Fed Likely to Remain Accommodative in the Near Term

@AmyLMagnotta, CFA, Brinker Capital

Equity market investors expressed concern last week after the release of the minutes from the latest FOMC meeting suggested that the Federal Reserve is considering slowing down the pace of the current quantitative easing (QE) program. The Fed is currently purchasing $85 billion of U.S. Treasury and Agency mortgage-backed securities per month.

The Fed has changed its stance on when policy would potentially move to a tightening bias, from emphasizing a calendar date to basing it on economic data. The Fed has stated that it would not raise short-term rates until the unemployment rate fell to 6.5% as long as inflation is not expected to rise above 2.5%. With inflation currently running well below their threshold and with the unemployment rate elevated at 7.9%, it is likely the Fed is more focused on bringing down the employment rate, potentially at the expense of higher inflation.

With short-term interest rates already at the zero bound, the asset purchases are attempting to promote the same result as additional cuts to the fed funds rate. Even if the Fed tapers off their asset purchases in the next few months, any QE is still easing. They would just be taking their foot off of the accelerator. We feel that economic growth should remain tepid in the first half of the year and not strong enough to bring down the unemployment rate significantly, so the Fed is likely to keep their accommodative stance. In addition, the key members of the FOMC – Bernanke, Yellen and Dudley – all lean to the dovish side with respect to monetary policy.

Before actual tightening occurs, the Fed will first have to end QE. When the Fed stops asset purchases, it would be in the context of an improving economy. An improving economy is typically a positive for asset prices. As ISI Group shows in the following charts, equity prices have eventually increased in past episodes of policy tightening.

The Fed raised interest rates from 1.00% to 5.25% from June 2004 to June 2006. After a modest correction, equity prices moved up substantially.

The Fed tightened in more aggressive increments during the 1994-1995 period. The equity markets moves sideways for a period of time, and then ultimately moved higher.

Balancing Act

Joe Preisser, Brinker Capital

Concern lurched back into the market place last week, as the specter of an eventual withdrawal of the extraordinary measures the U.S. Central Bank has employed since the financial crisis, served to temporarily rattle markets around the globe. Although stocks rebounded smartly as the week drew to a close, from what had been the largest two-day selloff seen since November, the increase in volatility is noteworthy as it spread quickly across asset classes, highlighting the uncertainty that lingers below the surface.

Equities listed in the United States retreated from the five-year highs they had reached early last week following the release of the minutes of the most recent Federal Open Market Committee (FOMC) meeting as the voices of those expressing reservations about continuing the unprecedented efforts of the Central Bank to stimulate the U.S. economy grew louder. The concern of these members of the Committee stems from a fear that the current accommodative monetary policy may lead to “asset bubbles” (Bloomberg News) that would serve to undermine these programs. “A number of participants stated that an ongoing evaluation of the efficacy, costs and risks of asset purchases might well lead the committee to taper, or end, its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred. The minutes stated.” (Wall Street Journal).

Tangible evidence of the unease these words created in the marketplace could be found in the Chicago Board Options Exchange Volatility Index, or VIX, which measures expected market volatility, as it leapt 19% in the aftermath of this statement representing its largest single-day gain since November 2011 (Bloomberg News). The reaction of investors to the mere possibility of the Fed pulling back its historic efforts illustrates the continued dependence of the marketplace on this intervention and highlights the difficulties facing the Central Bank in not derailing the current rally in equities when it eventually pares back its involvement.

A measure of the uncertainty surrounding the timing of the Federal Reserve’s withdrawal of its unprecedented efforts to support the U.S. economy was dispelled by St. Louis Fed President, James Bullard, in an interview he gave late last week. Mr. Bullard, currently a voting member of the FOMC, was quoted by CNBC, “I think policy is much easier than it was last year because the outright purchases are a more potent tool than the ‘Twist’ program was…Fed policy is very easy and is going to stay easy for a long time.”

Reports of statements made by The Chairman of the Federal Reserve, Ben Bernanke, earlier this month, which downplayed the potential creation of dangerous asset bubbles through the Central Bank’s actions, released Friday, helped to further assuage the market’s concerns. “The Fed Chairman brushed off the risks of asset bubbles in response to a presentation on the subject…Among the concerns raised, according to this person, were rising farmland prices, and the growth of mortgage real estate investment trusts. Falling yields on speculative-grade bonds also were mentioned as a potential concern” (Bloomberg News). Although the rhetoric offered by these members of the Federal Reserve in the wake of the release of the minutes of the FOMC was offered to alleviate fears, the text of the meeting has served as a reminder to the marketplace that the asset purchases currently underway, which total $85 billion per month, will be reduced at some point in the future, and as such, has served as a de facto tightening of policy.

Though investors appeared to be appeased by the words of Mr. Bullard as well as those of Mr. Bernanke, the steep selloff that accompanied the mention of a pull back of the Central Bank’s efforts is a reminder of the high-wire act the Fed is facing when it does in fact need to extricate itself from the bond market.

The Allure of Potential

Sue Bergin

One of the best things about referrals is that it demonstrates your track record. You’ve obviously done a good job if a client is willing to refer you to his family, friends and colleagues. According to a new study, however, you may want to focus on what you can do for the prospect, instead of touting what you have done for others.

Zakary Tormala of Stanford University and Michael Norton of Harvard Business School recently reported that people find potential more appealing and intriguing than equally-high achievement. They conducted a number of experiments in the areas of leadership and sports that explored the preference for this potential phenomenon.

In one study, participants received information about a leadership position in the banking division of a large company. Their task was to assess two candidates with identical academic backgrounds and determine which one would have a higher likelihood of success in the position. One candidate had two years of experience and a solid track record. The other candidate had no banking experience but achieved high scores on leadership potential tests. The participants believed that it was this second applicant that would be more successful and have better leadership potential five years out.

In a sporting context, the participants felt a rookie basketball player with a projected five-year performance deserved a $5.25 million salary. Interestingly enough, participants thought that a current five-year pro that actually achieved the same statistics should be paid $4.26 million.

The bottom line is this: save the talk of your achievements for your brochures and website. The potential difference you will make in someone’s life is what prospects will find most appealing.

Decoding the G7 Statement

Andy Rosenberger, CFA, Senior Investment Manager

Earlier this week, members of the seven richest countries met for the official G7 conference. Center to the assembly were discussions surrounding the recent actions by Japan to stimulate their economy through currency devaluation and higher inflation targets. Investors, hungry for a green light by the G7 that Japanese policies are warranted, were disappointed and confused as conflicting statements were issued. The official statement read:

“We, the G7 Ministers and Governors, reaffirm our longstanding commitment to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets. We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates. We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability. We will continue to consult closely on exchange markets and cooperate as appropriate.”

Confused by the statement? You weren’t alone. The statement, although obscure, was initially seen by the market as a green light. Specifically, market participants focused on the following sentence:

“We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments…”

However, only hours later, an unnamed “official” was quoted in a Reuters article as saying:

“The G7 statement signaled concern about excess moves in the yen.” and “The G7 is concerned about unilateral guidance on the yen. Japan will be in the spotlight at the G20 in Moscow this weekend.”

The unnamed “official” was enough to stop the yen’s depreciation; at least temporarily. Investors’ eyes will now turn to the G20 meeting this weekend for further clarification. However, the reality of all of this is that it’s more noise than news.

Japan has started down a path with which there’s no turning back. Too many failed stimulus attempts have been one of the major reasons as to why Japan hasn’t been able to escape its two-decade long deflationary spiral. Reversing course now would be disastrous for the Japanese economy, and more importantly, Japan’s newly elected Prime Minster Shinzo Abe. Prime Minster Abe has only months to establish his Liberal Democratic Party’s (LDP) credibility before another round of elections determine the party’s fate. Turning back now would surely cost the party its ruling power. Ultimately, it seems hard to believe that newly elected officials would side with six members from other countries over that of the voters and ultimately their political careers.

Finding Comfort Outside the Safety Bubble

Sue Bergin

The late author Charles Bukowski once said that, “the shortest distance between two points is often unbearable.” The flight to safety that we have seen over the last few years is proof that this sentiment describes how many feel about investments.

The fixed income market has gotten a $700 billion boost in the last three years, and $300 billion yanked from equity markets.  These are sure signs that investors have found the volatility in markets unbearable.

While the comfort of the safety bubble might calm clients of their market jitters, it isn’t necessarily in their best long-term interest. While fixed income securities are generally “safer” than equity investments, they have a downside.  They may produce returns that do not keep pace with inflation.

There is, however, another option outside of the safety bubble.  By incorporating alternative investment strategies that are less correlated to the markets, clients’ portfolios may be protected from downside risk, yet still capture opportunities for growth.

When clients express an aversion to the equity markets, perhaps it’s time to talk about alternative strategies like absolute return.  Absolute return strategies seek to deliver a positive return regardless of market behavior.  Because they typically have low market correlation, they offer some shelter to the volatility that clients find disturbing.  While not right for everyone, a good absolute return fund can add balance and consistency to a portfolio.

A Tale of Two Currencies

Joe Preisser, Brinker Capital

As the global marketplace continues to recover from the worst financial crisis since the Great Depression, two of the world’s major currencies, the yen and the euro, have embarked on remarkably different paths of late in a reflection of the efforts of the Central Bank’s, which guard the levers of these economies, to achieve growth and stability. The responses of the nations ‘ respective policy makers has led directly to a steep decline in the value of the Japanese Yen, while the European continent has seen its common medium of exchange rise to heights unreached since 2011. Although the nature of the challenges facing what are two of the largest economies in the world differ significantly, the efficacy of the monetary policies employed to combat them will have a profound effect on markets across the globe.

In Japan, newly elected Prime Minister, Shinzo Abe, has grabbed headlines after only a few weeks in office, through his advocacy of aggressive measures designed to foster growth within a nation that has been mired in stagnation. Dubbed “Abenomics”, the plan is a multifaceted approach to economic stimulus whose centerpiece is a desire to devalue the nation’s currency, in an effort to support its exporters by rendering the goods and services they provide less expensive on the world stage. According to the Wall Street Journal, on February 6th, “Analysts at Goldman Sachs Inc. estimate that for every 10 yen the currency weakens against the dollar, profits of exporters would rise by 7% to 10%.” Mr. Abe has professed his aim to achieve this through a controversial limiting of a measure of the Bank of Japan’s (BOJ) autonomy in an effort to effectively force the reflation of the economy through a program of unlimited monetary easing and large scale stimulus. In addition, the Prime Minister has pledged to fill the recently vacated position at the helm of the BOJ with an appointee who shares his commitment to revitalizing the country’s economy through all available means (The Economist, Jan 26th). The efforts undertaken thus far, combined with Mr. Abe’s emphatically-stated focus on combatting the deflation that has plagued Japan for more than a decade, have resulted in a sharp fall in the value of the yen, and a steep rise in equity prices listed on the nation’s exchange, which should be sustained as long as this endeavor proves successful. “The Nikkei has surged 32% since mid-November…The yen has declined 14% against the dollar over the same period…The gains in Tokyo have made Japan the world’s best-performing major stock market over the past three months ”(The Wall Street Journal, February 6th).

On the Continent, the nearly four-year-old struggle to maintain its union in the face of a perilous debt crisis that threatened the world economy, has led to an unprecedented effort by the European Central Bank (ECB) to support the common currency. The fear of a possible dissolution of this unique collection of countries led directly to the widespread selling of the euro, as well as large scale liquidations of bonds issued by its sovereign members. As the cost of repaying the debt of a host of the European Union’s members rose to unsustainable levels the President of the ECB, Mario Draghi elected to act pledging to do, “whatever it takes to preserve the euro”(Bloomberg News July 26,2012). This statement manifested itself in a series of massive sovereign debt purchases by The Central Bank in September of 2012 which was dubbed, “Outright Monetary Transactions.” Mr. Draghi’s effort brought stability back to the euro-zone, and as a result led to an appreciation of its currency. As investors have become more confident that the worst of the crisis has been averted, the euro has risen further, and is now back to levels untested in two years. The sequence of events on the Continent stands in stark contrast to those in Japan, as Europe’s exporters have seen the cost of their products increase, thus making it more difficult for them to compete in the global marketplace. The threat that this state of affairs poses to the recovery of the region’s economy is such that it was directly and repeatedly addressed by Mr. Draghi this week during a press conference in which he suggested that the Central Bank may take steps to counter the effects of the currency’s rise. The ECB President was quoted by Bloomberg News as saying on Feb 7th, “The exchange rate is not a policy target, but it is important for growth and price stability…We want to see if the appreciation is sustained, and if it alters our assessment of the risks to price stability.”

The historic measures undertaken by both the European Central Bank, and the Bank of Japan in the interest of maintaining stability and fostering growth have thus far been largely successful, however it will be the ongoing maintenance of the consequences of this success that will ultimately determine the fate of these economies.

Advance the Story with Correct Image Placement

Sue Bergin

When presenting reports to clients, you probably spend a good deal of time making sure that you have the charts and graphs that best tell the story. Another factor that influences clients’ reactions to images is placement.

Proper image placement has the “before” image displayed on the left and the “after” on the right.

This advice comes from a recent study out of the University of British Columbia.  The researchers suggest that language direction dictates the way in which we conceptualize time.[1]

To validate their hypothesis, researchers sought feedback on weight-loss ads with “before” and “after” photos placed in different locations.  The participants viewed the ads with “before” on the right more favorably (4.64 out of 7), than when the image appeared on the left (3.39).

While placing “before” images on the right will resonate best with English speaking clients, you’ll want to switch the image order for those clients who speak Hebrew or other right-to-left languages.

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[1]The Future Looks “Right:” Effects of the Horizontal Location of Advertising Images on Product Attitude, January, 2013

Networking Events

Bev Flaxington, The Collaborative

Advisors looking for ways to add value to their clients will often hold educational events. Most advisors see this as a chance for increasing satisfaction and retention, but also as a way to generate referrals. Educational events are a great way for the advisor to bring additional value to their clients.

Another option that isn’t as popular but can be extremely valuable to clients is to offer a peer networking event. In cases where your client base may include business owners, entrepreneurs, widowed or divorced women, or others with similar interests, an event set up purely for networking can give clients access to experts, information and connections. Let’s look at some best practices around doing this:

(1)    Identify the themes in your client base. Do you have people who might like to meet one another, or could learn from one another? Are there clients looking for introductions in order to grow their business, or who need information in their work or philanthropic lives that another client might be able to help with? Look through your client base to see where one client could add value to another client. See what your clients struggle with in their own lives – work, hobby, charitable, etc. and whether there are opportunities to get like-minded, complementary people in the same room.

(2)    Set expectations that this is a peer networking event. Give some structure to the evening. You could have an introduction to the event, talk about the networking objectives, and perhaps introduce clients at the outset. One possibility would be to go around and have each client introduce him- or herself and talk about their area of interest for the event. What would they like to gain? Another option would be to have areas of focus set up in different spots within the room so people can choose where to go to talk to others. Or you could set it up using the “Speed Dating” format where people rotate and talk to one another for a few minutes to exchange cards and interests. You could even have a speaker who is expert in networking to share some tips and ideas about how best to network for greatest advantage, and then ask people to practice the new skills they have learned with one another.

(3)    Set a “theme” for the evening. This could be anything from “The Back Office of the Small Business Owner” to “Philanthropic Interests in Africa”. Find out what your clients are interested in, what issues they are struggling with, what information they have to share and then create the event around these things. You could find an outside expert or a client, or other trusted advisor such as an accountant or attorney to speak on a topic and then ask clients to talk about different opportunities or aspects related to their lives and situations. For example, if you have a number of entrepreneurs in your client base, you could have an evening on “Going from Start-Up to Structure” and have clients who work with these firms talk about what they offer for help.

(4)    Keep the dialogue away from investing. These events are an opportunity for your clients to learn more about what your other clients may be doing, or may have to offer. It’s a way to bring like-minded people together to learn from one another and to possibly leverage one another. The focus isn’t on the investment process or the markets, it’s on meeting the needs of your clients for information and connection.

See if your client base lends itself to peer networking opportunities. In this age of social media connections, the truth is that many people still struggle to find the “right”contacts they need to help them grow their businesses, change their lives and learn about opportunities. Your clients may prove useful to one another as you facilitate these introductions.

U.S. Policy Update: Key Dates Ahead

@AmyLMagnotta, CFA, Brinker Capital

I recently attended Strategas Research Partners’ public policy conference in Washington, D.C. It was hard to not come away with the feeling that our government will remain dysfunctional for the foreseeable future. But there is still hope. If we could just put politics aside, there are many smart, reasonable people on both sides of the aisle that could come together to devise an acceptable solution for our fiscal problems that does not stifle economic growth.

In the near term, policy uncertainty remains. The deal to avoid the fiscal cliff dealt primarily on the tax side, making the lower rates permanent except for those in the top tax bracket. However, they continued to kick the can down the road on the spending side. While Congress has agreed on a short-term extension of the debt ceiling, the issue will return mid-year. Washington will continue to be a focus for markets this year.

Below are some key items to watch for on the policy front:

• The sequester, which consists $1.2 trillion of mandatory spending cuts over 10 years, half of which coming from the defense budget, is set to go into effect on March 1. At this point there is a high probability the cuts will happen. This will result in immediate negative headlines, but the impact of these spending cuts will not be felt for a few more months. Sequestration will also put some pressure on state and local governments as $37 billion of federal aid will be cut. A couple of months of cuts may force President Obama into a deal with the Republicans that would include some entitlement reform.
• The continuing resolution that currently funds the government expires on March 27. No resolution could result in a complete or partial shutdown of the federal government.
• The debt ceiling was extended until May 19, but the Treasury could stretch it out until July or August with extraordinary measures. Also included in the legislation is a requirement that both the House and the Senate produce a budget in April or their pay will be withheld.
• The CBO will release their outlook on February 4.
• Momentum is building for tax reform as Chairmen of the House Ways and Means Committee (Camp-R) and the Senate Finance Committee (Baucus-D) have hired dedicated staff. However, there is a lack of consensus on why we should do tax reform.
• Ratings agencies are looking for a plan to stabilize our debt to GDP ratio at 70%. To do this we would need spending cuts closer to $2 trillion over ten years.