Amy Magnotta, CFA, Senior Investment Manager, Brinker Capital
Weaker earnings reports weighed on U.S. equity markets in January with the S&P 500 Index falling -3% during the month. Many companies pointed to the impact of the stronger U.S. dollar as a reason for the weakness. More defensive sectors, including utilities and healthcare, were able to post positive returns, while the financials and energy sectors fared the worst, the latter impacted by the continued decline in crude oil prices. From a market cap perspective mid caps led, helped by the solid gains in REITs. Outside of mid caps, growth stocks were noticeably ahead of value stocks.
International equities led U.S. equities in January despite a stronger U.S. dollar. Euro-area markets were particularly strong, gaining more than 7% in local terms, due to the announcement of the European Central Bank’s quantitative easing program, which exceeded expectations. Switzerland equities declined more than -6% during the month as their central bank dropped the Swiss franc’s peg to the euro. Emerging markets had modest gains in both local and USD terms, led by strong performance from India.
Global sovereign yields moved lower again during January. The 10-year Treasury note ended the month 50 basis points lower at a level of 1.68%. As a result of the rate move, long-term Treasuries gained more than 8%. All sectors of the Barclays Aggregate were positive on the month. High yield credit spreads stabilized in January and the sector gained 0.7%. Even at this level, U.S. Treasury yields still look attractive relative to the sovereign debt of other developed nations.
Our macro outlook remains unchanged. When weighing the positives and the risks, we continue to believe the balance is shifted in favor of the positives over the intermediate-term and the global macro backdrop is constructive for risk assets. As a result our strategic portfolios are positioned with an overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.
- Global monetary policy accommodation: We anticipate the Fed beginning to raise rates in mid-2015, but at a measured pace as inflation remains contained. The ECB has taken even more aggressive action to support the European economy, and the Bank of Japan’s aggressive easing program continues.
- Pickup in U.S. growth: Economic growth has improved over the last few quarters. A combination of strengthening labor markets and lower oil prices are likely to provide the stimulus for stronger-than-expected economic growth.
- Inflation tame: Inflation in the U.S. remains below the Fed’s 2% target and inflation expectations have been falling. Outside the U.S. we see more deflationary pressures.
- U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. Earnings growth has been solid 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. Government spending will shift to a contributor to GDP growth in 2015 after years of fiscal drag.
- Lower energy prices help consumer: Lower energy prices should benefit the consumer who will now have more disposable income.
However, risks facing the economy and markets remain, including:
- Timing/impact of Fed tightening: QE ended without a major impact, so concern has shifted to the timing of the Fed’s first interest rate hike. While economic growth has picked up and the labor market has shown steady improvement, inflation measures and inflation expectations remain contained, which should provide the Fed more runway.
- Slower global growth; deflationary pressures: While growth in the U.S. has picked up, growth outside the U.S. is decidedly weaker. The Eurozone is flirting with recession and Japan is struggling to create real growth, while both are also facing deflationary pressures. Growth in emerging economies has slowed as well.
- Geopolitical risks: The geopolitical impact of the significant drop in oil prices, as well as issues in Greece, the Middle East and Russia, could cause short-term volatility.
- Significantly lower oil prices destabilizes global economy: While lower oil prices benefit consumers, significantly lower oil prices for a meaningful period of time are not only negative for the earnings of energy companies, but could put pressure on oil dependent countries, as well as impact the shale revolution in the U.S.
While valuations are close to long-term averages, the trend is still positive, investor sentiment is neutral, and the macro backdrop leans favorable, so we remain positive on equities. However, as we have lost the liquidity provided by the Fed, we expect higher levels of volatility in 2015. 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.
||Quality bias; overweight vs. Intl
||HY favorable after ST dislocation
||Benefit from higher volatility
||Oil stabilizes in 2H15
||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.