it quite clear they will be data dependent when it comes to interest rate policy in 2019 and the US and China recently agreed not to impose any additional tariffs during a 90-day negotiating period.  We expect good news on the trade front sooner rather than later.

Market drawdowns are never pleasant, but they do happen.  And when markets sell off it is important to keep one’s focus on the fundamentals and away from the media’s bias toward fear-mongering and frightening headlines.  Today, the fundamental underpinnings of both the economy and market remain robust and as a result, we remain optimistic on both into 2019.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Thoughts on the Federal Reserve Open Market Committee meeting and interest rates

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Tim Holland, CFA,
Senior Vice President, Global Investment Strategist

 

  • As expected, the FOMC raised the Fed Funds rate to a target range of 2.25% to 2.50%.
  • The question for many is given markets had effectively “priced in” or were largely expecting the rate increase, why did equities sell off sharply and bonds rally strongly on yesterday’s Fed Funds news?
  • We – and many market participants – expected the Fed’s post meeting statement and Chairman’s Powell press conference to strike a much more dovish tone over the outlook for interest rate policy into 2019.  We think the Fed fell short on both fronts.
  • The Fed now expects two (instead of three) rate increases next year and also lowered their estimate for GDP growth in 2019 and their estimate of the long-term neutral interest rate (the Fed Funds rate that neither hinders nor helps economic growth).
  • However, we believe the Fed did not adequately recognize the impact recent market volatility, slowing economic growth outside the US and the ongoing US / China trade dust up is likely having on corporate sentiment and spending, and how a weakening of both could ultimately cause the US economy to stall and potentially slide into recession.
  • We see two primary risks for the markets and the economy into the new year – 1) a monetary policy mistake (the Fed going too far, too fast) and 2) a trade policy mistake (the US / China trade dynamic worsening).  After today, we have not yet “solved for” monetary policy risk, which means investors will likely be looking even more intently for good news on the trade front.  We are optimistic that it is coming. In the meantime, the risk posed by monetary policy to the economy and markets has increased.
  • Finally, the next Fed meeting isn’t until January.  We expect investor disappointment over today’s FOMC statement and Chairman Powell’s press conference to be additive to already heightened market volatility.  However, a bear market is not our base case.  There is still time for monetary policy and trade policy to move in a more supportive direction for both the economy and risk assets as we enter 2019. Meanwhile, indicators of an imminent bear market or recession aren’t present, and we can continue to cite several positive economic and market data points, including…
    • The yield curve has not inverted
    • Inflation remains contained (including wage inflation)
    • Corporations and consumers have ample access to credit
    • US fiscal policy remains accommodative
    • US corporate earnings should grow 20%+ this year and by mid to high single digits next year
    • Market valuation is attractive with the S&P 500 trading at about 15x forward earnings

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Investment Insights Podcast: The top of many investor’s list of worries

Chris HartSenior Vice President

On this week’s podcast (recorded November 30, 2018), Chris discusses investor concerns about the Fed and interest rates.

 

Quick hits:

  • Recent statements by the Fed appear to indicate a change in its messaging after introducing the idea that a data dependent approach in 2019 might be prudent.
  • The Fed may be closer to a neutral stance regarding monetary policy—meaning a level at which the Fed Funds rate neither stimulates nor slows economic growth.
  • If the Fed does take a data-dependent approach in 2019, this doesn’t mean that it will become unpredictable from meeting to meeting.

For the rest of Chris’s insight, click here to listen to the audio recording.

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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.

Vlog – Quarter End Q&A: 3Q2018

Brinker Capital’s Global Investment Strategist, Tim Holland, asks and answers those questions we think will be top of mind for clients as they open their quarterly statements and think back on the quarter that was:

  1. Can this record bull market continue to run?
  2. Will weakness in emerging market equities spark a bear market here at home?
  3. Will the Fed continue to raise rates and what might that mean for the economy?

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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.

Investment Insights Podcast: The dreaded yield curve inversion


Andrew Goins
, CFA, Investment Manager

On this week’s podcast (recorded September 24, 2018), Andrew discusses the probability of future Fed rate hikes and the potential impact of the yield curve.

Quick hits:

  • The more highly anticipated event will be the release of the Beige Book following this weeks meetings, which covers everything discussed and includes the widely followed dot plot.
  • We’ve been dealing with a very flat yield curve for much of this year.
  • Everyone is watching closely for the dreaded yield curve inversion, which has been an ominous sign for impending recessions historically.
  • While the curve remains flat, but positively sloped, and with the weight of the evidence leaning positive, our portfolios remain overweight to equities.

For Andrew’s full insights, click here to listen to the audio recording.

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This is not a recommendation for Facebook, Amazon, Apple, Netflix and Google. These securities are shown for illustrative purposes only.

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.

Investment Insights Podcast: We are likely in the 7th inning of this game

Chris HartSenior Vice President

On this week’s podcast (recorded June 15, 2018), Chris discusses what we should expect in the later half of the cycle.

 

Quick hits:

  • In a widely anticipated move last week, the Fed raised its policy rate by 25 basis points up to a range of 1.75% to 2.0%.
  • It is important to remember that late in the cycle, by definition, means that there is still room for growth and expansion.
  • The Fed has to walk a tight path as it works to balance the risk of overtightening and choking off economic growth with the risk of overheating the economy.
  • Regardless of whether you tend to lean dovish or hawkish, there are indicators in the fixed income markets to watch for that help assess the potential for recession in the intermediate term.
  • Regardless of one’s opinion on policy and interest rates, we have consistently highlighted a theme of the road to interest rate normalization and the risks of policy uncertainty.

For the rest of Chris’s insight, click here to listen to the audio recording.

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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.

Dinner with Janet

By: Chuck Widger, Founder & Executive Chairman

Yellen_small-2On April 4, I joined a group of 15 private sector investors for a dinner with former Federal Reserve Chairwoman, Dr. Janet Yellen. It was a delightful, insightful, interesting, and informative evening. Below is a mix of her thoughts on the economy, Fed policy, and where we are headed. I am also noting important policy nuances raised by a couple of her core economic policy principles.

Yellen has a positive outlook on the economy. She sees economic growth in 2018 and 2019 at +2.5% and +2.8%, respectively. She described the economy and the labor market to be in excellent shape and expects tax cuts and spending to lift real GDP in 2018 and 2019 by one-half to three-quarters of a percentage point above the economy’s current growth rate of 2.6%. The labor market is almost at full employment, with the potential for the unemployment rate to drop another 0.6% to a level of 3.5%. However, the labor force participation rate may not improve because of structural reasons.

Absent extraordinary circumstances, the Fed will continue on its current path and pursue a total of three increases in the Fed Funds rate this year. What might those extraordinary circumstances be? While Yellen believes there is not a lot of pressure on margins from wage costs and thus no present inflation problems, overheating from all the stimulus is a possibility. Faster growth and a tighter labor market could cause the Fed to make a policy mistake. Significantly faster and greater increases in interest rates could (and they have in the past) chill growth and lead to a recession.

In discussing the economy and Fed policy-making, Yellen showed appealing humility. She acknowledged that our monetary leaders bring their best judgment not an absolute certainty to making policy choices. For example, while commenting on the natural rate of interest, she observed, “What if it’s higher than I/we anticipate? While I have a view on what it is, I do not have absolute certainty.” Humility combined with significant intellectual talent is always an appealing character trait.

So, what are the nuances? Two points stood out. First, her emphasis on the Phillips curve as the only actual framework for understanding the relationship between inflation and unemployment, and second, her view that tax reduction and full capital expensing will have little supply-side effect on economic growth. Both raise important policy distinctions between Keynesian and supply-side economics.

Keynesian economists put greater emphasis on the Fed’s ability to fine tune the economy than supply-siders. In contrast, supply-siders favor letting the natural forces in a market economy do their thing. Yellen’s emphatic statement endorsing the Phillips Curve as the only framework for predicting the tradeoffs between unemployment and inflation is quite Keynesian. For example, if unemployment is high, the policy choice is to reduce interest rates and increase the money supply to create demand and thereby reduce the unemployment rate with little impact on inflation. This is fine-tuning through government intervention.

phillips-curve-2Yellen similarly sees the tax reform’s rate reduction as increasing demand and thereby spurring demand because consumers have more to spend. Tax reform and full capital expensing will provide only a small spur to economic growth through increased production by businesses.

Supply-side economists, like the new Chair of the President’s Council of Economic Advisors Larry Kudlow, beg to differ. They believe when businesses produce and sell more because they have more after-tax cash, they create more demand through the purchases they make and the increased wages they pay. Supply-siders really aren’t interested in the demand side of the supply-demand equation because supply will create its own demand. Therefore, there is not much need for the Fed to “fine tune” the economy. Market forces will balance and grow the economy naturally.

These are important nuances. They reflect an economist’s view on the extent to which the Fed (and the federal government) should intervene in the economy.

The reality is there is something to each of these frameworks. The emphasis on application is, and should be, a matter of degree. There are very few absolutes in economics. The pragmatic application of theory works best.

Below are a few additional pieces of information from our discussion with Dr. Yellen.

  • For the GFC (Global Financial Crisis) there is plenty of blame to go around. The Fed failed to supervise the banking system and the shadow banking system. Our banking system engaged in poor practices and pursued unaligned incentives (bad behavior). And, the markets demanded high cash returns through CDAs and mortgage-backed securities.
  • The safety net placed under the financial system post-GFC has not been endangered by the deregulation pursued by the new administration.
  • Current worries are to the upside. An “overheating” economy is of more concern than undershooting the Fed’s inflation target.
  • Another worry is the Fed continues to conduct an accommodation experiment. As it increases rates, it must balance the different risks of slowing the economy and stoking inflation.
  • The Fed is now trying to engineer a “soft landing from below.”
  • Bitcoin is speculative excess according to Yellen. One dinner guest suggested interested investors should consult the 17th Century Dutch tulip bulb mania when considering bitcoin investments.

Yellen is to be thanked for her public service and her leadership as Chair of the Federal Reserve. A record of good stewardship of a vital US institution by a personable, highly intelligent public servant offers a refreshing reinforcement of public trust in a vital US institution.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice.  

Brinker Capital, Inc., a registered investment advisor. 

Chart source: The Economics Book: Big Ideas Simply Explained. DK Publishing, 2012. pg.203

President Trump, trade & the markets…Is it time to hit the panic button?

Holland_F_150x150
Tim Holland, CFASenior Vice President, Global Investment Strategist

On this week’s podcast (recorded March 23, 2018), Tim discusses the Trump Administration’s trade policies and its impact on Brinker Capital’s portfolio positioning.

Quick hits:

  • Investors have been fixated on the Trump Administration’s trade policy. First, the proposed tariffs on steel and aluminum imports and now talk of much broader based action directed at China.
  • After rallying strongly off its February lows, the S&P 500 has been correcting on increasing concerns protectionist trade policies will torpedo consumer and corporate sentiment and spending, and ultimately the stock market.
  • We remain bullish on the economy and risk assets, including US stocks. Why? Simply put, the hard and soft economic data – or maybe said another way, reality, not rhetoric – tells us we should.
  • 4 BIG BOXES that help drive our thinking: fiscal policy, monetary policy, economic fundamentals, and sentiment.

For the rest of Tim’s insight, click here to listen to the audio recording.

investment podcast

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.

 

Investment Insights Podcast: Fiscal policy takes the baton from monetary policy – What it means for the economy & risk assets

Tim Holland, CFA, Senior Vice President, Global Investment Strategist

On this week’s podcast (recorded February 23, 2018), Tim takes a closer look at US fiscal policy and how it might impact the economy and markets as we move through 2018.

Quick hits:

  • For now, we see fiscal policy as a net positive for economic growth and risk assets, particularly equities.
  • We also don’t see interest rates and inflation as a risk to the economy and markets.
  • We do think rates are biased higher, which is one reason we are conservatively positioned within fixed income.
  • Increased investor concern over higher rates and inflation is driving greater market volatility, something we all lived through earlier this month.

For Tim’s full insights, click here to listen to the audio recording.

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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 road to interest rate normalization in 2017

Holland 150 x 150Tim Holland, CFA, Senior Vice President, Global Investment Strategist

Since 1965, the Fed has implemented policy tightening 15 times and the impact on the bond market has not always translated into longer rates rising. For example, in 2004 the Fed began raising rates in response to concerns of a housing bubble. As a result, the bond market did well as the yield on the 10-year Treasury fell.

More recently, during the current market cycle, the Fed increased rates by 25 basis points in December 2015. The 10-year Treasury yield fell and the bond market generated a positive return while equities plummeted in the first quarter of 2016. A year later, the Fed increased rates by 25 basis points in December 2016. The impact on markets was minimal with both equities and fixed income generating strong positive returns in the two months that followed. Year to date, equities and bonds have rallied in the face of two rate increases by the Fed; first in March and then in June. We expect one more rate increase in 2017.

shutterstock_124163875 resizedCatalysts for higher interest rates

Many positive factors are currently present in the U.S. economy that justify and support a move toward interest rate normalization:

  • Stable U.S. economic growth. U.S. economic growth has been modest but steady. The new administration and an all-Republican government will try to stimulate the economy through reflationary policies including tax cuts, infrastructure spending and a more benign regulatory environment.
  • Supportive credit environment. High yield credit spreads have meaningfully contracted and are back to the tight levels we saw in 2014.
  • Inflation expectations. Historically, there has been a strong positive correlation between interest rates and inflation. Many of the anticipated policies of the Trump administration are inflationary. In addition, the Brinker Capital investment team believes the economy is in the second half of the business cycle, which is typically characterized by wage growth and increased capital expenditures—both of which eventually translate into higher prices. We expect inflation expectations to move higher.
  • Unemployment levels. The labor market has become stronger and is nearing full employment. Unemployment has dropped to a level last seen in 2001.

A rising rate environment should prove challenging for some areas of fixed income.  However, fixed income can serve as the ballast for a broadly diversified portfolio and a good counter to equity market volatility.  Our fixed income exposure is focused on strategies with below average duration and a yield cushion.

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.