Eurozone Crisis Report Card

Ryan DresselRyan Dressel, Investment Analyst, Brinker Capital

In January 2013 Amy Magnotta wrote in detail about how the actions of the European Central Bank (ECB) finally gave the markets confidence that policy makers could get their sovereign debt problems under control.[1] The purpose of this blog is to measure the progress of the ECB’s actions, as well as other critical steps taken to resolve the Eurozone crisis.

Maintaining the Euro: A+
The markets put a lot of faith in the comments made by the head of the ECB Mario Draghi in July, 2012. Draghi stated that he would “Pledge to do whatever it takes to preserve the euro.” These words have proven to be monumental in preserving the euro as a currency. Following his announcement, the ECB still had to put together a plan that would be approved by the ECB’s governing council (comprised of banking representatives from each of the 18 EU countries)[2]. The politics of the approval essentially boiled down to whether or not each council member supported the euro as a currency. Draghi’s plan ultimately passed when Germany’s Chancellor, Angela Merkel, endorsed it in September 2012.[3] The stabilization of the euro boosted lending and borrowing for European banks, and allowed governments to introduce necessary economic reforms outlined in the plan.

Since the plan was approved, the euro’s value versus the U.S. Dollar has continued to rise; reaching levels last seen in 2011. There is still some debate as to whether or not the currency will last over the long term, but for now its stability has helped avoid the worst possible outcome (financial collapse). There are several key elections coming up over the next month, which could renew the threat of breaking up the currency if anti-EU officials are elected.

Government Deficit Levels: B
The average Eurozone government deficit came in at 3.0% in 2013, which was down from 3.7% in 2012. Budgets will need to remain tight for years to come.

Corporate Earnings: B
The MSCI Europe All Cap Index has returned 27.46% in 2013 and 5.01% so far in 2014 (as of last week). The Euro area also recorded first quarter 2014 GDP growth at +0.2% (-1.2% in Q1 2013).[4] This indicates that companies in Europe have established some positive earnings growth since the peak of the crisis. On a global scale, Europe looks like an attractive market for growth.

Dressel_EuroZone_ReportCard_5.30.14

Unemployment: C
Unemployment in the Eurozone has stabilized, but has not improved significantly enough to overcome its structural problems. The best improvements have come out of Spain, Ireland and Portugal due to a variety of reasons. In Ireland, emigration has helped reduce jobless claims while a majority of economic sectors increased employment growth. In Spain, the increased competitiveness in the manufacturing sector has been a large contributor. Portugal has seen a broad reduction in unemployment stemming from the strict labor reforms mandated by the ECB in exchange for bailout packages. These reforms are increasing worker hours, cutting overtime payments, reducing holidays, and giving companies the ability to replace poorly performing employees.[5]

Dressel_EuroZone_ReportCard_5.30.14_1[6]

There are also some important fundamental factors detracting from the overall labor market recovery. The large divide between temporary workers and permanent workers in many Eurozone countries has made labor markets especially difficult to reform. This is likely due to a mismatch of skills between employers and workers. High employment taxes and conservative decision-making by local governments and corporations have also created challenges for the recovery.

Additional Reading: Euro Area Labor Markets

Debt Levels: D
Total accumulated public debt in the Eurozone has actually gotten worse since the ECB’s plan was introduced. In 2013 it was 92.6% of gross domestic product, up from 90.7% in 2012. The stated European Union limit is 60%, which reflects the extremely high amount of government borrowing required to stabilize their economies.

Overall Recovery Progress: B-
On a positive note, governments are finally able to participate in bond markets without the fear of bankruptcy looming. Banks are lending again. Unemployment appears to have peaked and political officials recognize the importance of improving economic progress.

Unlike the 2008 U.S. recovery however, progress is noticeably slower. The social unrest, slow decision making, low confidence levels, and now geopolitical risks in Ukraine have hampered the recovery. When you consider the financial state of Europe less than two years ago, you have to give the ECB, and Europe in general, some credit. Things are slowly heading in the right direction.

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

[1] January 4, 2013. “Is Europe on the Mend?” http://blog.brinkercapital.com/2013/01/04/is-europe-on-the-mend/
[2]
European Central Bank. http://www.ecb.europa.eu/ecb/orga/decisions/govc/html/index.en.html
[3] September 6, 2012. “Technical features of Outright Monetary Transactions. European Central Bank.” http://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html
[4] Eurostat
[5] August 6, 2012. “Portugal Enforces Labour Reforms but More Demanded.” http://www.wsws.org/en/articles/2012/08/port-a06.html
[6] Eurostat (provided by Google Public Data)

Volatility: Why it Matters

Ryan Dressel Ryan Dressel, Investment Analyst, Brinker Capital

Have you ever noticed how many commercials on TV use blind comparison tests to prove that their products are better than their competitors? Soft drinks, washing detergents, tablets, air fresheners, fast food chains, and even web sites all use this marketing tool on a fairly regular basis. One reason companies do this is to try to change your perception about their product. It’s human nature to associate a good or bad feeling about a product, brand, or company based on personal experiences. If you got sick from food at a restaurant for example, chances are you won’t return to that restaurant again, even if it changes the staff, menu, and décor. A blind comparison test is an attempt to convince you that a product isn’t as bad as you might think.

How can this be applied to your investments? You’ll hear dozens of mutual fund companies advertise that they are beating an index, benchmark, or peer group (such as Lipper) over a specific time frame. You could also open the Wall Street Journal and read about a mutual fund manager boasting smart decisions with regard to short-term news, such as the S&P 500 rising or falling in any given week. If you try to interpret headline news or those T.V. commercials without any context, there’s a good chance you could misjudge your portfolio and even worse, make an irrational decision! What you will rarely hear on T.V. or read in the papers is an advertisement for a portfolio that provides steady and consistent returns by managing volatility.

Why does volatility matter? To demonstrate the value of volatility, we’ll do a blind comparison using two hypothetical portfolios (you saw that coming right?). Both Portfolio A and Portfolio B started with an initial investment of $100,000 and have a sum of returns of 65% over a 10-year time period. The portfolios have the following annual returns over that time frame:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Portfolio A +2% +13% +5% +20% 7% 4% -7% -1% +16% +6%
Portfolio B +6% +25% -10% +36% -15% +11% -25% -7% +33% +11%

Which portfolio would you predict to have a higher balance at the end of the 10-year time frame? Looking at the returns we can observe a few things that jump out. Portfolio B managed to achieve extremely high gains in years 2, 4 and 9. Conversely, it also had a couple of really bad years in year 5, and year 7. It also finished the last two years with a combined +44%. Looking at Portfolio A, we can see that it never topped 20% in a given year, and never lost more than 7% in a year. It also finished seven out of the 10 years with a return of +7% or less.

If you chose Portfolio A, you would be correct!

Dressel_Volatility_4.18.14_3

As demonstrated in the charts above and below, Portfolio A has a much lower level of volatility. Through the power of compounding, this allowed Portfolio A to finish with a higher balance despite the fact that both portfolios have identical sum of returns. In reality, this is typically achieved by constructing a well-diversified portfolio using a wide array of asset classes. This is also a good reminder of how fixed income and absolute return strategies are beneficial to your portfolio in any market environment.

Dressel_Volatility_4.18.14_2

If these were actual investment products, there is no doubt that you would hear Portfolio B being advertised as an outperformer during a time frame that captures those years of strong performance. In the end however, the only thing that matters is the balance of your portfolio and that you are on track towards achieving your investment goals. Be sure to review your portfolio in the right context, especially during times of market “noise.”

Source: The data used and shown above is hypothetical in nature and shown for illustrative purposes. Not intended as investment advice.

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

When in Doubt, Blame the Weather

Ryan Dressel Ryan Dressel, Investment Analyst, Brinker Capital

The 2013-2014 winter has been nothing short of a worse-case scenario for the eastern half of the U.S. In Chicago, temperatures fell below zero an astounding 22 times (the Chicago record for a winter is 25), and let’s not forget the combined 67 inches of snow. In Atlanta, the city literally came to a halt during what became known as “Icepocalypse.” In Philadelphia, we’ve seen a total of 58 inches of snow (third highest on record) including 11 different snow storms dropping one inch or more.[1]

Source: TheAtlantic.com

Source: TheAtlantic.com

Those three locales give you a pretty good idea of just how wide spread the wrath of winter is this year. While it is difficult to measure the exact impact of the weather on the economy, we can conclude that economic activity will certainly lag in January, February and March. Despite the fact that most economic indices account for seasonal effects, they do not account for outlier years like this one. Weather has been blamed for poor economic reports ranging from job growth, to new housing starts, to manufacturing—but is it justified?

A 2010 study by the American Meteorological Society determined which U.S. states are most sensitive to extreme weather variability as it relates to economic output.[2]

Dressel_Weather_2.21.14_1The research concluded that the location with the most sensitive industries had the largest total economic effect. For example, agriculture is the most sensitive on an absolute basis, but the fact that agriculture makes up such a small percentage of most states’ Gross State Product (GSP) means that extreme weather has a small total effect on sensitivity. Conversely, manufacturing, financial services, and real estate have a large relative sensitivity because of their GSP impact. As you can see on the map, the states where these industries have a significant economic impact, translates in higher sensitivity to extreme weather.

The severity of winter in the states colored red and yellow justifies the weather-related hype, while the ones in blue can be ignored for economic purposes. If you include the effects of the Government shutdown, we’ve had four consecutive months of cloudy data that we can’t put into clear context!

[1] National Oceanic and Atmospheric Administration.
[2] U.S. Economic Sensitivity to Weather Variability. Jeffrey K. Lazo, Megan Lawson, Peter Larsen, Donald Waldman. December 28, 2010.

A Mixed Start to 2014

Ryan Dressel 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.

S&P500 Index - Earnings Growth vs. Predicted

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.
S&P Performance Jan 2014

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.


[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.

Demographic Changes Looming (Part Two)

10.17.13_BlogRyan Dressel, Investment Analyst, Brinker Capital

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

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

10.17.13_Demographics_Part2

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

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

Demographics_Part2

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

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

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

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


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

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

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

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

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

[7] The Great Divergence.  Timothy Noah,  2012

Demographic Changes Looming (Part One)

10.17.13_BlogRyan Dressel, Investment Analyst, Brinker Capital

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

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

Aging Population

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

10.17.13_Demographics_Part1

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

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

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

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

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


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

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