Update on Impact of Russia/Ukraine Conflict on Financial Markets

Stuart P. Quint, CFA, Senior Investment Manager and International Strategist

A past blog in March had commented on several scenarios of how the unrest in Ukraine could play out and the potential implications of those scenarios on financial assets.  Given the crash of the Malaysian airliner over Ukraine, an update seems appropriate.

We remain of the view that the conflict in Ukraine should have a limited impact but likely a longer timeframe to play out, potentially with risks to the downside.  Downside risks would materialize in the event of an overt Russian invasion or further separatist activity in other parts of Ukraine.

We mentioned 3 areas of potential impact: (1) fixed income, (2) commodity prices (particularly energy), and (3) emerging markets.  European equities could also be affected if tensions were to spiral and/or more serious economic sanctions were taken.

Fixed income (as measured by the Barclay’s Aggregate Total Return Index) has rallied nearly 2% since that time.  One factor in the continued rally might stem from risk aversion driven by geopolitical tensions.  However, fixed income has lagged the rally in riskier asset classes such as domestic and international equities.

Energy has staged a modest gain from March to July in spite of ongoing tensions between Russia and Ukraine.  This modest impact comes in spite of not only Russian tension, but also ethnic tensions in Israel and Iraq, also a major oil producer.  Energy markets have been complacent about rising supply sources from elsewhere, including the United States, along with muted demand from many emerging markets and Europe.  Any increase in political tensions along with improved economic growth in the US and more energy-intensive emerging markets could presage an increase in energy prices.

Gold, another traditional safe harbor asset, has actually declined over -2% over this time period.

Emerging market equities have rallied strongly (over +12% during this time period), though Russian equities lagged this gain.  Select continental European equity markets such as Germany and France have been flat and lagged performance of other equity markets, suggesting a slight negative impact from uncertainty in Ukraine.

Barring a major spiraling in tensions, we would expect economic and market fundamentals to be the overwhelming drivers of asset performance rather than geopolitical tensions out of Ukraine.

 

Monthly Market and Economic Outlook: July 2014

Amy Magnotta, CFA, Senior 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 stronger 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 Magnotta, CFA, Senior 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.

As 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 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 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-momentum 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.

We 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.

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 – Unrest in Ukraine and Investment Implications

Stuart P. Quint, CFA, Senior Investment Manager and International Strategist

Stuart joins us this week to share some comments on the developing situation in Ukraine and its impact on investors.  Click the play button below to listen in to his podcast, or read a summarized version of his thoughts below.

Podcast recorded March 3, 2014:

Ukraine’s struggles are overwhelming. Political, economic, and now military challenges confront the country. Politically and militarily speaking, the U.S. and the European Union (EU) have few tools at this time and modest willpower to oppose Russian intentions in Ukraine. And given that the ruling government is merely a caretaker for the May elections, it seems unlikely there will be a bailout package offered by the International Money Fund (IMF) any time soon. Default on existing international and local obligations appears likely in the near term.

Russia is not without its own constraints, though, as the Russian economy is directly tied to Europe. Three out of every four dollars of foreign direct investment in Russia come from Europe.[1]  The EU also remains Russia’s most important trading partner with 55% of Russian exports destined for Europe.[2]

Let’s take a look at the potential scenarios: (1) Russian annexation of the Crimea, (2) negotiated settlement with later elections that would most likely bring about a grand coalition government, probably with leanings toward Moscow, and (3) military escalation (civil war, Russian forces occupy eastern Ukraine, either of which results in a smaller Ukraine or outright disintegration as a sovereign state).

So what investment implications might this have? (1) The near term is helpful for fixed income, with commodities benefiting from any disruption of supply (oil, gas) and flight to safety (gold), and (2) negative impact most of all for European (Russia supplies 30% of European gas supply[3]) and emerging markets (mainly Russia, but also other markets with the need to import capital could suffer from currency weakness and higher interest rates demanded by investors).

A negotiated settlement involving recognition of Russian claims in exchange for a roadmap to stabilize the rest of Ukraine would reverse many of these trends.  Indeed, a similar situation occurred when Russia invaded Georgia in August 2008, but the crisis in Ukraine has potentially more serious implications given its proximity to Western Europe and that it carries a large population of over 45 million people.[4]

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

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[1] http://ec.europa.eu/trade/policy/countries-and-regions/countries/russia/
[2] Ibid
[3] http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Energy_production_and_imports
[4] http://data.worldbank.org/indicator/SP.POP.TOTL

Investment Insights Podcast – February 24, 2014

Bill Miller, Chief Investment Officer

On this week’s podcast (recorded February 20, 2014), we deviate from the traditional what we like, we don’t like, and what we’re doing about it format.

We currently find ourselves in an environment with remarkably stable prices as measured by inflation. A period that matches some of the same sentiments echoed by Warren Buffet in his 1980 Berkshire Hathaway annual report.

Often we hear bad things about emerging markets, Congress, Fed policy, etc., but we may be missing the forest for the trees. The 1970s, a period when prices were rising quickly and investors struggled to keep pace, offers an interesting perspective on today’s environment.

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.

Investment Insights Podcast – February 12, 2014

Bill Miller, Chief Investment Officer

On this week’s podcast (recorded February 11, 2014, prior to Janet Yellen’s first public statements since being sworn in):

• What we like: Emerging markets have quieted down; Improvement in the equity markets around the world, including the U.S.

• What we don’t like: Questions on how fast the global economies are growing

• What we are doing about it: We are hedged, but looking to remove hedges; tactical approach to Janet Yellen’s comments

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.

Monthly Market and Economic Outlook: February 2014

Amy Magnotta, CFA, Senior Investment Manager, Brinker Capital

After such a strong move higher in 2013, U.S. equity markets took a breather in January as the S&P 500 Index fell -3.5%. Volatility returned to the markets as concerns over the impact of Fed tapering and emerging economies weighed on investors. Investor sentiment, a contrarian indicator, had also climbed to extreme optimism levels, leaving the equity markets ripe for a short-term pullback.

In U.S. equity markets, the utilities (+3%) and healthcare (+1%) sectors delivered gains, while energy and consumer discretionary each declined -6%. Mid caps led both small and large caps in January, helped by the strong performance of REITs. Fourth quarter 2013 earnings season has been decent so far. Of the one-third of S&P 500 companies reporting, 73% have beat expectations.

U.S. equity markets led international markets in January, helped by a stronger currency. Performance within developed markets was mixed, with peripheral Europe outperforming (Ireland, Italy, Spain, Portugal), while Australia, France and Germany lagged.

Emerging markets equities significantly lagged developed markets in January, as the impact of Fed tapering, slower economic growth and higher inflation weighed on their economies. Countries with large current account deficits have seen their currencies weaken significantly. Latin America saw significant declines, with Argentina down -24%, Chile down -12% and Brazil down -11%. Asia fared slightly better, with the region down less than -5%. Emerging Europe was dragged lower with double-digit losses in Turkey.

Fixed income had a solid month of performance as interest rates fell across the yield curve. The 10-year Treasury note is now trading around 2.6%, 40 basis points lower than where it started the year. The Barclays Aggregate Index gained +1.5% in January, its best monthly return since July 2011. All major sectors were in positive territory for the month; however, higher-quality corporates led high yield. Municipal bonds edged out taxable bonds and continue to benefit from improving fundamentals.

We believe that the bias is for interest rates to move higher, but it will likely be choppy. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome. Despite rising rates, fixed income still plays a role in portfolios, as a hedge to equity-oriented assets if we see weaker economic growth or major macro risks as experienced in January. 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.

We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into 2014, with a number of factors supporting the economy and markets over the intermediate term.

• Monetary policy remains accommodative: Even with the Fed beginning to taper asset purchases, short-term interest rates should remain near zero until 2015. In addition, the ECB stands ready to provide support, and the Bank of Japan has embraced an aggressive monetary easing program in an attempt to boost growth and inflation.
• Global growth strengthening: U.S. economic growth has been slow and steady, but momentum picked up in the second half of 2013. 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 stable. Monthly payroll gains have averaged more than 200,000, and the unemployment rate has fallen to 7%.
• Inflation tame: With the CPI increasing +1.5% over the last 12 months, inflation in the U.S. is running below the Fed’s target.
• Increase in Household Net Worth: Household net worth rose to a new high in the third quarter, helped by both financial and real estate assets. Rising net worth is a positive for consumer confidence and future consumption.
• U.S. companies remain in solid shape: U.S. companies have solid balance sheets with cash that could be reinvested, returned to shareholders, or used for acquisitions. Corporate profits remain at high levels and margins have been resilient.
• Equity fund flows turned positive: Equity mutual funds have experienced inflows over the last three months while fixed income funds have experienced significant outflows, a reversal of the pattern of the last five years. Continued inflows would provide further support to the equity markets.
• Some movement on fiscal policy: After serving as a major uncertainty over the last few years, there seems to be some movement in Washington. Fiscal drag will not have a major impact on growth next year. All parties in Washington were able to agree on a two-year budget agreement, averting another government shutdown. However, the debt ceiling still needs to be addressed.

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

• Fed Tapering: The Fed will begin reducing the amount of their asset purchases in January, and if they taper an additional $10 billion at each meeting, QE should end in the fall. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, the economy appears to be on more solid footing this time and the withdrawal is more gradual. The reaction of emerging markets to Fed tapering is cause for concern and will contribute to higher market volatility.
• 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.

Risk assets should continue to perform if real growth continues to recover; however, we could see volatility as markets digest the slow withdrawal of stimulus by the Federal Reserve. Valuations have certainly moved higher, but are not overly rich relative to history. There are even pockets of attractive valuations, such as emerging markets. We are not surprised that we have experienced a pull-back in equity markets to start the year as investor sentiment was elevated and it had been an extended period of time since we last experienced a correction. However, we expect it to be more short-term in nature and maintain a positive view on equities for the year.

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

Asset Class Returns

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

Investment Insights Podcast – February 7, 2014

Bill Miller, Chief Investment Officer

On this week’s podcast (recorded February 6, 2014):

• What we like: Stability in emerging market currencies; European Central Bank fighting deflation

• What we don’t like: Hypersensitivity to growth metrics

• What we are doing about it: Letting natural hedging between asset classes manage volatility; remaining neutral in other portfolios; looking for a good employment number

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.