An End to Complacency

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

Volatility abruptly made an entrance onto the global stage, shoving aside the complacency that has reigned over the world’s equity markets this year as they have marched steadily from record high to record high. Asset prices were driven sharply lower last week, as gathering concerns that the Federal Reserve Bank of the United States may be closer than anticipated to raising interest rates, combined with increasing worries about the possibility of deflation in the Eurozone, and a default by the nation of Argentina, to weigh heavily on investor sentiment. The selling seen across equity markets last Thursday was particularly emphatic, with declining stocks listed on the NYSE outpacing those advancing by a ratio of 10:1, and the Chicago Board Options Exchange Volatility Index (VIX), which measures expected market volatility, climbing 25% to its highest point in four months, all combining to erase the entirety of the gains in the Dow Jones Industrial Average for the year.

Preisser_Complacency_8.4.14The looming specter of the termination of the Federal Reserve’s bond-buying program, which is scheduled for October, is beginning to cast its shadow over the marketplace as this impending reality, coupled with fears that the Central Bank will be forced to raise interest rates earlier than expected, has served to raise concerns. Evidence of this could be found last Wednesday, where, on a day that saw a report of Gross Domestic Product in the United States that far exceeded expectations, growing last quarter at an annualized pace of 4%, vs. the 2.1% contraction seen during the first three months of the year, and a policy statement from the Federal Reserve which relayed that, “short-term rates will stay low for a considerable time after the asset purchase program ends” (Wall Street Journal) equity markets could only muster a tepid response. It was the dissenting voice of Philadelphia Fed President, Charles Plosser who opined that, “the guidance on interest rates wasn’t appropriate given the considerable economic progress officials had already witnessed” (Wall Street Journal), which seemed to resonate the loudest among investors, giving them pause that this may be a signal of deeper differences beginning to emerge within the Federal Open Market Committee. Concern was further heightened on Thursday morning of last week, when a report of the Employment Cost Index revealed an unexpected increase to 0.7% for the second quarter vs. a 0.3% rise for the first quarter (New York Times), which stoked nascent fears of inflation, bolstering the case for the possibility of a more rapid increase in rates.

Negative sentiment weighed heavily on equity markets outside of the U.S. as well last week, as the possibility of deflationary pressures taking hold across the nations of Europe’s Monetary Union, combined with ongoing concerns over the situation in Ukraine and the second default in thirteen years by Argentina on its debt to unsettle market participants. According to the Wall Street Journal, “Euro-zone inflation increased at an annual rate of just 0.4% in July, having risen by 0.5% the month before. In July 2013 the rate was 1.6%” While a fall in prices certainly can be beneficial to consumers, it is when a negative spiral occurs, as a result of a steep decline, to the point where consumption is constrained, that it becomes problematic. Once these forces begin to take hold, it can be quite difficult to reverse them, which explains the concern it is currently generating among investors. The continued uncertainty around the fallout from the latest round of sanctions imposed on Russia, as a result of the ongoing conflict in Ukraine, further undermined confidence in stocks listed across the Continent and contributed to the selling pressure.

ArgentinaInto this myriad of challenges facing the global marketplace came news of a default by Argentina, after the country missed a $539 interest payment, marking the second time in thirteen years they have failed to honor portions of their sovereign debt obligations. The head of research at Banctrust & Co. was quoted by Bloomberg News, “the full consequences of default are not predictable, but they certainly are not positive. The economy, already headed for its first annual contraction since 2002 with inflation estimated at 40 percent, will suffer in a default scenario as Argentines scrambling for dollars cause the peso to weaken and activity to slump.”

With all of the uncertainty currently swirling in these, “dog days of summer,” it is possible that the declines we have seen of late may be emblematic of an increase in volatility in the weeks to come as we move ever closer to the fall, and the terminus of the Fed’s asset purchases.

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: February 2014

Amy MagnottaAmy 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.

Magnotta_Market_Update_2.7.14

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 ReturnsAsset Class Returns

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

Investment Insights Podcast – January 31, 2014

Investment Insights PodcastBill Miller, Chief Investment Officer

On this week’s podcast (recorded January 30, 2014):

  • What we like: Acceleration in the sales for companies; Pick-up in housing survey data; States building surplus; Global synchronized recovery.
  • What we don’t like: Emerging markets uncertainty; Investor sentiment too high
  • What we are doing about it: Hedging appropriately in tactical and strategic portfolios; Hedging against emerging market risks; Underlying currents strong.

Click the play icon below to launch the audio recording.

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

Investment Insights Podcast – 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.

Investment Insights Podcast – January 14, 2014

Investment Insights PodcastBill Miller, Chief Investment Officer

On this week’s podcast (recorded January 13, 2014):

  • What we like: Global synchronized recovery
  • What we don’t like: Complacency (too much bullishness) associated with the global synchronization, making the market vulnerable to pullbacks.
  • What we are doing about it: Minor hedging in some portfolios; looking at underlying health of global synchronized recovery as central event, with sentiment as a secondary event.

Click the play icon below to launch the audio recording.

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

Monthly Market and Economic Outlook: 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

Financial Advisors Finally Confident in U.S. Economy, Q3 Brinker Barometer Finds

We have the results of our third quarter 2013 Brinker Barometer® survey, a gauge of financial advisor confidence and sentiment regarding the economy, retirement savings, investing and market performance.

For the full press release, please click here, but in the meantime check out the infographic below for some of the highlights:

BrinkerBarometer3Q2013_WebFINAL

Sentiment

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

In February 1637, tulip bulbs sold in Holland for as much as 4,000 guilders each, over 10x the amount a skilled craftsman would earn in a year.  Months later, many tulip traders found themselves holding bulbs worth just a fraction of what they had paid for.

As crazy as prices got, tulip mania actually started with good fundamentals. Tulips were a relatively new introduction to Europe, and the flower’s intense color made it a heavily-desired feature of upper-class gardens. Most desirable were the exotic-looking, multi-colored tulips, which was caused by a mosaic virus not identified until the 1970s and now called the “tulip-breaking virus.” At best, tulip bulbs weren’t easy to produce and those with the virus suffered even lower reproduction rates. In the beginning, what occurred in the tulip market was classic supply and demand—a highly sought-after item with limited supply increasing in price. In 1634, that started to change as 11.1.13_Raupp_Sentimentspeculators were attracted to the rising prices, and in late 1636 prices started to accelerate rapidly, to where even single-color tulips were attracting prices of over 100 guilders apiece. The Dutch created a futures market for tulips that enabled traders to purchase and trade contracts to buy bulbs at the end of the season. At the peak, tulips could be traded several times a day without any physical tulips actually being exchanged or either party ever having any intention of planting the bulbs.

Then in February 1637, buyers vanished. Some suspect an outbreak of the bubonic plague as the cause, some a change in demand caused by war in Europe. Any way you look at it, the sentiment for the future price of tulip bulbs took a big U-turn, leaving many investors ruined.[1]

11.1.13_Raupp_Sentiment_1History is full of similar episodes, where investor sentiment got to extreme levels and prices diverged meaningfully from the underlying fundamental value of something, be it stocks, real estate, currency, or even tulip bulbs. Most recently the dot-com bubble in the early 2000s and the housing bubble in 2008 proved that speculation is alive and well.

While periods of extreme sentiment are easy to identify in retrospect, they’re anything but obvious while you’re in them. And while extreme levels of sentiment usually result in big price reversals, more modest levels can mark periods when the market is overbought or oversold, often followed by a market pull-back or rally. Recently, Robert Shiller of Yale University won the Nobel Prize in Economics for his work on irrational markets.

11.1.13_Raupp_Sentiment_2So how can you gauge sentiment? Some of the more popular ones are the Consumer Confidence Index and the Michigan Consumer Sentiment Index, which both try to gauge consumer’s attitudes on a variety of things, including future spending, the business climate, and their level of optimism or pessimism. More direct, and generally more volatile, are the AAII Investor Sentiment Survey and the Wells Fargo/Gallup Investor and Retirement Optimism Index, which ask investors directly about their thoughts on investments. It doesn’t end there. Investors watch Closed-End Fund discounts, Put/Call ratios, even tracking the occurrence of certain words or phrases in the media. In addition, many firms create their own blend of surveys and indexes to best gauge the overall sentiment level.

Sentiment certainly isn’t the be-all, end-all for trading your portfolio. There’s a saying that is attributed to John Maynard Keynes, “The market can remain irrational longer than you can remain solvent.” When sentiment starts moving in one direction, it’s hard to say when the reversal will occur and what will cause it. But knowing where sentiment levels are at any given time can help you get a better understanding of what markets have been doing and what to expect going forward.


[1] Mackay, Charles (1841), Extraordinary Popular Delusions and the Madness of Crowds, London: Richard Bentley, archived from the original on March 31, 2008.

You: The Key to Better Investment Returns…and More

Sue BerginSue Bergin

John Hancock’s recent Investor Sentiment Survey demonstrates that over half of investors who use an advisor are confident (56%) that doing so will lead to better investment returns.[1]

How’s that for a confidence boost?

The study also gives us tremendous insights into why clients choose to work with financial advisors and highlights the importance of three factors:

  1. Realistic assessment of one’s own investment management capabilities
  2. Confidence in advisors’ ability to generate better returns than the individual could do themselves and add value to the process
  3. Time constraints

A significant number of participants who work with advisors (47%) do so to obtain a comprehensive financial plan and for validation that their financial decisions are on track.   They tend a need to have a professional’s stamp of approval on their decisions.  This is a moderate showing of confidence in his or her own ability and reveals a willingness to seek and listen to advice.

You Are The Key37% of those working with advisors claim to do so because they lack the knowledge to manage their own investments.  43% of the respondents who do not have an advisor chose to go at it alone because they feel like they can manage comfortably on their own.

36% of the “do-it-yourself” group said that they did not think advisors provided good value for their money.

Working with An Advisor

No Advisor

56% believe working with an advisor will lead to better investment returns 43% have confidence in their own abilities and therefore do not need to work with an advisor
47% seek comprehensive financial planning advice and to validate financial decisions 40% actually enjoy the process
36% acknowledge they couldn’t manage investments on their own 36% lack confidence in advisors
24% don’t have the time

Few people think they could perform surgery on their own knee, but many investors believe they could get comparable results without a professional’s assistance. Technological innovations are only going to fuel that sentiment by making it easier and more fun than ever for the do-it-yourselfers.  The key for advisors is to focus on your unique qualification and the value you add to the relationship.

Instill confidence in your abilities, so theirs are never even considered.


[1] John Hancock Investor Sentiment Survey, January 7, 2013

Staying Ahead of the Curve Despite Recent Volatility

After a strong surge in global financial markets in the first quarter of 2012, risk assets – equities, commodities, corporate credit – have sold off thus far in the second quarter. Uncertainties over global growth and Europe have reentered markets. At Brinker Capital, we are not surprised that some of the euphoria is being worked off. We would not be surprised to see further consolidation.

Several of our fundamental and technical indicators were showing signs of concern earlier this spring. At the end of the first quarter, the various Brinker discretionary portfolios reduced exposure to risk assets. Future signposts suggest the volatility could continue.

For those of you who follow our market outlook and quarterly portfolio calls, this might be familiar material. Some of the indicators we monitor were flashing warning signals:

  • Event risk – European elections, particularly in France and Greece, along with stalling reform initiatives in Spain and Italy.
  • Market fundamentals – economic indicators such as consumer and CEO confidence and economic surprises appeared to be peaking. The S&P 500 appeared to have discounted a lot of good news in valuations.
  • Sentiment – though investors maintained bullish sentiment (low levels of short interest), corporate insiders were selling stock in 2012, a change from insider purchases seen last fall.

As a result, we reduced risk exposures across our various discretionary portfolios.

  • Destinations and Personal Portfolios reduced exposure to risk assets and were positioned underweight risk compared to a neutral positioning.
  • Crystal Strategy I reduced its portfolio beta from positive to now a modestly negative beta by reducing risk and adding inverse exposures designed to rise in falling markets.

We will continue to monitor the following signposts over the near term and actively manage our broadly diversified portfolios as appropriate.

  • U.S. – Fed meetings later in June and prospects for further Quantitative Easing. Later this summer, we need progress on addressing the massive fiscal cliff to be reached early in 2013, regardless of the outcome in November elections.
  • Europe – second round of Greek elections on June 17 and progress (or absence thereof) regarding further European integration (bank deposit guarantee, adding capital to weak banks, stabilization in bond yields).
  • China – further, but moderate, monetary and fiscal stimulus, enough to avert a hard landing, but not enough to bail out weak global growth or produce sizzling China growth. The government is happy to see cooling in property markets.