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

Investment Insights Podcast – June 26, 2014

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded June 19, 2014):

What we like: A string of good economic news; earnings season looks strong; expectations rising; Fed tapering showing that they are being reasonable about their exit

What we don’t like: Fed seems to be ignoring the increased inflation

What we are doing about it: Emphasis on real assets; watchful of a summer correction.

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.

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.

2013 Review and Outlook

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

2013 was a stellar year for U.S. equities, the best since 1997. Despite major concerns relating to the Federal Reserve (tapering of asset purchases, new Chairperson) and Washington (sequestration, government shutdown, debt ceiling), as well as issues like Cyprus and Syria, the U.S. equity markets steadily rallied throughout the year, failing to experience a pullback of more than 6%.

Source: Strategas Research Partners, LLC

In the U.S. markets, strong gains were experienced across all market capitalizations and styles, with each gaining at least 32% for the year. Small caps outperformed large caps and growth led value. Yield-oriented equities, like telecoms and utilities, generally lagged as they were impacted by the taper trade. The strongest performing sectors—consumer discretionary, healthcare and industrials—all gained more than 40%. Correlations across stocks continued to decline, which is a positive development for active managers.

YenDeveloped international markets produced solid gains for the year, but lagged the U.S. markets. Japan was the top performing country, gaining 52% in local terms; however, the gains translated to 27% in U.S. dollar terms due to a weaker yen. Performance in European markets was generally strong, led by Ireland, Germany and Spain.  Australia and Canada meaningfully lagged, delivering only mid-single-digit gains.

Concerns over the impact of Fed tapering and slowing economic growth weighed on emerging economies in 2013, and their equity markets significantly lagged that of developed economies. The group’s loss of -2.2% was exacerbated due to weaker currencies, especially in Brazil, Indonesia, Turkey and India. Emerging market small cap companies were able to eke out a gain of just over 1%, while less efficient frontier markets gained 4.5%.

Fixed income posted its first loss since 1999, with the Barclays Aggregate Index experiencing a decline of -2%. The yield on the 10-year U.S. Treasury began rising in May, and moved significantly higher after then Federal Reserve Chairman Bernanke signaled in his testimony to Congress that tapering of asset purchases could happen sooner than anticipated. The 10-year yield hit 3% but then declined again after the Fed decided not to begin tapering in September. It climbed steadily higher in November and December, ending the year at 3.04%—126 basis points above where it began the year.

TIPS were the worst performing fixed income sector for the year, declining more than -8%, as inflation remained low and TIPS have a longer-than-average duration. On the other hand, high-yield credit had a solid year, gaining more than 7%. Across the credit spectrum, lower quality outperformed.

Magnotta_Client_Newsletter_1.7.13_5We believe that the bias is for interest rates to move higher, but it will likely come in fits and starts. 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. 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 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 begin 2014, with a number of factors supporting the economy and markets.

  • Monetary policy remains accommodative: Even with tapering beginning in January, short-term interest rates should remain near zero until 2015. In addition, the European Central Bank 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 has picked up (+4.1% annualized growth in 3Q). The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S., growth has not been very robust but 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 only +1.2% 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 that are flush 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 turn 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 in January. 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.
  • Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery. Should mortgage rates move higher, it could jeopardize the recovery in the housing market.
  • Sentiment elevated: Investor sentiment is elevated, which typically serves as a contrarian signal. The market has not experienced a correction in some time.

Risk assets should continue to perform if real growth continues to recover, even in a higher interest rate environment; however, we 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. Markets rarely stop when they reach fair value. There are even pockets of attractive valuations, such as emerging markets. Momentum remains strong; the S&P 500 Index spent all of 2013 above its 200-day moving average. However, investor sentiment is elevated, which could provide ammunition for a short-term pull-back. A pull-back could be short-lived should demand for equities remain robust.

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.

Asset Class ReturnsAsset Class Returns

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.

High Profit Margins Outlook in 2014

Miller, Bill 2Bill Miller, Chief Investment Officer

Throughout this year, we have been in the camp that profit margins would not mean-revert.  Better measures of labor and manufacturing productivity, technology improvements and cheaper imports have all helped profits.  As the chart below shows, that was the case in the third quarter.  In 2014, we expect margins to remain persistently high.

The big three—productivity, technology and cheap imports—should help again next year.  Plus, we do not see excesses in business investment, inventory or debt (personal or commercial) in 2014.

Persistently high profit margins should help equities in 2014.

S&P 500 Operating Margins (Quarterly)

Source: International Strategy & Investment (ISI) Group LLC

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

Monthly Market and Economic Outlook: December 2013

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

U.S. equities continued to climb higher in November, with major indexes gaining between 2% and 4% for the month. Year to date through November, the S&P 500 Index has posted an impressive gain of 29.1%, while the small cap Russell 2000 Index has fared even better with a return of 36.1%. The last five years have proved to be a very good time to be invested in equity markets, with a cumulative return of 125% for the S&P 500 Index.

International developed equity markets posted small gains in November, and have failed to keep up with U.S. equity markets this year. In Japan, Prime Minister Abe’s policies have spurred risk taking, but the currency has also weakened. The European equity markets have benefited from economies and a financial system that are on the mend. Emerging markets continued to struggle in November and are negative year to date. Concerns over the impact of Fed tapering on emerging economies, as well as slower economic growth, have weighed on the asset class this year.

Interest rates have remained range-bound after the spike in the summer in response to Bernanke’s initial talk of tapering. The 10-year Treasury ended November at a level of 2.75%, just 10 basis points higher than where it began the month. Fixed income is still negative for the year-to-date period; the Barclays Aggregate was down -1.5% through November. However, high-yield credit has had a solid year so far, gaining close to 7%. We believe that the bias is for interest rates to move higher, but it will likely come in fits and starts.

12.13.13_Magnotta_MarketOutlook_2The Fed will again face the decision to taper asset purchases at their December meeting, and we expect volatility in risk assets and interest rates surrounding this decision, just as we experienced in the second quarter.  The recent economic data has surprised to the upside; however, inflation remains below the Fed’s target level. Despite their decision to reduce or end asset purchases, the Fed has signaled short-term rates will be on hold for some time. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome.

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

  • Monetary policy remains accommodative: The Fed remains accommodative (even with the eventual end of asset purchases, short-term interest rates will remain near-zero until 2015), the European Central Bank has provided additional support through a rate cut, and the Bank of Japan has embraced an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Global growth strengthening: U.S. economic growth has been steady and recently showing signs of picking up. The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S., growth has not been very robust, but it is positive.
  • Labor market progress: The recovery in the labor market has been slow, but stable. Monthly payroll gains have averaged more than 200,000 and the unemployment rate has declined.
  • Inflation tame: With the CPI increasing only +1% over the last 12 months, inflation in the U.S. has been running below the Fed’s target level.
  • Increase in household net worth: Household net worth rose to a new high in the third quarter, helped by both financial and real estate assets. Rising net worth is a positive for consumer confidence and future consumption.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.
  • Equity fund flows turn positive: Equity mutual funds have experienced inflows over the last two months while fixed income funds have experienced significant outflows, a reversal of the patter of the last five years. Continued inflows would provide further support to the equity markets.
  • Some Movement on Fiscal Policy: After serving as a major uncertainty over the last few years, there seems to be some movement in Washington. Fiscal drag will not have a major impact on growth next year. It looks like Congress may sign a two-year budget agreement, averting another government shutdown in January. However, the debt ceiling still needs to be addressed.

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

  • Fed Tapering: The markets are anxiously awaiting the Fed’s decision on tapering asset purchases, prompting further volatility in asset prices and interest rates. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, the economy appears to be on more solid footing.
  • Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery. Should mortgage rates move higher, it could jeopardize the recovery in the housing market.
  • Sentiment elevated: Investor sentiment is elevated, which typically serves as a contrarian signal. The market has not experienced a correction in some time.

Risk assets should continue to perform if real growth continues to recover even in a higher interest rate environment; however, we expect continued volatility in the near term as we await the Fed’s decision on the fate of quantitative easing. Despite the strong run, valuations for large cap U.S. equities still look reasonable on a historical basis by a number of measures. Valuations in international developed markets look relatively attractive as well, while emerging markets are more mixed. Momentum remains strong; the S&P 500 Index has spent the entire year above its 200-day moving average. However, investor sentiment is elevated, which could provide ammunition for a short-term pull-back surrounding the Fed’s tapering decision.

12.13.13_Magnotta_MarketOutlook_1

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

Asset Class Returns:12.13.13_Magnotta_MarketOutlook

Monthly Market and Economic Outlook: October 2013

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

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

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

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

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

We believe that interest rates have begun the process of normalization, and over the long term, the bias is for higher interest rates.  However, this process will be prolonged and likely characterized by fits and starts. The Fed will soon face the decision to taper asset purchases again later this year, with the earliest action in December.  Despite their decision to reduce or end asset purchases, the Fed has signaled short-term rates will be on hold for some time. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome. Our fixed income allocation is well positioned with less interest-rate risk and a yield premium versus the broad market.

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

We continue to approach our broad macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into the final months of the year, and a number of factors should continue to support the economy and markets.

  • Monetary policy remains accommodative: The Fed remains accommodative (even with the eventual end of asset purchases, short-term interest rates will remain low for the foreseeable future), the ECB stands ready to provide additional support if necessary, and the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Global growth strengthening: U.S. economic growth has been sluggish, but steady.  The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S. growth has not been very robust, but it is positive. China appears to have avoided a hard landing.
  • Labor market progress: The recovery in the labor market has been slow, but stable. Initial jobless claims, a leading indicator, have declined to a new cycle low.
  • Housing market improvement: The improvement in home prices, typically a consumer’s largest asset, boosts net worth, and as a result, consumer confidence.  However, another move higher in mortgage rates could jeopardize the recovery.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.

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

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

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

Some areas of opportunity currently include:

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

Asset Class Returns10.9.13_Magnotta_MarketOutlook

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

Quagmire

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The drums of war, which resounded so strongly from our nation’s Capital during the past few weeks, have quickly been muffled by the possibility of a relinquishment of the Syrian government’s chemical weapons stockpile to an international force.  The hastily, cobbled-together diplomatic effort led by the Russian government is dangerously scant on detail, but has offered, as German Chancellor Angela Merkel observed on Wednesday, “a small glimmer of hope” that these weapons of mass destruction can be seized peacefully (New York Times). The delay, and possible aversion of a military strike by the United States, brought about by this development has temporarily allayed tensions around the world and added strength to the current rally that has brought equities in the United States back within sight of the historic heights reached earlier this year.

9.13.13_Pressier_Quagmire_2The long march of the United States back toward armed conflict in yet another nation in the Middle East began with Secretary of State, John Kerry’s emphatic denunciation of the heinous chemical weapons attack perpetrated by the Syrian Government on August 21, which killed an estimated 1,429 people including at least 426 children (New York Times).  Mr. Kerry was quoted as saying, “the indiscriminate slaughter of civilians, the killing of women and children and innocent bystanders by chemical weapons is a moral obscenity…And there is a reason why no matter what you believe about Syria, all peoples and all nations who believe in the cause of our common humanity must stand up to assure that there is accountability for the use of chemical weapons so that it never happens again” (Wall Street Journal). The possibility of American intervention sparked a precipitous decline in stocks listed around the world, with those in the emerging markets having been sold particularly aggressively, as fears of a spillover into a broader regional conflict containing the potential to disrupt the price of crude oil, weighed on investors.

The unprecedented vote by the British Parliament on August 29 to decline the government’s request for an authorization of military force (Telegraph U.K.), began a tentative rebound in global equities, which was furthered by President Obama’s decision on August 31 to seek Congressional approval before embarking on an attack, as both decisions led to the ebbing of worries about any immediate action.  The recent emergence of the potential diplomatic solution to the crisis in Syria, brokered by Russia, has provided further fuel to the reversal in indices around the globe, as concerns of the unintended negative consequences which surround any military conflict have, for the time being, abated.

Chart representing MSCI Emerging Markets Index.

Chart representing MSCI Emerging Markets Index.

Though the President has requested that Congress delay any vote related to the authorization of force until this avenue of diplomacy is fully explored, the potential for United States military action lurks in the shadows and may have in fact been strengthened by this development.  Democratic Whip, Steny Hoyer of Maryland commented on the potential failure of Russia’s endeavor to Bloomberg News, “People would say, well, he went the extra mile…He took the diplomatic course that people had been urging him to take—and it didn’t work.  And therefore under those circumstances, the only option available to us to preclude the further use of chemical weapons and to try to deter and degrade Syria’s ability to use them is to act.”

The suffering in Syria, where the United Nations estimates the death toll to be in excess of 100,000 lives, with half of those lost being civilians and an untold number of injured and displaced, is a tragedy of unfathomable depth.  The fact that it has taken the use of some of the most hideous weapons on Earth to spur the international community to action in an effort to stop the slaughter is deeply regrettable, however it has brought with it the promise of an end to the conflict now in its third year.  Although a diplomatic solution is certainly preferable to military action, if the current negotiations fail to bring Bashar al-Assad’s store of chemical weapons, which is the largest active stockpile in the world, (Wall Street Journal), under international control, the use of force will be a necessary recourse, as the killing of innocents must be stopped.

9.13.13_Pressier_Quagmire_3It’s easy … to say that we really have no interests in who lives in this or that valley in Bosnia, or who owns a strip of brushland in the Horn of Africa, or some piece of parched earth by the Jordan River. But the true measure of our interests lies not in how small or distant these places are, or in whether we have trouble pronouncing their names. The question we must ask is, what are the consequences to our security of letting conflicts fester and spread. We cannot, indeed, we should not, do everything or be everywhere. But where our values and our interests are at stake, and where we can make a difference, we must be prepared to do so.” –William Jefferson Clinton

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

There’s a Reason It’s Cheap

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

A few years ago when I was down the shore in New Jersey with my family, I decided it was time for my then nine- and six-year-old children to try one of my favorite childhood pastimes—boogie boarding. For those unfamiliar, a boogie board is a (very) poor-man’s version of a surf board; basically a short board that helps you ride waves either on your stomach or, if you’re really good, your knees. So we went to the store to buy a pair of boards and found a pretty wide price range— $10 for the 26-inch, all-foam board to $100+ for the 42-inch poly-something-or-other board with the hard-slick bottom. Being a bit of a value investor, and not knowing how much the kids would like riding waves, I went with something much closer to the bottom end of that range. To make a long story short, three hours later I found myself with a broken board (who knew a foam board couldn’t handle a 200+ lb dad demonstrating?), a broken ego, and a trip back to the store to purchase a new pair of boards—this time closer to the middle of the price range. A good lesson for the kids, but definitely a reinforced lesson for me, is often when something is cheap there’s a very good reason why.

8.22.13_Raupp_Cheap_1I’m reminded of this lesson when I look at global equity valuations, particularly those in Europe. Forward P/E ratios (stock price divided by the next 12 months of projected earnings) in most of the major Eurozone countries fall in the 10- to 12-times range, which is relatively cheap from a historical perspective. Compared to the U.S. at 14½ and other developed countries like Japan and Australia at close to 14, the region seems pretty attractive. Tack onto that that the Eurozone has just emerged from its longest recession ever, and the idea that markets are forward-looking, it would seem like a great opportunity to rotate assets into cheap markets as their economies are improving. And we’re seeing some of that in the third quarter, as the Europe-heavy MSCI EAFE index has outpaced the S&P 500 by about 3% quarter-to-date.

But, similar to low-priced boogie boards, buyers of European equities need to be aware of the risks that come with your “bargain” purchase. This past Tuesday, German finance minister, Wolfgang Schauble, admitted that there would need to be another Greek bailout next year even though they’ve been bailed out twice in the last four years and restructured (defaulted on) 25% of their debt in 2012. All told, about $500 billion has gone to support an economy with a 2013 GDP of about $250 billion, and it hasn’t been enough. And by the way, youth unemployment is approaching 60%, and 2013 has seen multiple protests and strikes over austerity measures.

8.22.13_Raupp_Cheap_2Beyond Greece, Portugal and Ireland are running national debts of over 120% of GDP and could need additional bailout money. Italy is operating with a divided government and a national debt of over 130% of GDP, and the Netherlands and Spain are still on the downward side of the housing bubble. Germany has been Europe’s economic powerhouse and has played an integral role in containing the debt issues on Europe’s southern periphery. But they’ve been grudging financiers, so much so that German chancellor Angela Merkel has gone to great lengths to avoid the topic of additional bailouts ahead of upcoming German elections.

Sometimes that bargain purchase works out. You get the right product on sale or you’re able to buy cheap markets when the negatives have already been baked into the price. But make sure you’re considering all the angles, or you could quickly end up back at the store.