Monthly Market and Economic Outlook – May 2013

Magnotta@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:

  • 5.6.13_Magnotta_MonthlyNewsletter_3Global 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:

  • 5.6.13_Magnotta_MonthlyNewsletter_2Europe: 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.

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.

Sequestration Begins

Magnotta@AmyMagnotta, CFA, Brinker Capital

Sequestration, the automatic spending cuts that were agreed to as part of the debt ceiling compromise in the summer of 2011, came into effect on Friday, March 1. The Budget Control Act of 2011 established the bi-partisan “super committee” to produce deficit reduction legislation. As incentive for the super committee to agree to deficit reduction legislation, if Congress failed to act than the across the board spending cuts (sequestration), totaling $1.2 trillion over 10 years, would come into effect on January 2, 2013. The start date was delayed two months as part of the fiscal cliff deal. The cuts are split 50/50 between defense (which was supposed to get the Republicans to act) and domestic discretionary spending (which was supposed to get the Democrats to act).

As expected, Congress and the Administration have not been able to agree on serious deficit reduction so we now face the automatic budget cuts. The public does not seem to be as focused on sequestration as they were on the fiscal cliff. In a recent poll from The Hill, only 36% of likely voters know what the sequester is. The spending cuts are broad based, as the chart below from Strategas Research Partners shows; however, it will take some time for the cuts to come into effect.

3.4.13_Magnotta_Sequestration

Source: Strategas Research Partners, LLC

The drag on GDP growth from the sequester is estimated to be around -0.5% this year. This is not enough drag to push us into a recession if consensus estimates for 2013 growth are correct at 2-2.5%, but the effect is not negligible. The largest hit to GDP growth will likely be in the second quarter once a majority of the spending cuts have begun to take effect. If and when voters begin to feel the impact, there may be pressure on Washington to delay or eliminate the cuts.

We also face the expiration of the continuing resolution that funds the government on March 27, which, if not addressed, could result in a government shutdown. This could be a catalyst for another short-term fix. As typical in politics, whichever party is shouldering the most blame will be more likely to compromise to get a deal done.

The idea of real tax and entitlement reform that promotes growth and puts us on a long-term, sustainable fiscal path seems highly unlikely in this environment. Our elected leaders appear to lack the tenacity to make tough decisions. Sadly, kicking the can down the road is the path of least resistance and often the one that leads to reelection.

Bottom line: Fiscal policy in the U.S. will remain a risk throughout 2013. The spending cuts from the sequester alone are not enough to derail the economic recovery. However, tepid growth is likely to persist, especially in the first half of the year, as disposable incomes have fallen due to the expiration of the payroll tax cut. An accommodative Fed and an improving housing market are positives for growth.