Stalemate

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The ongoing dysfunction in Washington D.C. reached a fever pitch this week, as the failure of lawmakers to agree on a bill to fund the Federal Government resulted in the President ordering its first shutdown since 1995.  The inability of Congress to effectively legislate has led to the furlough of more than 800,000 Federal workers, and a shuttering of all non-essential services.  Although equity markets around the world have remained relatively sanguine about the current state of affairs inside the beltway, the looming deadline to raise the debt ceiling, which the Treasury Department has declared to be no later than October 17, has heightened the stakes of the current impasse immeasurably, as a breach of this borrowing limit would have dire consequences not just for the United States, but for the global economy in aggregate.  It is the presence of this possibility that provides us with cautious optimism that a resolution might be forthcoming; as our belief is that the closure of the government and the subsequent pressure being applied by the electorate to end the stalemate has pulled forward the debt ceiling debate, which may result in a bargain that addresses both issues.  However, we intend to remain hyper-vigilant about the progress of these negotiations as we fully recognize the severity of the impact of a failure to honor our nation’s debts.

10.4.13_Preisser_Stalemate_1The current standoff has resulted from a multiplicity of factors, chief amongst which is a fundamental ideological difference between the parties over the Affordable Care Act, popularly known as “Obamacare”, which went into effect this week.  It is the vehemence of both sides in this debate combined with the extreme partisanship in the Capital that have made this situation particularly perilous.  Despite assertions to the contrary, the shuttering of the government comes at an exorbitant cost.  According to the New York Times, “ the research firm IHS Inc. estimates that the shutdown will cost the country $300 million a day in lost economic output…Moody’s Analytics estimated that a shutdown of three or four weeks would cut 1.4 percentage points from fourth-quarter economic growth and raise the unemployment rate.”  With consensus estimates for GDP currently at only 2.5% per annum, the present state of affairs, if not soon rectified will take an ever increasing toll on the nation’s economy.

Since 1970 there have been a total of 18 shutdowns of the Federal Government, including this most recent closure.  Although each situation was unique, what is common amongst them is that investors have, on average, approached them with relatively little trepidation.  According to Ned Davis Research, “during the six shutdowns that lasted more than five trading days, the S&P fell a median 1.7%.”In fact, optimism in the marketplace has tended to follow these periods of uncertainty.  Bloomberg News writes that, “the S&P has risen 11 percent on average in the 12 months following past government shutdowns, according to data compiled by Bloomberg on instances since 1976.  That compares with an average return of 9 percent over 12 months.”

Source: Ned Davis Research Group

Source: Ned Davis Research Group

There is one glaring difference between this year’s shuttering of the government and those of recent history, and that is the presence of the debt ceiling.  According to the New York Times, “the Treasury said last week that Congress had until Oct. 17 to raise the limit on how much the federal government could borrow or risk leaving the country on the precipice of default.”  Though we can look to the past as a guide to use to try and gauge the impact of a government shutdown, there is no way to accurately predict the effect of a failure of the United States government to fulfill its obligations, as this would be unprecedented. The need for Congress to raise the debt ceiling cannot be overstated, as the very sanctity of U.S. sovereign obligations depends upon it.  The importance of this faith to the global economy was captured by Nobel Prize winning economist, Paul Krugman, “Financial markets have long treated U.S. bonds as the ultimate safe asset; the assumption that America will always honor its debts is the bedrock on which the world financial system rests.”

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.

The Next Chairman of The Federal Reserve Is…

Andy RosenbergerAndrew Rosenberger, CFA, Senior Investment Manager, Brinker Capital

In the study of various sciences such as physics, biology, or even economics, we often create models to help us better understand the world around us.  These models often start out simple and usually only account for a few variables at a time.  For example, when solving a physics problem, we may assume that friction doesn’t influence the movement of an object.  That may be an okay assumption if you were calculating the movement of an ice skater along the ice, but ignoring friction could have a devastating impact when discussing vehicle safety or sending a spaceship to the moon.  So too is the case with investments.  As investors, we often create models to try and explain the economic world around us.  For example, to explain the price of a stock or asset class, we may look to the future earnings power and discount rates to calculate a fair value.  But too often these models fail.  Just as many came to believe in the efficient market hypothesis theory, the 2008 financial crisis proved to be a wake-up call that the world of sociology and investor behavior is more complicated than even the most sophisticated models of today.

Since the failure of many traditional valuation models, many investors have shifted from a bottom-up-only view of the world to one that incorporates a more top-down approach.  Thanks in part to massive amounts of liquidity in the form of Quantitative Easing, Fed-watching has become a main source of the new top-down approach.  Unfortunately, leadership at the Federal Reserve remains in question and a seat change may be afoot again.  During an interview on June 18 with Charlie Rose, President Obama stated, “He’s [Ben Bernanke] already stayed a lot longer than he wanted, or he was supposed to.” The statement was a clear signal that new leadership will begin February 1 of next year.

Source: Zeorehedge.com via Paddy Power

Source: Zeorehedge.com via Paddy Power

Over the past month, the search for a new Fed Chairman has narrowed to an apparently short list of two candidates: Larry Summers and the current Vice Chairman of the Federal Reserve, Janet Yellen.  While many influential members of the economic community were quick to vocally support Yellen, the pendulum of consensus now appears to be forming around Larry Summers.  In fact, the nomination has garnered so much momentum in the financial community, that Paddy Power, a United Kingdom-based gambling site, is taking wagers on the outcome.  The current odds are fascinating, with Larry Summers a 1:2 favorite over Janet Yellen, with 2:1 (against) odds.  Amazingly, as charted by Zero Hedge, in less than a month’s time, Summers has moved from having an outside chance to being the favorite.  If you’re skeptical of foreign-based online gambling websites, even reputable sources such as Bloomberg put the odds of a Summers nomination at 60%[1].

What does this mean for investors?  Whereas the investing community largely expects a Yellen nomination to represent a continuation of the current monetary policy as directed under Chairman Bernanke, a Summers nomination is far more uncertain.  However, I’ll quote from one of our trusted research providers, 13D Research:

We have read everything that Summers has written in recent years and we suspect his views coincide very closely with that of President Obama. What makes this all so interesting is that Summers is a vocal supporter of fiscal expansion. It is highly possible that if he is nominated and confirmed by the Senate that he will push for a form of Overt Monetary Finance…Today’s Financial Times carries an article on Summers that quoted remarks he made about the effectiveness of quantitative easing at a conference last April. “QE in my view is less efficacious for the real economy than most people suppose…If QE won’t have a large effect on demand, it will not have a large effect on inflation either.” Summers also gave a highly optimistic outlook for the U.S. economy. “I think the market is underestimating the pace at which the Fed will alter its current course and the consequences of that for interest rates.” This means a radical change in the markets’ expectations. The article also emphasized the following: “People who have discussed policy with him say Mr. Summers regards fiscal policy as a more effective tool than monetary policy.” What has been lacking at the Fed is a strong personality and intellectual leadership. Summers is brash, intelligent and self-confident, traits which may enable him to take charge of the FOMC. A regime change of this order of magnitude would be a game changer of the highest order, impacting inflation, economic growth, wages, gold, and the U.S. dollar….

8.13.13_Rosenberger_NextFedChairman_1The jury is still out as to who will ultimately be the next Fed Chairman and what their policies will be.  Similarly, given that Summers represents a shift away from the status quo, his recent surge in garnering the nomination may partially be why markets have decided to take a breather.  After all, markets prefer predictability and quantitative easing has been a major tailwind for investor confidence.  Thus, we wouldn’t be surprised to see higher market volatility as investors adjust their models and conceptual frameworks to reflect the possibility of a new Federal Reserve paradigm led by Larry Summers.


[1] Bloomberg, http://www.bloomberg.com/news/2013-08-12/the-fed-race-heats-up.html

The Brinker Barometer: Absolute Return Strategies On The Rise

Each quarter, we conduct a survey among financial advisors to gauge their confidence and sentiment regarding the economy, retirement savings, investing and market performance.  In our most recent Brinker Barometer, we asked respondents to reflect on key financial issues, including their clients’ retirement readiness, investing and the nation’s debt problems.

Click here for the official press release

Below is an infographic that sums up the results of the latest Brinker Barometer survey:

Brinker_Barometer_Q4_2012

Fiscal Cliff Update

MagnottaAmy Magnotta, CFA, Brinker Capital

The odds of a deal in Washington before year-end have increased as conversations between President Obama and Speaker Boehner have become more serious since Sunday. There has not been any public discussion of the negotiations, which is a positive sign. With less than three weeks left in the year, we need to see major progress soon, allowing for enough time to draft and vote on legislation before Congress leaves Washington for the Christmas holiday.

The highest probability outcome remains that a short-term deal is agreed on that serves as a down payment on tax and entitlement reform in 2013. This deal will include the framework for increased tax revenues and spending cuts, as well as an increase in the debt ceiling, which we feel will result in a fiscal drag of closer to 1% of GDP in 2013. It is our belief that this type of deal would be a positive for markets and confidence.

If time runs out on a larger deal, the House could pass a bill that maintains all of the current tax rates for those with incomes below $200,000, raises the capital gains and dividend taxes to 20%, and patches the Alternative Minimum Tax. However, the fiscal drag under this option is significantly higher than consensus. In addition, the brinkmanship would continue as the debt ceiling would have to be dealt with in early 2013.

The final potential outcome is that no deal can be reached and we go off the cliff completely. While we believe this is a lower probability event, it remains a risk. The markets would likely react negatively as the resulting fiscal drag would be greater than expected, and there would be a lack of confidence that Washington is serious about getting a handle on our long-term fiscal issues.

One big catalyst that should force both parties to reach a deal before year-end is that the Alternative Minimum Tax (AMT) patch expired at the end of 2011 and needs to be extended for this calendar year. If the AMT is not patched there will be a significant increase in the number taxpayers who are impacted, shifting the burden into the middle class. According to the Tax Policy Center, under current law if Congress does not act, the percentage of taxpayers affected by the AMT will increase from 4% to 32%. This increased tax bill would be a hit to consumers and a significant negative for growth in the first half of 2012.

12.11.12_Magnotta_Fiscal Cliff

Source: Strategas Research Partners, LLC

A deal on the fiscal cliff could restore some confidence that both parties in Washington can compromise on policy and are serious about setting us on a sustainable, long-term fiscal path. Some level of certainty on a deal could also boost business confidence, and as a result, investment and economic growth.

Follow Amy on Twitter @AmyLMagnotta.

The Implications Of The 2012 Presidential Election

This Tuesday marked the end of the 2012 Presidential Election campaign, with Barack Obama heading back to the White House.  In a campaign marked by elements of vitriol and an astronomical amount of money spent, most experts ballpark it around $6 billion in total, the results were status quo.   Republicans maintained their majority in the House, while the Democrats, after picking up a few surprise seats, remain in control of the Senate and Presidency.

As the new(ish) regime begins to game-plan for the next four years, a number of issues to address lay in wait.  The first, and potentially most significant, is the fiscal cliff the government must face before January 1, 2013.  With the Bush-era tax cuts expiring in conjunction with spending cuts, the U.S. economy will see about a 4% drag on GDP, forcing policymakers to address the looming recession.  The most likely scenario is an extension of most of the provisions already in place, which would result in a drag on GDP closer to 1%.

A key proponent in all of this is a compromise of tax increases on high-income earners—a significant area of compromise for President Obama. It would seem that the majority of investors are anticipating such a short-term deal to take place, but if no deal is signed before the end of the year, the market will react to the disappointment.

Next on tap for the President is a defined, long-term fiscal package. And while it will be a difficult task with a split government, it has been done before.  It is important for investors to have a roadmap to address our fiscal issues as it would reduce uncertainties, provide businesses and consumers with a higher level of confidence, and ultimately spend and contribute to positive growth. One strong point here is our high demand for U.S. Treasuries, even at current low rates.

With possible changes facing the Federal Reserve and tax increases, we are faced with a number of uncertainties.  We’ve crossed the election off our list of concerns and now turn our heads to the fiscal cliff. So as we head into year end, we will prepare for market volatility while keeping a close eye on what Congress is planning.

Did Chairman Bernanke Seal the Reelection of Barack Obama?

Andy Rosenberger, Brinker Capital

Presidential and Vice Presidential candidates Mitt Romney and Paul Ryan wasted no time in criticizing the Federal Reserve’s newest measure to stimulate the U.S. economy through additional monetary policy, otherwise known as Quantitative Easing (QE3). Within hours of the Fed announcement, Mitt Romney likened the need for more easing to failed Obama policies while Paul Ryan later said it represented “sugar-high economics”. The two fiscally minded candidates are understandably frustrated with the new measures by the Fed.

According to intrade.com, a market-based prediction market whereby speculators can gamble real money on the outcome of future events, the probability of President Obama’s reelection jumped significantly after the announcement by the Fed. The spike in reelection odds is the largest since the death of Osama bin Laden in May of last year.

According to intrade.com, President Obama now has over a 66% chance of winning the election this November, an increase of over 5% since the QE3 announcement. With such a dramatic move in reelection odds, the news of new quantitative easing is certainly a blow to the Romney campaign and a major reason why Mitt Romney has publicly said he would not reappoint Chairman Bernanke if given the chance.

Chart Source: www.intrade.com, 9/17/12