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: March 2014

Amy Magnotta, CFA, Senior Investment Manager, Brinker Capital

The U.S. equity market suffered a mild pullback in the second half of January, but resumed its trend higher in early February. The S&P 500 Index gained 4.3% in February to close at a record-high level. The consumer discretionary (+6.2%) and healthcare (+6.2%) sectors led during the month, while telecom (-1.8%) and financials (+3.1%) lagged. From a style perspective, growth continues to lead value across all market caps.

International equity markets edged out U.S. markets in February, helped by a weaker U.S. dollar. Performance on the developed side was mixed. Japan suffered a decline for the month (-0.5%), but Europe posted solid gains (+7.3%).  Emerging markets bounced back (+3.3%) as taper fears eased somewhat; however, they remain negative for the year.

Interest rates were unchanged in February and all fixed income sectors posted small gains. The 10-year Treasury ended the month at 2.66%, 34 basis points lower than where it started the year. Credit, both investment grade and high yield, continues to perform very well as spreads grind lower. High yield gained over 2% for the month. Municipal bonds have started the year off very strong gaining more than 3% despite concerns over Puerto Rico. Flows to the asset class have turned positive again, and fundamentals continue to improve.

While we believe that the bias is for interest rates to move higher, it will likely be a choppy ride. Despite an expectation of rising rates, fixed income still plays an important role in portfolios as a hedge to equity-oriented assets, just as we saw 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 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 tapering asset purchases, short-term interest rates should remain near zero until 2015. Federal Reserve Chair Yellen wants to see evidence of stronger growth. In addition, the European Central Bank stands ready to provide support, and the Bank of Japan has embraced an aggressive monetary easing program.
• Global growth stable: U.S. economic growth has been slow and steady. While momentum picked up in the second half of 2013, the weather appears to have had a negative impact on growth to start 2014. 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. The unemployment rate has fallen to 6.6%.
• Inflation tame: With the CPI increasing just +1.6% over the last 12 months, inflation in the U.S. is running below the Fed’s target.
• U.S. companies remain in solid shape: U.S. companies have solid balance sheets 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: 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 has been some movement in Washington. Fiscal drag will not have a major impact on growth this year. All parties in Washington were able to agree on a two-year budget agreement, averting another government shutdown, and the debt ceiling was addressed.

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

• Fed tapering/exit: The Fed began reducing the amount of their asset purchases in January, and should they continue with an additional $10 billion at each meeting, quantitative easing 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 certain emerging markets. After the near 6% pullback in late January/early February, investor sentiment is now elevated again.

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.

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

A Mixed Start to 2014

Ryan Dressel, Investment Analyst, Brinker Capital

With 2013 in the rear view mirror, investors are looking for signs that the U.S. economy has enough steam to keep up the impressive growth pace for equities set last year.  This means maintaining sustainable growth in 2014 with less assistance from the Federal Reserve in the form of its asset purchasing program, quantitative easing.  Based on economic data and corporate earnings released so far in January, investors have had a difficult time reaching a conclusion on where we stand.

To date, 101 of the S&P 500 Index companies have reported fourth quarter 2013 earnings (as of this writing).  71% have exceeded consensus earnings per share (EPS) estimates, yielding an aggregate growth rate 5.83% above analyst estimates (Bloomberg).  The four-year average is 73% according to FactSet, indicating that Wall Street’s expectations are still low compared to actual corporate performance.  Information technology and healthcare have been big reasons why, with 85% and 89% of companies beating fourth quarter EPS estimates respectively.

Despite these positive numbers, two industries that are failing to meet analyst estimates are consumer discretionary and materials.  Both of these sectors tend to outperform the broad market during the recovery stage of a business cycle, which we currently find ourselves in.  If they begin to underperform or are in line with the market, then it could indicate the beginning of a potential short-term market top.

Click to enlarge

There has been mixed data on the macro front as well:

Positive Data

• Annualized U.S. December housing starts were stronger than expected (999,000 vs. Bloomberg analyst consensus 985,000).
• U.S. Industrial production rose 0.3% in December, marking five consecutive monthly increases.[1]
• U.S. December jobless claims fell 3.9% to 335,000; the lowest total in five weeks.
• The HSBC Purchasing Managers’ Index (PMI) was above 50 for most of the developed and emerging markets.  An index reading above 50 indicates expansion from a production standpoint.  This data supports a broad-based global economic recovery.

Negative Data:

• The Thomson Reuters/University of Michigan index of U.S. consumer confidence unexpectedly fell to 80.4 from 82.5 in December.
• The average hourly wages of private sector U.S. works (adjusted for inflation) fell -0.03% compared to a 0.3% increase in CPI for December, 2013.  Wages have risen just 0.02% over the last 12 months indicating that American workers have not been benefiting from low inflation.
• Preliminary Chinese PMI fell to 49.6 in January, compared to 50.5 in December and the lowest since July 2013.

Click to enlarge

The mixed corporate and economic data released in January has led to a sideways trend for the S&P 500 so far in 2014.  We remain optimistic for the year ahead, but are managing our portfolios with an eye on the inherent risks previously mentioned.

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[1]  The statistics in this release cover output, capacity, and capacity utilization in the U.S. industrial sector, which is defined by the Federal Reserve to comprise manufacturing, mining, and electric and gas utilities. Mining is defined as all industries in sector 21 of the North American Industry Classification System (NAICS); electric and gas utilities are those in NAICS sectors 2211 and 2212. Manufacturing comprises NAICS manufacturing industries (sector 31-33) plus the logging industry and the newspaper, periodical, book, and directory publishing industries. Logging and publishing are classified elsewhere in NAICS (under agriculture and information respectively), but historically they were considered to be manufacturing and were included in the industrial sector under the Standard Industrial Classification (SIC) system. In December 2002 the Federal Reserve reclassified all its industrial output data from the SIC system to NAICS.

What About The Correction?

Jeff Raupp, CFA, Senior Investment Manager

Over the holidays, I spent a lot of time with some family members that I don’t often get to see. We got together, had a little too much to eat and drink, and gave each other updates on what’s happening in our lives. Between the updates on kids, new careers, and new houses (no new spouses or kids this year), we never miss the opportunity to get some free advice from one another.

My two sisters are both in healthcare and handle all questions related to our aches and pains. My cousin the mechanic will venture out to the driveway and listen to the ping in your engine for the cost of getting him a beer. You get the idea.

My contribution is on the investment side, fielding questions about 529 plans, IRA distributions, 401(k) plans, etc. But the biggest question is always some version of “where is the market going?” This year’s edition, fueled by the huge returns in stocks in 2013 (and a good dose of CNBC), was “do you think we’re going to get a market correction?”

I suggested that when you look at how far the market has run and the high levels of investor sentiment right now—indicating that a lot of good news is priced into the market— I could easily see the market pulling back 5-10% on some unexpected bad news. The natural response from my family was, “What should I do?” “Nothing,” was my presumably blunt response.

My rationale is this: From a fundamental standpoint, the market looks good. Companies continue to grow earnings at a steady, albeit slow, rate. The market isn’t cheap, but it isn’t expensive either, and rarely does P/E compress without a recession. Speaking of the r-word, GDP growth continues to be sluggish, but it’s positive and expected to increase in 2014. Housing, the root cause of the last recession, continues to improve in spite of rising rates. And the Fed launched the previously-dreaded tapering of its quantitative easing without any market hiccup.

Depending on the attention span of my audience, all of that might boil down to simply saying, “We could get a correction, but if you’ve got at least 6-12 months, I think the market will be positive from here.”

Now, let’s go check out that leak on my car…

Federal Reserve: To Taper or Not To Taper

Bill Miller, Chief Investment Officer

Today, Ben Bernanke, current Chairman of the Federal Reserve, is expected to announce a decision on whether to taper or not to taper.  There are good arguments to taper, namely good employment growth and a budget deal between the Republicans and the Democrats.  Likewise, there are good arguments to not taper, including low inflation and the possibility of higher interest rates.  A key consideration for the Fed, should they decide to taper, will be interest rates.  More specifically, the Fed does not want long-term interest rates to increase suddenly.  We estimate that a sharp 1% increase in the long-term Treasury bond could cause as much as a 10% correction in the stock market.

Yesterday morning (December 17), ISI Group reported that the Fed will likely announce that there will be $400 billion left to buy in their Quantitative Easing program. This strikes us as a clever compromise between the taper or not to taper decision. Most importantly, it is not sudden.  Both the stock and bond markets will have time, probably five months or more, to measure the impact of tapering. Thus, we hope to stay long stocks for normal seasonal strength in the first quarter of the new year.  On the other hand, if the Fed announces a more sudden tapering exit, adding shorts to hedge stock market risk is a likely approach.

The Next Chairman of The Federal Reserve Is…

Andrew 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

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….

The 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.

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

Consequences Remain from Quantitative Easing

Andrew Rosenberger, CFA, Brinker Capital

Despite the now numerous iterations of quantitative easing, the full effects of large-scale asset purchases aren’t fully understood by market participants or policy makers. After four years of experimenting in this new Petri dish, markets understand how liquidity is created, but not where that liquidity ultimately flows to. Arguably, as evidence by P/E multiple expansion, new highs on the major indices, high yield credit spread at all-time lows, and a still sluggish economy, many believe that much of this liquidity has found its way into risky assets as opposed to the broader economy.

If we take a step back for a moment, there are three potential adverse consequences from quantitative easing (QE):

1. Future inflation
2. Negative political and/or sovereign perceptions
3. Asset bubbles

To date, two out of those three adverse consequences haven’t been a problem. On the inflation front, TIPS breakeven rates are range bound, precious metal prices are falling, and lagging measures of inflation via governmental statistics are tempered. Similarly, although there have been some negative headlines surrounding the risks of QE, by no means are these rumblings excessive or prohibitive to policy continuation. However, what may present an issue is the persistence of increasing asset valuations.

While many members of the Fed believe higher asset prices create a “wealth effect”, two recent bubbles suggest that the last thing policymakers need on their plate is another asset bubble. Finding the delicate balance between boosting wealth and not creating a new bubble suggests that the Fed will ultimately need to pullback on quantitative easing should price trends continue at their current pace. Thus, in a circular reference type of thought process, I worry that the regulator to higher equity prices may ultimately be higher equity prices in and of themselves. Said a bit differently, higher asset prices has the potential to cause concern for the Fed, resulting in a tapering off of quantitative easing, ultimately translating to a pullback in equity prices. Hence, higher equity prices may ultimately be the reason that central banks have to ease off of the pedal. Thus, in a “reflexivity” sort of way, rapidly rising asset prices may be bad for assets in the back of 2013 or 2014.

In today’s market environment, the name of the investing game is investing alongside the Fed. Naturally, one can then understand why the Federal Reserve “tapering” their quantitative easing is such a big deal. When the rules of the game change, it takes time for markets to understand the paradigm shift and transition from the easy liquidity from central banks. Our belief is that the Fed is well aware that it greatly influences markets and thus will try to make this transition as smooth as possible without pushing markets into bubble territory.

Winds of Change

Joe Preisser, Portfolio Specialist, Brinker Capital

The winds of change have begun to blow through Washington, D.C. carrying with them whispers that the Federal Reserve Bank of the United States is contemplating a more immediate slowing of the unprecedented stimulus measures it has employed since the financial crisis than many analysts anticipate, which could have broad implications across the global landscape. Several signals have been offered by the American Central Bank in the past few weeks to prepare the marketplace for the impending reduction of their involvement, highlighting the delicate nature of this endeavor.

The Institution faces a daunting challenge in trying to scale back a program that has largely been credited with fueling a dramatic rise in asset prices, without interrupting the current rally in equity markets.  Although the U.S. economy has shown itself to be growing at a moderate pace, a measure of uncertainty lingers within investors as to whether this growth is robust enough to compensate for the paring back of the Bank’s historically unprecedented accommodative monetary policies.

As the depths of the ‘Great Recession’ threatened to pull the global economy into depression, the U.S. Central Bank undertook a herculean effort to bring the country back from the precipice of disaster. The tangible result of these efforts has been a deluge of liquidity forced upon the marketplace, which has given birth to a tremendous rally in share prices of companies listed around the globe, and helped to repair much of the damage inflicted by the crisis. The dramatic expansion of the Fed’s balance sheet, since the inception of these programs, has culminated in the most recent iteration of these efforts—an open-ended program of quantitative easing, comprised of the purchase of $45 billion per month in longer dated U.S. Treasury debt and $40 billion of agency mortgage-backed securities, undertaken in September of last year, that has brought the aggregate amount of assets acquired by the Bank to more than $3 trillion.

The chart above depicts the increase in the size of the Fed’s balance sheet (white line) versus the S&P 500 Index (yellow line).

As the economic recovery has gained momentum in the United States, with notable improvements seen in both the labor and housing markets, concern has been voiced that the flood of liquidity flowing from Washington should be tapered, lest it potentially result in the creation of artificial asset bubbles, which in turn could present risks to price stability.

The first broach of the possibility of the Fed varying the additions it is making to its balance sheet came in a press release from the Federal Open Market Committee on May 1 which stated that, “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” This statement was followed by the May 11th publication of an article authored by Jon Hilsenrath of the Wall Street Journal, who is widely considered to be a de facto mouthpiece for the Central Bank, “officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves. The timing on when to start is still being debated” (Wall Street Journal). Comments issued on Thursday by the President of the San Francisco Fed, John William’s, referred once again to the possibility of the Central Bank’s program being scaled back, potentially sooner than many market participants anticipate, “It’s clear that the labor market has improved since September.  We could reduce somewhat the pace of our securities purchases, perhaps as early as this summer” (Bloomberg News).

Though the Fed has stated that it will continue its accommodative monetary policies until the unemployment rate in the United States has been reduced from its current rate of 7.5% to a target of 6.5%, it appears that the pace of this accommodation may change in the near term.  While the consensus among market participants is for this gradual reduction in quantitative easing to begin sometime this year, no one is sure of the scale or the exact timing.  As the Central Bank has played such an integral role in helping to engineer the current rally in equities, it will be imperative to closely monitor the deftness with which they handle the extrication of their involvement.

Monthly Market and Economic Outlook – May 2013

@AmyMagnotta, CFA, Brinker Capital

Risk assets continued their run in April, despite a small 3% pull-back mid-month. The easy monetary policies pursued by central banks in developed economies have forced investors out of cash and into higher yielding fixed income and equity strategies.  On May 3 the S&P 500 pushed above 1600 to an all-time high.  International equity markets outperformed U.S. equity markets in April, helped by continued strong performance from the Japanese equity markets, but U.S. markets continue to lead year to date. Even with stronger equity markets, the fixed income markets also rallied in April as interest rates moved lower and credit spreads tightened further.

After a near 20% move in the U.S. equity markets since November of last year, we may be susceptible to a pull-back in the near term; however, our longer-term view remains constructive. The market remains in a stronger fundamental position that at the 2007 high.

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 through the second quarter. A number of factors should continue to support the economy and markets for the remainder of the year:

• Global Monetary Policy Accommodation: The Fed continues with their quantitative easing program, the ECB has pledged to support the euro, and now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. The markets remain awash in liquidity.
• Housing Market Improvement: Home prices are increasing, helped by tight supply. Sales activity is picking up, and affordability remains at high levels. An improvement in housing, typically a consumer’s largest asset, is a boost to consumer confidence.
• 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. Borrowing costs remain very low. Corporate profits remain at high levels and margins have been resilient.
• Equity Fund Flows Turn Positive: After experiencing years of significant outflows, investors have begun to reallocate to equity mutual funds. Positive flows could provide a tailwind to the global equity markets.

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

• Europe: The ECB programs have bought time, but cannot solve the underlying problems in Europe. Austerity measures are serving only to weaken growth further and cause higher unemployment and social unrest. After how it dealt with Cyprus, there is risk of policy error in Europe once again.
• U.S. Fiscal Policy: The automatic spending cuts will start to negatively impact growth in the second quarter, shaving an estimated 0.5% from GDP. In addition, the debt ceiling will need to be addressed again later this year.

Because of massive government intervention in the global financial markets, we will continue to be susceptible to event risk. Instead of taking a strong position on the direction of the markets, we continue to seek high conviction opportunities and strategies within asset classes. Some areas of opportunity currently include:

• Domestic Equity: dividend growers, housing-related plays
• International Equity: Japan, small and micro-cap emerging markets, frontier markets
• Fixed Income: non-Agency mortgage backed securities, corporate credit, short duration strategies
• Real Assets: REIT Preferreds, Master Limited Partnerships
• Absolute Return: relative value, long/short credit
• Private Equity: company specific opportunities

Annualized for periods greater than one year. Past performance is no guarantee of future results. Source: FactSet, Red Rocks Capital.

 

 

 

The views expressed by Brinker Capital are for informational purposes only. Brinker Capital, Inc. a Registered Investment Advisor.