Monthly Market and Economic Outlook: August 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

After pushing higher for most of July, the U.S. equity markets fell -2% on the last day to end the month in the red. Continued geopolitical concerns, a debt default in Argentina and a higher than expected reading on the Employment Cost Index could have provided a catalyst for the sell-off. Investor sentiment levels were elevated in July, so it is not surprising to have any bad news lead to a short-term pull-back in the equity markets. However, we believe equity markets are biased upward over the next six to twelve months and further weakness could be a buying opportunity.

U.S. small cap stocks have significantly lagged large caps so far this year. In July the small cap Russell 2000 Index declined -6.1%. The Russell 2000 is down -3.1% for the year-to-date period, compared to the +5.5% gain for the Russell 1000 Index. From a style perspective, value lagged growth in July but remains solidly ahead for the year-to-date period.

Developed Europe significantly lagged the U.S. equity markets in July, but Japan was able to deliver a positive return. Emerging markets continued their rally in July, gaining +2.0% for the month. Emerging markets have gained +8.5% through the first seven months of the year, well ahead of developed markets. Countries that struggled in 2013 due to the Fed’s taper talk, like India and Indonesia, have been very strong performers, while negative performance in Russia has weighed on the complex. The U.S. dollar has shown recent strength versus both developed and emerging market currencies.

New York Stock ExchangeU.S. Treasury yields edged slightly higher in July. The 10-year yield has fallen 56 basis points from where it began the year (as of 8/7/14), while the 2-year part of the yield curve has moved up eight basis points. As a result, the yield curve has flattened between the 10-year and 2-year tenors; however, it remains steep relative to history. While sluggish economic growth and geopolitical risks could be keeping a ceiling on U.S. rates, relative value could also be a factor. A 2.4% yield on a 10-year U.S. Treasury looks attractive relative to a 0.5% yield on 10-year Japanese government bonds, a 1.1% yield on 10-year German bonds, and a 2.6% yield on Spanish 10-year sovereign debt.

All taxable fixed income sectors were flat to slightly negative on the month. High yield fared the worst, declining -1.3% as spreads widened 50 basis points. Municipal bonds were slightly positive for the month and continue to benefit from a positive technical backdrop with strong demand for tax-free income being met with a lack of new issuance.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, with a number of factors supporting the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even with quantitative easing slated to end in the fall, U.S. short-term interest rates should remain near-zero until 2015 if inflation remains contained. The ECB and the Bank of Japan are continuing their monetary easing programs.
  • Global growth stable: U.S. growth rebounded in the second quarter. Outside of the U.S., growth has not been very robust, but it is still positive.
  • Labor market progress: The recovery in the labor market has been slow but steady. The unemployment rate has fallen to 6.2% and jobless claims have fallen to new lows.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. M&A deal activity has picked up this year. Corporate profits remain at high levels and margins have been resilient.
  • Less drag from Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Fiscal drag will not have a major impact on growth in 2014, and the budget deficit has also declined significantly.

Risks facing the economy and markets remain, including:

  • Fed Tapering/Tightening: If the Fed continues at the current pace, quantitative easing will end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual and the economy appears to be on more solid footing this time. Should inflation pick up, market participants will shift quickly to concern over the timing of the Fed’s first interest rate hike. Despite the recent uptick in the CPI, the core Personal Consumption Expenditure Price (PCE) Index, the Fed’s preferred inflation measure, is up only +1.5% over the last 12 months.
  • Election Year/Seasonality: While we noted there has been some progress in Washington, we could see market volatility pick up later this year in response to the mid-term elections. In addition, August and September tend to be weaker months for the equity markets.
  • Geopolitical Risks: The events in the Middle East and Russia could have a transitory impact on markets.

Risk assets should continue to perform over the intermediate term as we expect continued economic growth; however, we could see increased volatility and a shallow correction as markets digest the end of the Federal Reserve’s quantitative easing program. Economic data, especially inflation data, will be watched closely for signs that could lead the Fed to tighten monetary policy earlier than expected. Equity market valuations look elevated, but not overly rich relative to history, and maybe even reasonable when considering the level of interest rates and inflation. Investor sentiment, while down from excessive optimism territory, is still elevated, but the market trend remains positive. In addition, credit conditions still provide a positive backdrop for the markets.

Asset Class Outlook

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.

Source: Brinker Capital

Brinker Capital, Inc., a Registered Investment Advisor. 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

An End to Complacency

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

Volatility abruptly made an entrance onto the global stage, shoving aside the complacency that has reigned over the world’s equity markets this year as they have marched steadily from record high to record high. Asset prices were driven sharply lower last week, as gathering concerns that the Federal Reserve Bank of the United States may be closer than anticipated to raising interest rates, combined with increasing worries about the possibility of deflation in the Eurozone, and a default by the nation of Argentina, to weigh heavily on investor sentiment. The selling seen across equity markets last Thursday was particularly emphatic, with declining stocks listed on the NYSE outpacing those advancing by a ratio of 10:1, and the Chicago Board Options Exchange Volatility Index (VIX), which measures expected market volatility, climbing 25% to its highest point in four months, all combining to erase the entirety of the gains in the Dow Jones Industrial Average for the year.

Preisser_Complacency_8.4.14The looming specter of the termination of the Federal Reserve’s bond-buying program, which is scheduled for October, is beginning to cast its shadow over the marketplace as this impending reality, coupled with fears that the Central Bank will be forced to raise interest rates earlier than expected, has served to raise concerns. Evidence of this could be found last Wednesday, where, on a day that saw a report of Gross Domestic Product in the United States that far exceeded expectations, growing last quarter at an annualized pace of 4%, vs. the 2.1% contraction seen during the first three months of the year, and a policy statement from the Federal Reserve which relayed that, “short-term rates will stay low for a considerable time after the asset purchase program ends” (Wall Street Journal) equity markets could only muster a tepid response. It was the dissenting voice of Philadelphia Fed President, Charles Plosser who opined that, “the guidance on interest rates wasn’t appropriate given the considerable economic progress officials had already witnessed” (Wall Street Journal), which seemed to resonate the loudest among investors, giving them pause that this may be a signal of deeper differences beginning to emerge within the Federal Open Market Committee. Concern was further heightened on Thursday morning of last week, when a report of the Employment Cost Index revealed an unexpected increase to 0.7% for the second quarter vs. a 0.3% rise for the first quarter (New York Times), which stoked nascent fears of inflation, bolstering the case for the possibility of a more rapid increase in rates.

Negative sentiment weighed heavily on equity markets outside of the U.S. as well last week, as the possibility of deflationary pressures taking hold across the nations of Europe’s Monetary Union, combined with ongoing concerns over the situation in Ukraine and the second default in thirteen years by Argentina on its debt to unsettle market participants. According to the Wall Street Journal, “Euro-zone inflation increased at an annual rate of just 0.4% in July, having risen by 0.5% the month before. In July 2013 the rate was 1.6%” While a fall in prices certainly can be beneficial to consumers, it is when a negative spiral occurs, as a result of a steep decline, to the point where consumption is constrained, that it becomes problematic. Once these forces begin to take hold, it can be quite difficult to reverse them, which explains the concern it is currently generating among investors. The continued uncertainty around the fallout from the latest round of sanctions imposed on Russia, as a result of the ongoing conflict in Ukraine, further undermined confidence in stocks listed across the Continent and contributed to the selling pressure.

ArgentinaInto this myriad of challenges facing the global marketplace came news of a default by Argentina, after the country missed a $539 interest payment, marking the second time in thirteen years they have failed to honor portions of their sovereign debt obligations. The head of research at Banctrust & Co. was quoted by Bloomberg News, “the full consequences of default are not predictable, but they certainly are not positive. The economy, already headed for its first annual contraction since 2002 with inflation estimated at 40 percent, will suffer in a default scenario as Argentines scrambling for dollars cause the peso to weaken and activity to slump.”

With all of the uncertainty currently swirling in these, “dog days of summer,” it is possible that the declines we have seen of late may be emblematic of an increase in volatility in the weeks to come as we move ever closer to the fall, and the terminus of the Fed’s asset purchases.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.

Investment Insights Podcast – July 25, 2014

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded July 23, 2014), we alter the format to provide commentary on a recent publication from the Ned Davis Research Group.

The article references an old adage that when the public gets in the stock market, it’s too late. While that’s a bit cynical, the public is not always wrong. Recently, the bond market seems to show that over the past five years, the public is pretty smart. Here are some additional takeaways:

  • The allocation to stocks is on the high side, but not excessive
  • Cash allocation seems low
  • Flows into equities and bonds have been good

This, and other measures, lends itself to believe that the public is in (the market), but not excessively in. However, are they in because they want to be in or because the have to be in? The Fed’s zero interest rate policy seems to drive behavior of investors towards stocks–creating a feeling that the public is not in.

The takeaway is that we have to be mindful if the allocations get too big. A defense for that is diversification across different asset classes.

Click the play icon below to launch the audio recording or click here.

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.

Monthly Market and Economic Outlook: July 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

Equity markets continued to grind higher in the second quarter despite continued tapering by the Federal Reserve, a negative GDP print, and rising geopolitical tensions. All asset classes have delivered positive returns in the first half of the year, led by long-term U.S. Treasury bonds. There has been a lack of volatility across all asset classes; the CBOE Volatility Index (VIX) fell to its lowest level since February 2007.

Year to date the U.S. equity markets are slightly ahead of international markets. All S&P sectors are positive year to date, led by utilities and energy. Mid cap value has been the best performing style, helped by the double-digit performance of REITs. U.S. large caps have outperformed small caps, but after experiencing a drop of more than -9%, small caps rebounded nicely in June. Value leads growth across all market capitalizations.

Despite concerns surrounding the impact of Fed tapering on emerging economies, emerging market equities outperformed developed markets in the second quarter, and have gained more than 6% so far this year, putting the asset class ahead of developed international equities. Small cap emerging markets and frontier markets have had even Magnotta_Market_Update_7.09.14_1stronger performance. The dispersion of performance within emerging markets has been high, with India, Indonesia and Argentina among the top performers, and China, Mexico and Chile among the laggards. On the developed side, performance from Japan has been disappointing but a decent rebound in June bumped it into positive territory for the year-to-date period.

Despite a consensus call for higher interest rates in 2014, U.S. Treasury yields moved lower. The 10-year Treasury Note is currently trading at 2.6% (as of 7/7/14), still below the 3.0% level where it started the year. While sluggish economic growth and geopolitical risks could be keeping a ceiling on U.S. rates, technical factors are also to blame. The supply of Treasuries has been lower due to the decline in the budget deficit, and the Fed remains a large purchaser, even with tapering in effect. At the same time demand has increased from both institutions that need to rebalance back to fixed income after experiencing strong equity markets returns, and investors seeking relative value with extremely low interest rates in Japan and Europe.

With the decline in interest rates and investor risk appetite for credit still strong, the fixed income asset class has delivered solid returns so far this year. Both investment grade and high yield credit spreads continue to grind tighter. Emerging market bonds, both sovereign and corporate, have also experienced a nice rebound after a tough 2013. Municipal bonds benefited from a positive technical backdrop with strong demand for tax-free income being met with a lack of new issuance.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, with a number of factors supporting the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even with quantitative easing slated to end in the fall, U.S. short-term interest rates should remain near-zero until 2015 if inflation remains contained. The ECB and the Bank of Japan are continuing their monetary easing programs.
  • Global growth stable: We expect a rebound in U.S. growth in the second quarter after the polar vortex helped to contribute to a decline in economic output in the first quarter. Outside of the U.S., growth has not been very robust, but it is still positive.
  • Labor market progress: The recovery in the labor market has been slow, but we have continued to add jobs. The unemployment rate has fallen to 6.1%.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. M&A deal activity has picked up this year. Corporate profits remain at high levels and margins have been resilient.
  • Less Drag from Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Fiscal drag will not have a major impact on growth in 2014, and the budget deficit has also declined significantly.

Risks facing the economy and markets remain, including:

  • Fed Tapering/Tightening: If the Fed continues at the current pace, quantitative easing will end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual and the economy appears to be on more solid footing this time. Should inflation pick up, market participants will shift quickly to concern over the timing of the Fed’s first interest rate hike. Despite the recent uptick in the CPI, the core Personal Consumption Expenditure Price Index (PCE), the Fed’s preferred inflation measure, is up only +1.5% over the last 12 months.
  • Election Year: While we noted there has been some progress in Washington, we could see market volatility pick up later this year in response to the mid-term elections.
  • Geopolitical Risks: The events surrounding Iraq, as well as Russia/Ukraine are further evidence that geopolitical risks cannot be ignored.

Risk assets should continue to perform if we experience the expected pickup in economic growth; however, we could see increased volatility and a shallow correction as markets digest the end of the Federal Reserve’s quantitative easing program. Economic data, especially inflation data, will be watched closely for signs that could lead the Fed to tighten monetary policy earlier than expected. Equity market valuations look elevated, but not overly rich relative to history, and maybe even reasonable when considering the level of interest rates and inflation. Investor sentiment remains overly optimistic, but the market trend remains positive. In addition, credit conditions still provide a positive backdrop for the markets.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class

Outlook

Favored Sub-Asset Classes

U.S. Equity

+

Large cap bias, dividend growers

Intl Equity

+

Emerging and Frontier markets, small cap

Fixed Income

Global high yield credit, short duration

Absolute Return

+

Closed-end funds, event driven

Real Assets

+/-

MLPs, natural resources equities

Private Equity

+

Diversified

 

Source: Brinker Capital

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

Investment Insights Podcast – July 1, 2014

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded June 30, 2014), Bill addresses some of the things we don’t like first, then gives greater insight into what we are doing about it:

What we don’t like: Interest rates are stubbornly low; expectations were that they would rise over the first-half of the year; low interest rates hurt retirees ability to generate income

What we like: How we are handling this financial repression

What we are doing about it: Emphasizing three themes in fixed income: yield, shorter maturity bonds, and inclusion of absolute return

Click the play icon below to launch the audio recording or click here

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.

World Cup of Liquidity

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

With the eyes of the world currently trained on Brazil, and the incredible spectacle of the globe’s most popular sporting event, there is another coordinated effort taking place on the world stage, albeit one with less fanfare and pageantry, but possessing a far greater effect on the global economy, and that is the historically accommodative policies of two of the world’s major central banks. The unprecedented amount of liquidity being thrust into the system by these institutions has helped fuel the current bull market in equities, which continues to push stocks listed around the world further and further into record territory.

World CupThe more powerful of these central banks, the Federal Reserve Bank of The United States, is attempting to gradually extricate itself from a portion of the record measures it has taken to revive growth following the Great Recession, which have caused its balance sheet swell to more than $4 trillion (New York Times) while not causing the economy to suddenly decelerate. “To this end, last week the Fed announced a continuation of the reduction of its monthly bond purchases by $10 billion, bringing the new total to $35 billion.” They also voiced their collective intention to keep short-term interest rates at their current historically low levels until 2015. Financial markets rallied following this news as investors focused largely on the Fed’s comments regarding rates, as well as the little-discussed fact that although their monthly purchases are being slowly phased out, the Central Bank continues to reinvest the proceeds from maturing bonds, thus maintaining a measure of the palliative effect. According to the New York Times, “Fed officials generally argue that the effect of bond buying on the economy is determined by the Fed’s total holdings, not its monthly purchases. In this view, reinvestment would preserve the effect of the stimulus campaign.” Although the American Central Bank is attempting to pare back its efforts to boost growth in the world’s largest economy, the accommodative measures currently in place look to remain so long after its bond purchases are concluded.

Preisser_Liquidity_6.23.17_2Mario Draghi, on June 5, made history when he announced that the European Central Bank (ECB) had become the first major Central Bank to introduce a negative deposit rate. As part of a collection of measures designed to spur growth and combat what has become dangerously low inflation within the Monetary Union, the ECB effectively began penalizing banks for any attempt to keep high levels of cash stored with them. In addition to this unprecedented step, Mr. Draghi unveiled a plan to issue four-year loans at current interest rates to banks, with the stipulation that the funds in turn be lent to businesses within the Eurozone, (New York Times). The actions of the ECB were cheered by investors who sent stocks listed across the Continent to levels unseen in more than six-and-a-half years, with the expectation that the Central Bank will remain committed to combating the significant economic challenges that remain for this collection of sovereign nations. To this end, Mr. Draghi suggested, during his press conference, that he is considering additional growth inducing measures, which may include the highly controversial step of direct asset purchases. Mr. Draghi gave voice to his resolve, and a glimpse of what the future might hold when he said, “we think this is a significant package. Are we finished? The answer is no” (New York Times).

The actions of both the Federal Reserve and the European Central Bank have directly contributed to the current rally in risk assets, but have also created a conundrum of sorts for investors; as though their historic measures have sent prices to record levels, the conclusion of these programs carry with them serious risks of disruption, as they too are unprecedented.

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.

Monthly Market and Economic Outlook: June 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

The global equity markets continued to climb higher in May. In the U.S. the S&P 500 Index hit another all-time high, gaining more than 3% for the month. The technology and telecom sectors were the top performing sectors in May, but all sectors were positive except for utilities. In a reversal of March and April, growth outpaced value across all market capitalizations, but large caps remained ahead of small caps. In the real assets space, REITs and natural resources equities continued to post solid gains despite low inflation.

International developed equity markets were slightly behind U.S. markets in May, but emerging market equities outperformed. After a weak start to the year, emerging market equities are now up +3.5% year to date through May, even with China down more than -3%. The dispersion in the performance of emerging market equities remains wide. Indian equities rallied strongly in May, gaining more than 9%, after the election of a new prime minister and his pro-business BJP party.

Despite a consensus call for higher interest rates in 2014, U.S. Treasury yields have continued to fall. The yield on the 10-year Treasury note ended the month at 2.5%, still above its recent low of 1.7% in May 2013, but well below the 3.0% level where it started the year. While lower than expected economic growth and geopolitical risks could be keeping a ceiling on U.S. rates, technical factors are also to blame. The supply of Treasuries has been lower due to the decline in the budget deficit, and the Fed remains a large purchaser, even with tapering in effect. At the same time demand has increased from both institutions that need to rebalance back to fixed income after such a strong equity market in 2013 and investors seeking relative value with extremely low interest rates in Japan and Europe.

Magnotta_Market_Update_6.10.14As interest rates have declined, fixed income has performed in line with equities so far this year. All fixed income sectors were positive again in May. Municipal bonds and investment grade credit have been the top performing fixed income sectors so far this year. Both investment grade and high yield credit spreads continue to grind tighter. Within the U.S. credit sector fundamentals are solid and the supply/demand dynamic is favorable, but valuations are elevated. Emerging market bonds have also experienced a nice rebound after a tough 2013. Municipal bonds benefited from a positive technical backdrop with strong demand for tax-free income being met with a dearth of issuance.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, with a number of factors supporting the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even with the Fed tapering asset purchases, short-term interest rates should remain near-zero until 2015 if inflation remains low. The ECB announced additional easing measures, and the Bank of Japan continues its aggressive monetary easing program.
  • Global growth stable: U.S. economic growth has been slow but steady. Economic growth declined in the first quarter, but we expect it to turn positive again in the second quarter. Outside of the U.S. growth has not been very robust, but it is still positive.
  • Labor market progress: The recovery in the labor market has been slow, but we have continued to add jobs. The unemployment rate has fallen to 6.3%. Unemployment claims have hit cycle lows.
  • Inflation tame: With core CPI running below the Fed’s target at +1.8% and inflation expectations contained, the Fed retains flexibility to remain accommodative.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be used for acquisitions, capital expenditures, hiring, or returned to shareholders. M&A deal activity has picked up this year. Corporate profits remain at high levels and margins have been resilient.
  • Less drag from Washington: After serving as a major uncertainty over the last few years, there has been some movement in Washington. Fiscal drag will not have a major impact on growth this year. The deficit has also shown improvement in the short-term.

Risks facing the economy and markets remain, including:

  • Fed Tapering/Tightening: If the Fed continues at the current pace, quantitative easing should end in the fourth quarter. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual and the economy appears to be on more solid footing this time. The new Fed chairperson also adds to the uncertainty. Should economic growth and inflation pick up, market participants will shift quickly to concern over the timing of the Fed’s first interest rate hike.
  • Emerging markets: Slower growth could continue to weigh on emerging markets. While growth in China is slowing, there is not yet evidence of a hard landing.
  • Election year: While we noted there has been some progress in Washington, we could see market volatility pick up later this year in response to the mid-term elections.
  • Geopolitical risks: The events surrounding Russia and Ukraine are further evidence that geopolitical risks cannot be ignored.

Risk assets should continue to perform if real growth continues to recover; however, we could see volatility as markets digest the continued withdrawal of stimulus by the Federal Reserve. Economic data will be watched closely for signs that could lead to tighter monetary policy earlier than expected. Equity market valuations are fair, but are not overly rich relative to history, and may even be reasonable when considering the level of interest rates and inflation. Investor sentiment remains elevated but is not at extreme levels. Credit conditions still provide a positive backdrop for the markets.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class Outlook Favored Sub-Asset Classes
U.S. Equity + Large cap bias, dividend growers
Intl Equity + Frontier markets, small cap
Fixed Income Global high-yield credit, short duration
Absolute Return + Closed-end funds, event driven
Real Assets +/- MLPs, natural resources equities
Private Equity + Diversified approach

Source: Brinker Capital

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

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.

Sentiment

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

In February 1637, tulip bulbs sold in Holland for as much as 4,000 guilders each, over 10x the amount a skilled craftsman would earn in a year.  Months later, many tulip traders found themselves holding bulbs worth just a fraction of what they had paid for.

As crazy as prices got, tulip mania actually started with good fundamentals. Tulips were a relatively new introduction to Europe, and the flower’s intense color made it a heavily-desired feature of upper-class gardens. Most desirable were the exotic-looking, multi-colored tulips, which was caused by a mosaic virus not identified until the 1970s and now called the “tulip-breaking virus.” At best, tulip bulbs weren’t easy to produce and those with the virus suffered even lower reproduction rates. In the beginning, what occurred in the tulip market was classic supply and demand—a highly sought-after item with limited supply increasing in price. In 1634, that started to change as 11.1.13_Raupp_Sentimentspeculators were attracted to the rising prices, and in late 1636 prices started to accelerate rapidly, to where even single-color tulips were attracting prices of over 100 guilders apiece. The Dutch created a futures market for tulips that enabled traders to purchase and trade contracts to buy bulbs at the end of the season. At the peak, tulips could be traded several times a day without any physical tulips actually being exchanged or either party ever having any intention of planting the bulbs.

Then in February 1637, buyers vanished. Some suspect an outbreak of the bubonic plague as the cause, some a change in demand caused by war in Europe. Any way you look at it, the sentiment for the future price of tulip bulbs took a big U-turn, leaving many investors ruined.[1]

11.1.13_Raupp_Sentiment_1History is full of similar episodes, where investor sentiment got to extreme levels and prices diverged meaningfully from the underlying fundamental value of something, be it stocks, real estate, currency, or even tulip bulbs. Most recently the dot-com bubble in the early 2000s and the housing bubble in 2008 proved that speculation is alive and well.

While periods of extreme sentiment are easy to identify in retrospect, they’re anything but obvious while you’re in them. And while extreme levels of sentiment usually result in big price reversals, more modest levels can mark periods when the market is overbought or oversold, often followed by a market pull-back or rally. Recently, Robert Shiller of Yale University won the Nobel Prize in Economics for his work on irrational markets.

11.1.13_Raupp_Sentiment_2So how can you gauge sentiment? Some of the more popular ones are the Consumer Confidence Index and the Michigan Consumer Sentiment Index, which both try to gauge consumer’s attitudes on a variety of things, including future spending, the business climate, and their level of optimism or pessimism. More direct, and generally more volatile, are the AAII Investor Sentiment Survey and the Wells Fargo/Gallup Investor and Retirement Optimism Index, which ask investors directly about their thoughts on investments. It doesn’t end there. Investors watch Closed-End Fund discounts, Put/Call ratios, even tracking the occurrence of certain words or phrases in the media. In addition, many firms create their own blend of surveys and indexes to best gauge the overall sentiment level.

Sentiment certainly isn’t the be-all, end-all for trading your portfolio. There’s a saying that is attributed to John Maynard Keynes, “The market can remain irrational longer than you can remain solvent.” When sentiment starts moving in one direction, it’s hard to say when the reversal will occur and what will cause it. But knowing where sentiment levels are at any given time can help you get a better understanding of what markets have been doing and what to expect going forward.


[1] Mackay, Charles (1841), Extraordinary Popular Delusions and the Madness of Crowds, London: Richard Bentley, archived from the original on March 31, 2008.

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.

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