World Cup of Liquidity

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

With the eyes of the world currently trained on Brazil, and the incredible spectacle of the globe’s most popular sporting event, there is another coordinated effort taking place on the world stage, albeit one with less fanfare and pageantry, but possessing a far greater effect on the global economy, and that is the historically accommodative policies of two of the world’s major central banks. The unprecedented amount of liquidity being thrust into the system by these institutions has helped fuel the current bull market in equities, which continues to push stocks listed around the world further and further into record territory.

World CupThe more powerful of these central banks, the Federal Reserve Bank of The United States, is attempting to gradually extricate itself from a portion of the record measures it has taken to revive growth following the Great Recession, which have caused its balance sheet swell to more than $4 trillion (New York Times) while not causing the economy to suddenly decelerate. “To this end, last week the Fed announced a continuation of the reduction of its monthly bond purchases by $10 billion, bringing the new total to $35 billion.” They also voiced their collective intention to keep short-term interest rates at their current historically low levels until 2015. Financial markets rallied following this news as investors focused largely on the Fed’s comments regarding rates, as well as the little-discussed fact that although their monthly purchases are being slowly phased out, the Central Bank continues to reinvest the proceeds from maturing bonds, thus maintaining a measure of the palliative effect. According to the New York Times, “Fed officials generally argue that the effect of bond buying on the economy is determined by the Fed’s total holdings, not its monthly purchases. In this view, reinvestment would preserve the effect of the stimulus campaign.” Although the American Central Bank is attempting to pare back its efforts to boost growth in the world’s largest economy, the accommodative measures currently in place look to remain so long after its bond purchases are concluded.

Preisser_Liquidity_6.23.17_2Mario Draghi, on June 5, made history when he announced that the European Central Bank (ECB) had become the first major Central Bank to introduce a negative deposit rate. As part of a collection of measures designed to spur growth and combat what has become dangerously low inflation within the Monetary Union, the ECB effectively began penalizing banks for any attempt to keep high levels of cash stored with them. In addition to this unprecedented step, Mr. Draghi unveiled a plan to issue four-year loans at current interest rates to banks, with the stipulation that the funds in turn be lent to businesses within the Eurozone, (New York Times). The actions of the ECB were cheered by investors who sent stocks listed across the Continent to levels unseen in more than six-and-a-half years, with the expectation that the Central Bank will remain committed to combating the significant economic challenges that remain for this collection of sovereign nations. To this end, Mr. Draghi suggested, during his press conference, that he is considering additional growth inducing measures, which may include the highly controversial step of direct asset purchases. Mr. Draghi gave voice to his resolve, and a glimpse of what the future might hold when he said, “we think this is a significant package. Are we finished? The answer is no” (New York Times).

The actions of both the Federal Reserve and the European Central Bank have directly contributed to the current rally in risk assets, but have also created a conundrum of sorts for investors; as though their historic measures have sent prices to record levels, the conclusion of these programs carry with them serious risks of disruption, as they too are unprecedented.

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 – June 2013

Magnotta@AmyMagnotta, CFA, Senior Investment Manager, Brinker Capital

Financial market performance diverged in May. Despite selling off in the second half of the month as investors began to worry about the Federal Reserve tapering its asset purchases, U.S. equity markets delivered solid returns, with the S&P 500 gaining +2.1%. In the equity markets, high dividend oriented sectors (utilities, telecom, staples) delivered negative returns, as did interest rate sensitive sectors like REITs and MLPs. International equity markets declined in May and were negatively impacted by a stronger U.S. dollar. Emerging markets continue to lag developed international markets.

Interest rates moved higher in May, attempting to return to more normal levels. In the U.S., both the 10-year Treasury note and 30-year bond climbed over 40 basis points resulting in negative returns for all major income sectors. Year to date, U.S. fixed income markets (Barclays Aggregate Index) have declined -0.9% while U.S. equity markets (S&P 500) have gained over 14%.

06.07.13_Magnotta_MarketOutlook_1The fear of the Fed tapering its stimulus as early as September has continued to weigh on investors as we move into June. While equity market indexes are just 3% off the recent highs, we’re experiencing more volatility. The last two occasions when the Fed has attempted to pare stimulus, the equity markets experienced double-digit declines. However, if the Fed does follow through with reducing the amount of asset purchases, it will do so in the context of an improving economy. More recent economic data has been mediocre, the recovery in employment will continue to be slow, and inflation is falling and now well below the Fed’s target. Market participants will be focusing on every data point in an effort to predict the Fed’s actions.

Interest rates have come down slightly from recent highs, but the 10-year note remains above 2%. We expect to see more bond market volatility as interest rates attempt to return to more normal levels. However, with growth still sluggish and inflation low, we expect interest rates to remain range-bound over the intermediate term.

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:

  • 06.07.13_Magnotta_MarketOutlook_2Global Monetary Policy Accommodation: The Fed remains accommodative (even if they scale back on asset purchases), 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. This liquidity has helped to boost markets.
  • Housing Market Improvement: An improvement in housing, typically a consumer’s largest asset, is a boost to net worth and, as a result, consumer confidence. However, a significant move higher in mortgage rates, which are now above 4%, could jeopardize the recovery.
  • 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 fund flows turned positive in 2013, and while muted compared to flows into fixed income funds, remain a tailwind after several years of outflows. Investors experiencing losses on their fixed income portfolios could also be a driver of flows to equity funds.

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

  • Europe: The risk of policy error in Europe still exists. While the ECB is willing to act as a lender of last resort, the region has still not addressed its debt and growth problems.
  • Sluggish Global Growth: Europe is in recession while Japan is using unconventional measures to create growth. China is showing signs of slowing further, as is Brazil.
  • U.S. Fiscal Drag: While we achieved some certainty on fiscal issues earlier this year, drag from higher taxes and the sequester will weigh on personal incomes and growth this year.

06.07.13_Magnotta_MarketOutlook_4Because 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 & micro-cap emerging markets, frontier markets
  • Fixed Income: non-Agency mortgage backed securities, emerging market corporates, global high yield, short duration strategies
  • Real Assets: REIT Preferreds
  • Absolute Return: relative value, long/short credit
  • Private Equity: company specific opportunities

06.07.13_Magnotta_MarketOutlook

Winds of Change

Joe PreisserJoe 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.

5.17.13_Pressier_WindsOfChange

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.