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.

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 – June 6, 2014

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded June 5, 2014): Bill reacts to the long-awaited policy change announcement from Mario Draghi, president of the European Central Bank.

What we like: Announcement met or exceeded expectations; lower interest rates; bank lending stimulated; a wide variety of positives overall

What we don’t like: Didn’t deliver the “helicopter”; fell short of establishing a program to buy securities, similar to quantitative easing

What we are doing about it: Leaning towards a more bullish posture in Europe; looking at emerging market companies that would benefit from the lower interest rates

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: April 2014

Amy MagnottaAmy Magnotta, CFA, Senior Investment Manager, Brinker Capital

The full quarter returns masked the volatility risk assets experienced during the first three months of the year. Markets were able to shrug off geopolitical risks stemming from Russia and the Ukraine, fears of slowing economic growth in the U.S. and China, and a transition in Federal Reserve leadership. In a reversal of what we experienced in 2013, fixed income, commodities and REITs led global equities.

The U.S. equity market recovered from the mild drawdown in January to end the quarter with a modest gain. S&P sector performance was all over the map, with utilities (+10.1%) and healthcare (+5.8%) outperforming and consumer discretionary (-2.9%) and industrials (+0.1%) lagging. U.S. equity market leadership shifted in March. The higher growth-Magnotta_Market_Update_4.10.14momentum stocks that were top performers in 2013, particularly biotech and internet companies, sold off meaningfully while value-oriented and dividend-paying companies posted gains. Leadership by market capitalization also shifted as small caps fell behind large caps.

International developed equities lagged the U.S. markets for the quarter; however, emerging market equities were also the beneficiary of a shift in investor sentiment in March. The asset class gained more than 5% in the final week to end the quarter relatively flat (-0.4%). Performance has been very mixed, with a strong rebound in Latin America, but with Russia and China still weak. This variation in performance and fundamentals argues for active management in the asset class. Valuations in emerging markets have become more attractive relative to developed markets, but risks remain which call into question the sustainability of the rally.

After posting a negative return in 2013, fixed income rallied in the first quarter. The yield on the 10-year U.S. Treasury note fell 35 basis points to end the quarter at 2.69% as fears of higher growth and inflation did not materialize. After the initial decline from the 3% level in January, the 10-year note spent the remainder of the quarter within a tight range. All fixed income sectors were positive for the quarter, with credit leading. Both investment-grade and high-yield credit spreads continued to grind tighter throughout the quarter. Within the U.S. credit sector, fundamentals are solid and the supply/demand dynamic is favorable, but valuations are elevated, especially in the investment grade space. We favor an actively managed best ideas strategy in high yield today, rather than broad market exposure.

While we believe that the long-term bias is for interest rates to move higher, the move will be protracted. Fixed income still plays an important role in portfolios as protection against equity market volatility. Our fixed income positioning in portfolios—which includes an emphasis on yield-advantaged, shorter-duration and low-volatility absolute return strategies—is designed to successfully navigate a rising or stable interest rate environment.

Magnotta_Market_Update_4.10.14_2We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we begin the second quarter, 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. In addition, the ECB stands ready to provide support if necessary, and the Bank of Japan continues its aggressive monetary easing program.
  • Global growth stable: U.S. economic growth has been slow and steady. While the weather appears to have had a negative impact on growth during the first quarter, we still see pent-up demand in cyclical sectors like housing and capital goods. 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 6.7%.
  • Inflation tame: With the CPI increasing just +1.1% over the last 12 months and core CPI running at +1.6%, inflation is below the Fed’s 2% target. Inflation expectations are also tame, providing the Fed flexibility to remain accommodative.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets with cash that could be reinvested, used for acquisitions, or returned to shareholders. 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. Congress agreed to both a budget and the extension of the debt ceiling. The deficit has also shown improvement in the short term.
  • Equity fund flows turned positive: Continued inflows would provide further support to the equity markets.

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

  • Fed tapering/tightening: If the Fed continues at its current pace, quantitative easing should end in the fourth quarter. Historically, risk assets have 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 economic growth and inflation pick up, market participants may become more concerned about the timing of the Fed’s first interest rate hike.
  • 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.
  • Emerging markets: Slower growth and capital outflows could continue to weigh on emerging markets. While growth in China is slowing, there is not yet evidence of a hard landing.
  • 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. Valuations have certainly moved higher, but are not overly rich relative to history, and may even be reasonable when considering the level of interest rates and inflation. Credit conditions still provide a positive backdrop for the markets.

Magnotta_Market_Update_4.10.14_3

Source: Brinker Capital

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.

Data points above compiled from FactSet, Standard & Poor’s, MSCI, and Barclays. The views expressed are those of Brinker Capital and are for informational purposes only. Holdings subject to change.

Investment Insights Podcast – January 24, 2014

Investment Insights PodcastBill Miller, Chief Investment Officer

On this week’s podcast (recorded January 23, 2014):

  • What we like: Strong manufacturing data out of Europe; Global synchronized recovery.
  • What we don’t like: High-sentiment indicators; global markets fairly valued, but need to see faster growth to drive equity prices higher; China slowing
  • What we are doing about it: Minor hedging in some portfolios; buying in the U.S. and European markets; looking at underlying global synchronized recovery as powerful force.

Click the play icon below to launch the audio recording.

The views expressed are those of Brinker Capital and are for informational purposes only. Holdings are subject to change.

Demographic Changes Looming (Part Two)

10.17.13_BlogRyan Dressel, Investment Analyst, Brinker Capital

Part two of a two-part blog series. Head here to read part one.

Urbanization
Another noticeable change has been the amount of people living in urban versus rural areas.  The world is undergoing the largest wave of urban growth in history.  For the first time in history, more than half of the world’s population lives in towns or cities.[1]  In 1970, 73.6% of the population lived in urban areas in the U.S., compared to 79% in 2012.  In China, the shift has been even greater; 51% of people live in urban areas today, compared to just 20.6% in 1982.  Other major nations have experienced similar degrees of urbanization (percentage of population living in urban areas below)[2]

10.17.13_Demographics_Part2

Cities provide numerous economic benefits and challenges; some of which include: entrepreneurialism, education opportunities, traffic congestion, pollution, and poverty to name a few.  Perhaps the biggest challenge as a result of this trend will be a spike in food, water and commodity prices, which are already high.[3][4]  Some Governments, scientists and environmentalists are already working on solutions to these problems (such as China’s plan for a massive new desalination plant[5]), but in many areas resources are limited and solutions are inefficient on a large scale.

Wealth Inequality
Finally, the trend of wealth inequality in the United States is approaching an all-time high.  For perspective, in 1928 the top 1% of the population earned nearly 20% of all income.  The wealth gap was at its lowest in the 1960s and 1970s, but has been steadily widening since then.

Demographics_Part2

This trend has been made public in the U.S. as demonstrated by the Occupy Wall Street movement in 2012.  Regardless of your opinion surrounding the subject, wealth inequality has created noticeable economic challenges.

Some of the nationwide problems associated with wealth inequality include deteriorating health,[6] the potential for corruption (in many different facets), and a relatively weaker middle class which has historically fueled the most economic growth in the U.S.

The income gap has been blamed on everything from computers, to immigration, to global competition, but simply stated there is no clear consensus regarding the cause.[7]  This needs to be kept in mind by investors, economists and especially politicians before we spend public dollars on initiatives that aren’t effective at reducing the problems previously mentioned.

These changing demographic trends will no doubt provide challenges, but can also present exciting opportunities for generations to come if they are properly prepared for.


[1] The United nations Population Fund.  http://www.unfpa.org/pds/urbanization.htm  May, 2007.

[2] Population Reference Bureau, 2012 World Population Data Sheet, 2012.

[4] New York Times Online.  http://www.nytimes.com/2006/08/22/world/22water.html?_r=0  Celia Dugger. August 22, 2006.

[5] China Daily.  http://usa.chinadaily.com.cn/china/2011-04/09/content_12298084.htm  Cheng Yingqi.  September 4, 2011.

[6] American Medical Association.  http://www.who.int/social_determinants/publications/health_in_an_unequal_world_marmott_lancet.pdf Michael Marmot.  December 9, 2006.

[7] The Great Divergence.  Timothy Noah,  2012

Demographic Changes Looming (Part One)

10.17.13_BlogRyan Dressel, Investment Analyst, Brinker Capital

This is part one in a two-part blog series.

In 2013, it seems the financial headlines have been dominated lately by policy changes of the Federal Reserve, dysfunction in Washington, China’s threat of a hard economic landing, or Europe’s ongoing sovereign debt crisis.  Lost in these headlines are some major demographic trends that are already under way, or are looming on the horizon over the next decade.  Many of these changes will have a profound impact on investors, governments and societies in the United States and abroad.

Aging Population

The world’s developed countries are aging quite quickly.  As of the most recent 2010 census, the median age in the U.S. is 37.1, compared to 28.2 in 1970.  This is actually fairly low in comparison to some of the world’s other developed nations.

10.17.13_Demographics_Part1

This is not a huge surprise as the baby boomer generation is reaching middle age.  It does, however, have some large implications that need to be watched closely by investors, companies and governments over the next decade.

What implications does this trend have for the U.S. and abroad?  For starters, an aging population will put a large strain on healthcare costs as the number of people who need access Medicare increases.  A study by Health Affairs cites aging population as a main driver of rising health care cost forecasts.  It projects national health care spending to grow at an average annual rate of 5.8% over the 2012 – 2022 period (currently near 4% in 2013).  By 2022 health care spending financed by federal, state, and local governments is projected to account for 49% of total national health expenditures and to reach a total of $2.4 trillion.[1]

Second, smaller subsequent generations (Gen X, Gen Y) will have to increase productivity to maintain the current low, single-digit GDP growth in the United States.  The responsibilities of the baby boomer generation upon retirement will naturally have to be absorbed by younger generations.  A 2013 study released by the Georgetown Center on Education and the Workforce (CEW) indicates that this trend is already occurring. It cites that there are more job openings created as a result of retirements today than in the 1990s.[2] The U.S. can fuel this productivity by increasing competitiveness in manufacturing, and using competitive advantages such as low energy costs and technological advancements.

Third, an increased focus will be put on fixed income and absolute return investment strategies, especially if the U.S is entering a rising interest-rate environment as many economists believe.  As populations age, their risk tolerance will naturally decrease as people need to plan for their years in retirement.  In 2012, only 7% of households aged 65 or older were willing to take above-average or substantial investment risk, compared to 25% of households in which the household head was between 35-49 years old.  Despite a growing life expectancy, the retirement age is still 65. This has major causes for concern for social security, capital gains tax policies, and corporate pension plans.  Subsequent generations will need to place an increased importance on individual retirement saving should the program terms change, or disappear altogether.

Part two of this blog will look at two additional trends of urbanization and wealth inequality.


[1] Health Affairs.  National Health Expenditure Projections, 2012 – 22: Slow Growth Until Coverage Expands and Economy Improves. September 18, 2013.

[2] Georgetown Center on Education and the Workforce.
http://cew.georgetown.edu/failuretolaunch/. September 30, 2013.

Monthly Market and Economic Outlook: September 2013

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

The U.S. equity markets experienced a modest pullback in August, with a -2.9% decline in the S&P 500 Index, fueled by concern over the anticipated Fed tapering of asset purchases as well as a U.S.-led military strike on Syria. However, the index is still up +16.2% through August, the best start since 2003.

International equity markets fared better than U.S. markets in August despite the headwind of a stronger U.S. dollar.  So far this year, the return of developed international equities has been about half of the S&P 500 return while emerging market equities have declined -8.8%.  Both Brazil and India have experienced declines of more than -20.0%, suffering from significantly weaker currencies and slowing growth.

Fixed income outperformed equities in August on a relative basis, but the Barclays Aggregate Index still fell -0.5%.  Interest rates continued their move higher, and the yield curve steepened further. The yield on the 10-year U.S. Treasury note has increased 140 basis points from a low of 1.6% in early May, to 3% on September 5, fueled by the Fed’s talk of tapering asset purchases.  The technicals in the fixed income market have deteriorated markedly.  The rise in rates has not yet lost momentum, and investor sentiment has turned, causing large redemptions in fixed income strategies. Our portfolios remain positioned in defense of rising interest rates, with a shorter duration, emphasis on spread product and a healthy allocation to low volatility absolute return strategies.

Interest rates are normalizing from artificially low levels, but still remain low on a historical basis.  Despite slowing or ending 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. In addition, the fundamentals in certain areas of fixed income strategies, including non-Agency MBS, high-yield credit and emerging-market credit, look attractive.

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 to move high enough to stall the housing market recovery, it would be a negative for economic growth.

Outside of the housing market, the U.S. economy continues to grow at a modest pace.  Initial jobless claims, a leading indicator, have continued to decline.  Both the manufacturing and service PMIs have moved further into expansion territory. U.S. companies remain in solid shape and valuations do not appear stretched. M&A activity has picked up. Global economic growth is also showing signs of improvement, in Europe, Japan and even China.

However, risks do remain.  In addition to the major risk of interest rates that move too high too fast, the markets are anticipating the end of the Fed’s quantitative easing program.  Should the Fed follow through in reducing monetary policy accommodation, it will do so in the context of an improving economy.  Washington will again provide volatility generating headlines as we approach deadlines for the budget and debt ceiling negotiations.  However, unlike in previous years, there is no significant fiscal drag to be addressed.  In addition, the nomination of a new Fed Chairman and geopolitical risks (Syria) are of concern.  The market may have already priced in some of these risks.

Risk assets should do well if real growth continues to recover despite the higher interest rate environment; however, we expect continued volatility in the near term. As a result, in our strategic portfolios we remain slightly overweight to risk.  We continue to seek high conviction opportunities and strategies within asset classes.

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

 Asset Class Returns9.6.13_Magnotta_MarketOutlook

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
8.8.13_Magnotta_AugustOutlook_3

Monthly Market and Economic Outlook – July 2013

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

Risk assets were off to a decent start in the second quarter but then retreated after Federal Reserve Chairman Ben Bernanke’s testimony to Congress on May 22 laid the ground work for a reduction in monetary policy accommodation through tapering their asset purchases as early as September. While the U.S. equity markets were able to end the quarter with decent gains, developed international markets were relatively flat and emerging markets experienced sizeable declines. Weaker currencies helped to exacerbate these losses.

After starting to move higher in May, interest rates rose sharply in June and into early July, helped by the fears of Fed tapering. The yield 10-year U.S. Treasury has increased 100 basis points over the last two months to a level of 2.64% (through 7/10). The increase in rates was all in real terms as inflation expectations fell. Bonds experienced their worst first half of the year since 1994, in which we experienced four short-term rate hikes before June 30.

7.12.13_Magnotta_MarketOutlook_2While we have seen these levels of rates in the recent past (we spent much of the 2009-2011 period above these levels), the sharpness of the move may have been a surprise to some fixed income investors who then began to de-risk portfolios. In June, higher-risk sectors like investment-grade credit, high-yield credit and emerging market debt, as well as longer duration assets like TIPS, fared the worst. With growth still sluggish and inflation low, we expect interest rates to remain relatively range-bound over the near term; however, we do expect more volatility in the bond market. 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, emphasis on spread product and a healthy allocation to low volatility absolute return strategies.

After weighing on the markets in June, investors have begun to digest the Fed’s plans to taper asset purchases at some point this year. 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.

7.12.13_Magnotta_MarketOutlook_3We 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 scale back on asset purchases short-term interest rates will remain low), 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. This liquidity has helped to boost markets.
  • 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. Monthly payroll gains over the last three months have averaged 196,000 and the unemployment rate has fallen to 7.6%. The most recent employment report also showed gains in average hourly earnings.
  • Housing market improvement: An improvement in housing, typically a consumer’s largest asset, is a boost to net worth, and as a result, consumer confidence. However, a significant move higher in mortgage rates, which are now above 4.5%, 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:

  • 7.12.13_Magnotta_MarketOutlook_4Fed 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: 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. A recent spike in the Chinese interbank lending market is cause for concern.

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, dividend growers, financial healing (housing, autos)
  • 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

Asset Class Returns
7.12.13_Magnotta_MarketOutlook_1