Investment Insights Podcast – December 24, 2013

Investment Insights PodcastBill Miller, Chief Investment Officer

Last week, the Federal Reserve announced their new policy on tapering.  ISI Group calculates that if the Fed continues on this new track, they would buy $455 billion more of bonds in 2014 before the taper finishes.

  • Good news: New policy, gradual taper, means interest rates weren’t forced to spike
  • Bad news: Not likely of staying on track. Stronger employment data and economic growth early in 2014 would make the Fed taper at faster rate, driving interest rates up.
  • What we are doing about it: Product-specific, but tactics would include researching managers who perform well in a rising interest rate environment or utilizing inverse ETFs

Click the play icon below to launch the audio recording.

The views expressed above are those of Brinker Capital and are not intended as investment advice.

Federal Reserve: To Taper or Not To Taper

Miller, Bill 2Bill Miller, Chief Investment Officer

Today, Ben Bernanke, current Chairman of the Federal Reserve, is expected to announce a decision on whether to taper or not to taper.  There are good arguments to taper, namely good employment growth and a budget deal between the Republicans and the Democrats.  Likewise, there are good arguments to not taper, including low inflation and the possibility of higher interest rates.  A key consideration for the Fed, should they decide to taper, will be interest rates.  More specifically, the Fed does not want long-term interest rates to increase suddenly.  We estimate that a sharp 1% increase in the long-term Treasury bond could cause as much as a 10% correction in the stock market.

Yesterday morning (December 17), ISI Group reported that the Fed will likely announce that there will be $400 billion left to buy in their Quantitative Easing program. This strikes us as a clever compromise between the taper or not to taper decision. Most importantly, it is not sudden.  Both the stock and bond markets will have time, probably five months or more, to measure the impact of tapering. Thus, we hope to stay long stocks for normal seasonal strength in the first quarter of the new year.  On the other hand, if the Fed announces a more sudden tapering exit, adding shorts to hedge stock market risk is a likely approach.

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.

12.13.13_Magnotta_MarketOutlook_1

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

Investment Insights Podcast – December 6, 2013

Miller_PodcastBill Miller, Chief Investment Officer

We are entering into a period where good news is bad news.On this week’s podcast (recorded December 5, 2013):

  • Good news: U.S. economy is better with many positive indicators (employment, housing starts).
  • Bad news: Markets are not reacting to the good news, drawing into question Fed policy.
  • What we are doing about it: Remaining bullish for 2014, keeping an eye on interest rates and Fed tapering.

Click the play icon below to launch the audio recording.

Monthly Market and Economic Outlook: November 2013

MagnottaAmy Magnotta, CFA, Senior Investment Manager, Brinker Capital

The impressive run for global equities continued in October. While U.S. and developed international markets have gained more than 25% and 20% respectively so far this year, emerging markets equities, fixed income, and commodities have lagged. Emerging markets have eked out a gain of less than 1%, but fixed income and commodities have posted negative year-to-date returns (through 10/31). While interest rates were relatively unchanged in October, the 10-year Treasury is still 100 basis points higher than where it began the year.

After the Fed decided not to begin tapering asset purchases at their September meeting, seeking greater clarity on economic growth and a waning of fiscal policy uncertainty, attention turned to Washington. A short-term deal was signed into law on October 17, funding the government until mid-January 2014 and suspending the debt ceiling until February 2014. With the prospects of a grand bargain slim, we expect continued headline risk coming out of Washington.

The Fed will again face the decision to taper asset purchases at their December meeting, and we expect volatility in risk assets and interest rates to surround this decision, just as we experienced in the second quarter.  More recent economic data has surprised to the upside, including a +2.8% GDP growth rate and better-than-expected gains in payrolls. Despite their decision to reduce or end asset purchases, the Fed has signaled that 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.

11.12.13_Magnotta_MarketOutlook_1However, we continue to view a rapid rise in interest rates as one of the biggest threats to the economic recovery.  The recovery in the housing market, in both activity and prices, has been a positive contributor to growth this year.  Stable, and potentially rising, home prices help to boost consumer confidence and net worth, which impacts consumer spending in other areas of the economy.  Should mortgage rates move high enough to stall the housing market recovery, it would be a negative for economic growth.

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 approach the end of the year, 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 are likely to remain near-zero until 2015), the ECB 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 sluggish, but steady. 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 201,000[1] over the last three months.
  • Inflation tame: With the CPI increasing only +1.2% over the last 12 months, inflation in the U.S. has been running below the Fed’s target level.
  • Equity fund flows turn positive: Equity mutual funds have experienced inflows of $24 billion over the last three weeks, compared to outflows of -$12 billion for fixed income funds.[2] Continued inflows would provide further support to the equity markets.
  • Housing market improvement: The improvement in home prices, typically a consumer’s largest asset, boosts net worth, and as a result, consumer confidence.  However, another move higher in mortgage rates could jeopardize the recovery.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.

However, risks facing the economy and markets remain, including:

  • 11.12.13_Magnotta_MarketOutlook_2Fed mismanages exit: The Fed will soon have to face the decision of when to scale back asset purchases, which could prompt further volatility in asset prices and interest rates. If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.  If the Fed does begin to slow asset purchases, it will be in the context of an improving economy.
  • Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery.
  • Sentiment elevated: Investor sentiment is elevated, which typically serves as a contrarian signal.
  • Fiscal policy uncertainty: Washington continues to kick the can down the road, delaying further debt ceiling and budget negotiations to early 2014.

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, especially as we await the Fed’s decision on the fate of QE. Equity market valuations remain reasonable; however, sentiment is elevated. 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.

Some areas of opportunity currently include:

  • Global Equity: large cap growth, dividend growers, Japan, frontier markets, international microcap
  • Fixed Income: MBS, global high yield credit, short duration
  • Absolute Return: closed-end funds, relative value, long/short credit
  • Real Assets: MLPs, company specific opportunities
  • Private Equity: company specific opportunities

Asset Class Returns

11.12.13_Magnotta_MarketOutlook

Monthly Market and Economic Outlook: October 2013

Magnotta@AmyMagnotta, CFA, Senior Investment Manager, Brinker Capital

Developed market equities have had an impressive run so far in 2013, while fixed income, emerging markets and commodities have lagged. After telegraphing a tapering of asset purchases, the Fed surprised investors on September 18 with a decision to keep the quantitative easing program in place, wanting to see greater clarity on economic growth and a waning of fiscal policy uncertainty before reducing the level of asset purchases.

Asset prices moved immediately higher in response to the Fed’s decision; however that served to be the high-water mark for equities for the quarter.  Then concern over U.S. fiscal policy surfaced and has weighed on markets over the last few weeks. Unlike in previous years, deals to raise the debt ceiling and fund the government will result in limited fiscal drag; however, the headlines will serve to increase market volatility over the short term.

U.S. equity markets posted solid gains in the third quarter, led by small caps and growth-oriented companies.  High-yielding equities continue to lag. Developed international equity markets meaningfully outpaced U.S. markets in the quarter, with most countries generating double-digit returns.  As a result, the gap of outperformance for U.S. markets has narrowed for the year.  Emerging economies have been negatively impacted by the discussion of the Fed reducing liquidity, slower economic growth and weaker currencies.  While emerging markets equities rebounded in the third quarter, as a group they are still negative for the year with Brazil and India especially weak.

Interest rates continued their rise to start the quarter, with the 10-year Treasury note briefly hitting 3% in the beginning of September.  Rates then began to move lower, helped by an avoidance of conflict in Syria and the postponing of Fed tapering. All fixed income sectors were positive in the third quarter, led by high-yield credit.  Year to date through September, high yield has produced gains, while all other major fixed income sectors are negative. Outflows from taxable bond funds have slowed significantly in recent weeks, so the technical backdrop has improved somewhat.

We believe that interest rates have begun the process of normalization, and over the long term, the bias is for higher interest rates.  However, this process will be prolonged and likely characterized by fits and starts. The Fed will soon face the decision to taper asset purchases again later this year, with the earliest action in December.  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. Our fixed income allocation is well positioned with less interest-rate risk and a yield premium versus the broad market.

However, we continue to view a continued rapid rise in interest rates as one of the biggest threats to the U.S. economic recovery.  The recovery in the housing market, in both activity and prices, has been a positive contributor to growth this year.  Stable, and potentially rising, home prices help to boost consumer confidence and net worth, which impacts consumer spending in other areas of the economy.  Should mortgage rates move high enough to stall the housing market recovery, it would be a negative for economic growth.

We continue to approach our broad macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into the final months of the year, and a number of factors should continue to support 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 low for the foreseeable future), the ECB stands ready to provide additional support if necessary, and the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Global growth strengthening: U.S. economic growth has been sluggish, but steady.  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. China appears to have avoided a hard landing.
  • Labor market progress: The recovery in the labor market has been slow, but stable. Initial jobless claims, a leading indicator, have declined to a new cycle low.
  • Housing market improvement: The improvement in home prices, typically a consumer’s largest asset, boosts net worth, and as a result, consumer confidence.  However, another move higher in mortgage rates could jeopardize the recovery.
  • 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.

However, risks facing the economy and markets remain, including:

  • Fiscal policy uncertainty: After Congress failed to agree on a continuing resolution to fund the government, we entered shutdown mode on October 1.  While the economic impact of a government shutdown is more limited, the failure to raise the debt ceiling (which will be reached on October 17) would have a more lasting impact. A default remains unlikely in our opinion, and there will be little fiscal drag as a result of a deal, but the debate does little to inspire confidence. The Fed continues to provide liquidity to offset the impact.
  • Fed mismanages exit: The Fed will soon have to face the decision of whether to scale back asset purchases, which could prompt further volatility in asset prices and interest rates. If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.  The Fed will also be under new leadership next year, which could add to the uncertainty.  However, if the Fed does begin to slow asset purchases, it will be in the context of an improving economy.
  • Significantly higher interest rates: Rates moving significantly higher from here could stifle the economic recovery.
  • Europe: While the economic situation appears to be improving in Europe, the risk of policy error still exists.  The region has still not addressed its structural debt and growth problems; however, it seems leaders have realized that austerity alone will not solve its issues.

Risk assets should continue to perform if real growth continues to recover despite the higher interest rate environment; however, we expect heightened volatility in the near term. Valuations in the U.S. equity market remain reasonable while valuations abroad look more attractive. We continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Some areas of opportunity currently include:

  • Global Equity: Large-cap growth, dividend growers, Japan, frontier markets, international microcap
  • Fixed Income: MBS, global credit, short duration
  • Absolute Return: closed-end funds, relative value, long/short credit
  • Private Equity: company-specific opportunities

Asset Class Returns10.9.13_Magnotta_MarketOutlook

The views expressed above are those of Brinker Capital and are not intended as investment advice.

Morning Comment from Tower Bridge Advisors

pic-meyerJames M. Meyer, CFA, Principal and CIO, Tower Bridge Advisors

Stocks finished mixed in a relatively quiet session the day after the Fed decided not to begin reducing its bond buying program.

If you never put a lid on the cookie jar, eventually your kids, and probably your dog, will get fat and sick. If your doctor prescribes an antibiotic every time you have chills or a fever, half the time there will be no benefit and eventually your body will develop a resistance to the antibiotics. If the Fed keeps dropping $85 billion every month out of helicopters, stock and bond prices will go up in the short run but eventually we will all have to face a set of unintended consequences.

9.20.13_TowerBridge_ComentaryWith that said, I don’t want to overstate any reaction to the Fed’s decision to keep its full bond buying program in place. Another couple of months of buying $85 billion per month instead of $70-75 billion won’t make a big difference. Stocks and bonds reacted Wednesday afternoon and that’s about it for the reaction. However, buying $85 billion of bonds every month is rather similar to persistently giving a strong antibiotic, whether it is needed or not. There may not be immediate harm but there will almost certainly be unintended consequences the longer the process persists. How long is too long? No one knows yet. But with the Fed’s balance sheet closing in on $4 trillion and the fact that soon it will own 40% of all government debt maturing five years out or longer, the problems in the future unwinding what it has created are only going to get more difficult if the Fed doesn’t stop adding to its balance sheet soon.

I understand that the government could shut down in October for a few weeks and that Republican conservatives might create a similar debt ceiling crisis to the one it created two years ago. But the Fed isn’t going to solve that problem with an extra $10 billion in bond purchases. In fact, the Fed isn’t going to solve those problems at all. I get the possibility that the Fed was concerned that real interest rates were getting too high and wanted to scare the bond vigilantes with a surprise. It get the possibility of delaying the start of tapering until the Fed knows who the next Chairman might be to make sure he or she is on board with the game plan. So I am willing to give the Fed a couple of months grace period. But with that said, QE is a much more effective crisis policy than a policy designed to maintain economic growth. Flooding the economy with money doesn’t create demand. Certainly, recipients will gladly take the money but the choice of spending it or investing it depends on market conditions. Given the very slow velocity of money both before and during QE, the market has said rather loudly that it would rather invest than spend. That means investors benefit with much stimulation of economic growth or job creation. Here once again is an example of misguided policy whose unintended consequence is to widen the gap between the wealthy and middle classes.

9.20.13_TowerBridge_Comentary_1We are almost certainly not going to see economic data over the next 1-3 months that is going to move the needle enough by itself to change forward outlooks. Indeed, our economy has been adding about 180,000 jobs per month for almost four years and the pace has remained remarkably consistent if you look at a three or six month moving average. Jobless claims are back to pre-recession levels. Existing home sales, which are about 15x new home sales, are booming. So are car sales. Ladies and gentlemen, we are not in a sick economy and everyone who voted to maintain the status quo yesterday should know that. And those who were unsure yesterday are likely to still be unsure next month or next quarter. Economics is never an exact science and there isn’t a formula that will determine tomorrow’s rate of growth. Federal Reserve forecasts of future growth have been persistently too high since the recovery began. Every subsequent forecast adjustment has been downward, including the adjustment announced on Wednesday. Yet forecasts of job creation and unemployment rates have been pretty accurate. The missing ingredient has been weaker than expected productivity, a function of weaker than expected investment. Tax policy, regulatory policy, fiscal policy and uncertainty created by a dysfunctional government all contribute to lack of investment spending.

With that all said, the Fed didn’t move and that leaves us with the question, “What now?” First of all, there is no need to change any economic or earnings projections. There is no need to change outlooks for Europe or China. Interest costs might be marginally less but the economic impact will be negligible. Obviously, throwing more money at financial assets raises asset prices. The impact of Wednesday’s surprise was felt Wednesday afternoon. There isn’t likely to be much follow through. Again, does anyone really believe that a change of $10 billion in Fed bond purchases would move any needle by a whole lot? I certainly don’t. Just as so many government programs in recent years (e.g. first time home buyer credits or cash for clunkers) pulled benefits forward without creating long term value, Wednesday’s decision created a pop in asset prices that probably simply borrow from future gains. No more or no less.

The true facts are that this economy is what it is, an economy growing about 2% per year, despite significant headwinds created by fiscal policy and Congressional gridlock. The headwinds may be a bit less next year as we anniversary the payroll tax increase but housing growth rates will decline next year and one can’t count on the trickle down impact of a 15-25% growth in stock prices to continue indefinitely. As noted, the Fed has persistently forecasted future growth that was too high. As Fed Chairman Bernanke noted yesterday, the fly in the ointment has been weak gains in productivity. With capacity utilization below 80% and incentives to invest virtually non-existent, one shouldn’t expect productivity to improve until investment spending accelerates. Certainly the uncertainty the Fed created this week surrounding monetary policy won’t help in that regard.

The bottom line is that my near term economic and stock market outlook don’t change. By near term, I mean through 2014. I don’t even see a storm that is likely to hit in 2015 at this time, but no crystal ball is that clear looking two years out. Eventually, and that means within five years, as the Fed does exit and interest rates return to normal levels, there will be problems. Big ones. Government debt service costs are going to skyrocket. That will not only cause further cuts in government spending and entitlements.

9.20.13_TowerBridge_Comentary_2Let me make one point very clear. Nothing has been done about entitlements to date because Congress wasn’t forced to act. When debt service costs rise by $200-400 billion per year, it will be forced to act. Market forces can overwhelm politics. Just look back to 2008. When Congress is forced to act, it will raise the starting age and/or means test Social Security more than it does today and it will cost shift Medicare so that recipients must pay some of the costs. Congress won’t do this because it is the right thing to do or because it is good politically. It will do this because it will be left with no other option. Again, it will happen this decade and the timing will be directly tied to the sharp increase in costs to service our Federal debt. Parenthetically, every developed nation plus China will face the same dilemma; how do you offset rising debt service costs. The responses may differ but the problem is widespread.

That storm is at least 2-3 years away. It may be 4-5 years away. But it isn’t 10 years out. Problems ultimately get solved when markets force them to be solved. Look at the health of U.S. banks today. Markets forced that. Markets made railroads efficient after the Penn Central bankruptcy. Mini-mills saved the steel industry. Japan and German car makers forced the U.S. Big Three to enter the 21st century. The good news is that crisis not only forces change, it forces change for the good because that is the only path to survival. Politicians almost always lack the courage to make changes ahead of crisis. That point transcends both borders and political parties. It takes crisis to force change.

Futures point to a flat opening.

The views expressed above are those of Jim Meyer and Tower Bridge Advisors and are not intended as investment advice.

# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.
Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Monthly Market and Economic Outlook: August 2013

Magnotta@AmyMagnotta, CFA, Senior Investment Manager, Brinker Capital

The U.S. equity markets hit new all-time highs in July after investors digested the Fed’s plans to taper asset purchases.  The S&P 500 Index gained over 5% during the month while the small cap Russell 2000 Index gained 7%. So far 2013 has been a stellar year for U.S. equities with gains of 20%. Second quarter earnings have been decent with 69% of S&P 500 companies beating estimates (as of 8/5)[1]; however, revenue growth remains weak at just +1.3% year over year. We will need to see stronger top-line growth for margins to be sustainable at current high levels.

8.8.13_Magnotta_AugustOutlook_1Developed international equity markets also participated in July’s rally, helped by a weaker U.S. dollar. The MSCI EAFE Index gained just over 4% for the month in local terms and gained over 5% in USD terms. Japan’s easing policies have been celebrated by investors, driving Japanese equity markets 17% higher so far in 2013. Emerging markets were able to eke out a gain of just 1% in July as Brazil and India continued to struggle in the face of slowing growth and weaker currencies.

While interest rate volatility overwhelmed the second quarter, the fixed income markets stabilized in July. After moving sharply higher in May and June, the 10-year U.S. Treasury rose only nine basis points during the month and at 2.64% (as of 8/5), remains at levels we experienced as recently as 2011. The Barclays Aggregate Index was relatively flat for the month. Small losses in Treasuries and agency mortgage-backed securities were offset by gains in credit. The high yield sector had a nice rebound in July as credit spreads tightened, gaining 1.9%.

8.8.13_Magnotta_AugustOutlook_2With growth still sluggish and inflation low, we expect interest rates to remain relatively range-bound over the near term; however, the low end of the range has shifted higher.  Volatility in the bond market should continue as the Fed begins to taper asset purchases.  Negative technical factors, like continued outflows from fixed income funds, could weigh on the asset class. Our portfolios remain positioned in defense of rising interest rates with a shorter duration, an emphasis on spread product, and a healthy allocation to low volatility absolute return strategies.

The pace of U.S. economic growth has continued to be modest, but attractive relative to growth in the rest of the developed world. U.S. GDP growth in the first half of the year has been below expectations; however, there are signs that growth has been picking up in the second quarter, including an increase in both the manufacturing and non-manufacturing purchasing manager’s indices (PMIs) and a decline in unemployment claims.  The improvement in the labor markets has been slow but steady.  Should the Fed follow through with their plans to reduce monetary policy accommodation, it will do so in the context of an improving economy, which should be a positive for equity markets.

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 the second half of the year.  A number of factors should continue to support the economy and markets for the remainder of the year:

  • Monetary policy remains accommodative: The Fed remains accommodative (even with the eventual end of asset purchases, short-term interest rates will remain low for the foreseeable future), the ECB has pledged to support the euro, and now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Fiscal policy uncertainty has waned: After resolutions on the fiscal cliff, debt ceiling and sequester, the uncertainty surrounding fiscal policy has faded.  The U.S. budget deficit has improved markedly, helped by stronger revenues.  Fiscal drag will be much less of an issue in 2014.
  • Labor market steadily improving: The recovery in the labor market has been slow, but steady.
  • Housing market improvement: The improvement in home prices, typically a consumer’s largest asset, boosts net worth and as a result, consumer confidence.  However, a significant move higher in mortgage rates could jeopardize the recovery.
  • 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.

However, risks facing the economy and markets remain, including:

  • Fed mismanages exit: If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.
  • Significantly higher interest rates: Rates moving significantly higher from here could stifle the economic recovery.
  • Europe: While the economic situation appears to be bottoming, the risk of policy error in Europe still exists.  The region has still not addressed its debt and growth problems; however, it seems leaders have realized that austerity alone will not solve its problems.
  • China: A hard landing in China would have a major impact on global growth.

We continue to seek high conviction opportunities and strategies within asset classes for our client portfolios.  Some areas of opportunity currently include:

  • Domestic Equity: favor U.S. over international, financial healing (housing, autos), dividend growers
  • International Equity: frontier markets, Japan, micro-cap
  • Fixed Income: non-Agency mortgage-backed securities, short duration, emerging market corporates, global high yield and distressed
  • Real Assets: REIT Preferreds
  • Absolute Return: relative value, long/short credit, closed-end funds
  • Private Equity: company specific opportunities
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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.

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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.

Investment Insights Video: Responding to Rising Interest Rates

In May, Federal Reserve Chairman, Ben Bernanke, announced the possibility that they will begin tapering in the upcoming months. As that notion looms, so too does the prospective of rising interest rates.

We sat down with Bill Miller, Chief Investment Officer, and Jeff Raupp, Senior Portfolio Manager to discuss how Brinker is prepared to respond to the upcoming policy changes.  In this installment of Investment Insights, Bill and Jeff will give financial advisors and investors a clearer understanding of the tools available to Brinker Capital and how our portfolios can manage the impending environment of rising interest rates.