Investment Insights Podcast – July 18, 2014

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded July 16, 2014) the subject matter pertains to the Congressional Budget Office’s release of their long-term outlook. It’s important to note that this forecast is a 75-year time horizon; so focus should be on the near-term debate in Washington:

What we like: Raised the long-term growth rate of the economy; lowered healthcare costs and interest rate costs which is a positive in the near term

What we don’t like: Healthcare and interest rate costs in the long term; interest rates likely to rise eventually; Social Security likely to rise in the near future; defense spending cutbacks

What we are doing about it: As citizens, being thoughtful when exercising the right to vote; keeping an eye on higher interest rates and impact on fixed income

Click the play icon below to launch the audio recording or click here.

Source: CNBC

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 2014

Amy MagnottaAmy Magnotta, CFASenior Investment Manager, Brinker Capital

The global equity markets continued to climb higher in May. In the U.S. the S&P 500 Index hit another all-time high, gaining more than 3% for the month. The technology and telecom sectors were the top performing sectors in May, but all sectors were positive except for utilities. In a reversal of March and April, growth outpaced value across all market capitalizations, but large caps remained ahead of small caps. In the real assets space, REITs and natural resources equities continued to post solid gains despite low inflation.

International developed equity markets were slightly behind U.S. markets in May, but emerging market equities outperformed. After a weak start to the year, emerging market equities are now up +3.5% year to date through May, even with China down more than -3%. The dispersion in the performance of emerging market equities remains wide. Indian equities rallied strongly in May, gaining more than 9%, after the election of a new prime minister and his pro-business BJP party.

Despite a consensus call for higher interest rates in 2014, U.S. Treasury yields have continued to fall. The yield on the 10-year Treasury note ended the month at 2.5%, still above its recent low of 1.7% in May 2013, but well below the 3.0% level where it started the year. While lower than expected economic growth and geopolitical risks could be keeping a ceiling on U.S. rates, technical factors are also to blame. The supply of Treasuries has been lower due to the decline in the budget deficit, and the Fed remains a large purchaser, even with tapering in effect. At the same time demand has increased from both institutions that need to rebalance back to fixed income after such a strong equity market in 2013 and investors seeking relative value with extremely low interest rates in Japan and Europe.

Magnotta_Market_Update_6.10.14As interest rates have declined, fixed income has performed in line with equities so far this year. All fixed income sectors were positive again in May. Municipal bonds and investment grade credit have been the top performing fixed income sectors so far this year. Both investment grade and high yield credit spreads continue to grind tighter. Within the U.S. credit sector fundamentals are solid and the supply/demand dynamic is favorable, but valuations are elevated. Emerging market bonds have also experienced a nice rebound after a tough 2013. Municipal bonds benefited from a positive technical backdrop with strong demand for tax-free income being met with a dearth of issuance.

We approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds, with a number of factors supporting the economy and markets over the intermediate term.

  • Global monetary policy remains accommodative: Even with the Fed tapering asset purchases, short-term interest rates should remain near-zero until 2015 if inflation remains low. The ECB announced additional easing measures, and the Bank of Japan continues its aggressive monetary easing program.
  • Global growth stable: U.S. economic growth has been slow but steady. Economic growth declined in the first quarter, but we expect it to turn positive again in the second quarter. 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 we have continued to add jobs. The unemployment rate has fallen to 6.3%. Unemployment claims have hit cycle lows.
  • Inflation tame: With core CPI running below the Fed’s target at +1.8% and inflation expectations contained, the Fed retains flexibility to remain accommodative.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be used for acquisitions, capital expenditures, hiring, or returned to shareholders. M&A deal activity has picked up this year. Corporate profits remain at high levels and margins have been resilient.
  • Less drag from Washington: 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. The deficit has also shown improvement in the short-term.

Risks facing the economy and markets remain, including:

  • Fed Tapering/Tightening: If the Fed continues at the current pace, quantitative easing should end in the fourth quarter. Risk assets have historically reacted negatively when monetary stimulus has been withdrawn; however, this withdrawal is more gradual and the economy appears to be on more solid footing this time. The new Fed chairperson also adds to the uncertainty. Should economic growth and inflation pick up, market participants will shift quickly to concern over the timing of the Fed’s first interest rate hike.
  • Emerging markets: Slower growth could continue to weigh on emerging markets. While growth in China is slowing, there is not yet evidence of a hard landing.
  • Election year: While we noted there has been some progress in Washington, we could see market volatility pick up later this year in response to the mid-term elections.
  • Geopolitical risks: The events surrounding Russia and Ukraine are further evidence that geopolitical risks cannot be ignored.

Risk assets should continue to perform if real growth continues to recover; however, we could see volatility as markets digest the continued withdrawal of stimulus by the Federal Reserve. Economic data will be watched closely for signs that could lead to tighter monetary policy earlier than expected. Equity market valuations are fair, but are not overly rich relative to history, and may even be reasonable when considering the level of interest rates and inflation. Investor sentiment remains elevated but is not at extreme levels. Credit conditions still provide a positive backdrop for the markets.

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 Outlook Favored Sub-Asset Classes
U.S. Equity + Large cap bias, dividend growers
Intl Equity + Frontier markets, small cap
Fixed Income Global high-yield credit, short duration
Absolute Return + Closed-end funds, event driven
Real Assets +/- MLPs, natural resources equities
Private Equity + Diversified approach

Source: Brinker Capital

 Brinker Capital, Inc., a Registered Investment Advisor. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

Monthly Market and Economic Outlook: March 2014

Amy MagnottaAmy 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.

Magnotta_MonthlyUpdate_3.4.14

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.

Trust, but Verify

John CoyneJohn Coyne, Vice Chairman

I recently had the opportunity to participate in the 2014 FSI OneVoice conference in Washington, D.C. on a panel centered on issues related to both liquid and traditional alternative investments.  Our nation’s capital proved to be a great venue for the discussion as it called to mind the signature quote that Ronald Reagan used in his discussions with the Soviet Union, “Trust, but verify.”

As the former chief compliance officer here at Brinker Capital, I was impressed by the thoroughness of the due diligence process outlined by the audience of compliance gatekeepers during their discussions about the products circulating through their companies in both the liquid and illiquid space.  It was clear that while they maintain excellent relationships with their product sponsor partners (no, they do not treat them like the evil empire), they have really elevated their game, particularly in understanding the advisor/investor motivations in determining the appropriateness of a particular investment.  It is clear that many eyes are on the investment decision as it winds its way through the Broker/Dealer pipeline.

Financial Services InstituteFSI is providing the type of farsighted stewardship that recognizes that the product manufacturers, custodians, Broker/Dealer’s and the advisors must have a common communion around the needs of the client.  Events like the OneVoice conference demonstrate that their fostering and encouragement of an effective dialogue among all these parties creates the best potential for success.

Taking care of the client…the Gipper would be proud.

2013 Review and Outlook

Amy MagnottaAmy Magnotta, CFA, Senior Investment Manager, Brinker Capital

2013 was a stellar year for U.S. equities, the best since 1997. Despite major concerns relating to the Federal Reserve (tapering of asset purchases, new Chairperson) and Washington (sequestration, government shutdown, debt ceiling), as well as issues like Cyprus and Syria, the U.S. equity markets steadily rallied throughout the year, failing to experience a pullback of more than 6%.

Source: Strategas Research Partners, LLC

In the U.S. markets, strong gains were experienced across all market capitalizations and styles, with each gaining at least 32% for the year. Small caps outperformed large caps and growth led value. Yield-oriented equities, like telecoms and utilities, generally lagged as they were impacted by the taper trade. The strongest performing sectors—consumer discretionary, healthcare and industrials—all gained more than 40%. Correlations across stocks continued to decline, which is a positive development for active managers.

YenDeveloped international markets produced solid gains for the year, but lagged the U.S. markets. Japan was the top performing country, gaining 52% in local terms; however, the gains translated to 27% in U.S. dollar terms due to a weaker yen. Performance in European markets was generally strong, led by Ireland, Germany and Spain.  Australia and Canada meaningfully lagged, delivering only mid-single-digit gains.

Concerns over the impact of Fed tapering and slowing economic growth weighed on emerging economies in 2013, and their equity markets significantly lagged that of developed economies. The group’s loss of -2.2% was exacerbated due to weaker currencies, especially in Brazil, Indonesia, Turkey and India. Emerging market small cap companies were able to eke out a gain of just over 1%, while less efficient frontier markets gained 4.5%.

Fixed income posted its first loss since 1999, with the Barclays Aggregate Index experiencing a decline of -2%. The yield on the 10-year U.S. Treasury began rising in May, and moved significantly higher after then Federal Reserve Chairman Bernanke signaled in his testimony to Congress that tapering of asset purchases could happen sooner than anticipated. The 10-year yield hit 3% but then declined again after the Fed decided not to begin tapering in September. It climbed steadily higher in November and December, ending the year at 3.04%—126 basis points above where it began the year.

TIPS were the worst performing fixed income sector for the year, declining more than -8%, as inflation remained low and TIPS have a longer-than-average duration. On the other hand, high-yield credit had a solid year, gaining more than 7%. Across the credit spectrum, lower quality outperformed.

Magnotta_Client_Newsletter_1.7.13_5We believe that the bias is for interest rates to move higher, but it will likely come in fits and starts. 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. 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 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 begin 2014, with a number of factors supporting the economy and markets.

  • Monetary policy remains accommodative: Even with tapering beginning in January, short-term interest rates should remain near zero until 2015. In addition, the European Central Bank 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 has picked up (+4.1% annualized growth in 3Q). The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S., growth has not been very robust but 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 only +1.2% 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 that are flush 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 turn 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 in January. 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.
  • 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 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. Markets rarely stop when they reach fair value. There are even pockets of attractive valuations, such as emerging markets. Momentum remains strong; the S&P 500 Index spent all of 2013 above its 200-day moving average. However, investor sentiment is elevated, which could provide ammunition for a short-term pull-back. A pull-back could be short-lived should demand for equities remain robust.

Asset Class Outlook

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

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.

Monthly Market and Economic Outlook: October 2013

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

Developed market equities have had an impressive run so far in 2013, while fixed income, emerging markets and commodities have lagged. After telegraphing a tapering of asset purchases, the Fed surprised investors on September 18 with a decision to keep the quantitative easing program in place, wanting to see greater clarity on economic growth and a waning of fiscal policy uncertainty before reducing the level of asset purchases.

Asset prices moved immediately higher in response to the Fed’s decision; however that served to be the high-water mark for equities for the quarter.  Then concern over U.S. fiscal policy surfaced and has weighed on markets over the last few weeks. Unlike in previous years, deals to raise the debt ceiling and fund the government will result in limited fiscal drag; however, the headlines will serve to increase market volatility over the short term.

U.S. equity markets posted solid gains in the third quarter, led by small caps and growth-oriented companies.  High-yielding equities continue to lag. Developed international equity markets meaningfully outpaced U.S. markets in the quarter, with most countries generating double-digit returns.  As a result, the gap of outperformance for U.S. markets has narrowed for the year.  Emerging economies have been negatively impacted by the discussion of the Fed reducing liquidity, slower economic growth and weaker currencies.  While emerging markets equities rebounded in the third quarter, as a group they are still negative for the year with Brazil and India especially weak.

Interest rates continued their rise to start the quarter, with the 10-year Treasury note briefly hitting 3% in the beginning of September.  Rates then began to move lower, helped by an avoidance of conflict in Syria and the postponing of Fed tapering. All fixed income sectors were positive in the third quarter, led by high-yield credit.  Year to date through September, high yield has produced gains, while all other major fixed income sectors are negative. Outflows from taxable bond funds have slowed significantly in recent weeks, so the technical backdrop has improved somewhat.

We believe that interest rates have begun the process of normalization, and over the long term, the bias is for higher interest rates.  However, this process will be prolonged and likely characterized by fits and starts. The Fed will soon face the decision to taper asset purchases again later this year, with the earliest action in December.  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. Our fixed income allocation is well positioned with less interest-rate risk and a yield premium versus the broad market.

However, we continue to view a continued rapid rise in interest rates as one of the biggest threats to the U.S. economic recovery.  The recovery in the housing market, in both activity and prices, has been a positive contributor to growth this year.  Stable, and potentially rising, home prices help to boost consumer confidence and net worth, which impacts consumer spending in other areas of the economy.  Should mortgage rates move high enough to stall the housing market recovery, it would be a negative for economic growth.

We continue to approach our broad macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into the final months of the year, and a number of factors should continue to support 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 low for the foreseeable future), the ECB stands ready to provide additional support if necessary, and the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Global growth strengthening: U.S. economic growth has been sluggish, but steady.  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. China appears to have avoided a hard landing.
  • Labor market progress: The recovery in the labor market has been slow, but stable. Initial jobless claims, a leading indicator, have declined to a new cycle low.
  • Housing market improvement: The improvement in home prices, typically a consumer’s largest asset, boosts net worth, and as a result, consumer confidence.  However, another move higher in mortgage rates 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.

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

  • Fiscal policy uncertainty: After Congress failed to agree on a continuing resolution to fund the government, we entered shutdown mode on October 1.  While the economic impact of a government shutdown is more limited, the failure to raise the debt ceiling (which will be reached on October 17) would have a more lasting impact. A default remains unlikely in our opinion, and there will be little fiscal drag as a result of a deal, but the debate does little to inspire confidence. The Fed continues to provide liquidity to offset the impact.
  • Fed mismanages exit: The Fed will soon have to face the decision of whether to scale back asset purchases, which could prompt further volatility in asset prices and interest rates. If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.  The Fed will also be under new leadership next year, which could add to the uncertainty.  However, if the Fed does begin to slow asset purchases, it will be in the context of an improving economy.
  • Significantly higher interest rates: Rates moving significantly higher from here could stifle the economic recovery.
  • Europe: While the economic situation appears to be improving in Europe, the risk of policy error still exists.  The region has still not addressed its structural debt and growth problems; however, it seems leaders have realized that austerity alone will not solve its issues.

Risk assets should continue to perform if real growth continues to recover despite the higher interest rate environment; however, we expect heightened volatility in the near term. Valuations in the U.S. equity market remain reasonable while valuations abroad look more attractive. We continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Some areas of opportunity currently include:

  • Global Equity: Large-cap growth, dividend growers, Japan, frontier markets, international microcap
  • Fixed Income: MBS, global credit, short duration
  • Absolute Return: closed-end funds, relative value, long/short credit
  • Private Equity: company-specific opportunities

Asset Class Returns10.9.13_Magnotta_MarketOutlook

The views expressed above are those of Brinker Capital and are not intended as investment advice.

Stalemate

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The ongoing dysfunction in Washington D.C. reached a fever pitch this week, as the failure of lawmakers to agree on a bill to fund the Federal Government resulted in the President ordering its first shutdown since 1995.  The inability of Congress to effectively legislate has led to the furlough of more than 800,000 Federal workers, and a shuttering of all non-essential services.  Although equity markets around the world have remained relatively sanguine about the current state of affairs inside the beltway, the looming deadline to raise the debt ceiling, which the Treasury Department has declared to be no later than October 17, has heightened the stakes of the current impasse immeasurably, as a breach of this borrowing limit would have dire consequences not just for the United States, but for the global economy in aggregate.  It is the presence of this possibility that provides us with cautious optimism that a resolution might be forthcoming; as our belief is that the closure of the government and the subsequent pressure being applied by the electorate to end the stalemate has pulled forward the debt ceiling debate, which may result in a bargain that addresses both issues.  However, we intend to remain hyper-vigilant about the progress of these negotiations as we fully recognize the severity of the impact of a failure to honor our nation’s debts.

10.4.13_Preisser_Stalemate_1The current standoff has resulted from a multiplicity of factors, chief amongst which is a fundamental ideological difference between the parties over the Affordable Care Act, popularly known as “Obamacare”, which went into effect this week.  It is the vehemence of both sides in this debate combined with the extreme partisanship in the Capital that have made this situation particularly perilous.  Despite assertions to the contrary, the shuttering of the government comes at an exorbitant cost.  According to the New York Times, “ the research firm IHS Inc. estimates that the shutdown will cost the country $300 million a day in lost economic output…Moody’s Analytics estimated that a shutdown of three or four weeks would cut 1.4 percentage points from fourth-quarter economic growth and raise the unemployment rate.”  With consensus estimates for GDP currently at only 2.5% per annum, the present state of affairs, if not soon rectified will take an ever increasing toll on the nation’s economy.

Since 1970 there have been a total of 18 shutdowns of the Federal Government, including this most recent closure.  Although each situation was unique, what is common amongst them is that investors have, on average, approached them with relatively little trepidation.  According to Ned Davis Research, “during the six shutdowns that lasted more than five trading days, the S&P fell a median 1.7%.”In fact, optimism in the marketplace has tended to follow these periods of uncertainty.  Bloomberg News writes that, “the S&P has risen 11 percent on average in the 12 months following past government shutdowns, according to data compiled by Bloomberg on instances since 1976.  That compares with an average return of 9 percent over 12 months.”

Source: Ned Davis Research Group

Source: Ned Davis Research Group

There is one glaring difference between this year’s shuttering of the government and those of recent history, and that is the presence of the debt ceiling.  According to the New York Times, “the Treasury said last week that Congress had until Oct. 17 to raise the limit on how much the federal government could borrow or risk leaving the country on the precipice of default.”  Though we can look to the past as a guide to use to try and gauge the impact of a government shutdown, there is no way to accurately predict the effect of a failure of the United States government to fulfill its obligations, as this would be unprecedented. The need for Congress to raise the debt ceiling cannot be overstated, as the very sanctity of U.S. sovereign obligations depends upon it.  The importance of this faith to the global economy was captured by Nobel Prize winning economist, Paul Krugman, “Financial markets have long treated U.S. bonds as the ultimate safe asset; the assumption that America will always honor its debts is the bedrock on which the world financial system rests.”

U.S. Policy Update: Key Dates Ahead

Magnotta @AmyLMagnotta, CFA, Brinker Capital

I recently attended Strategas Research Partners’ public policy conference in Washington, D.C. It was hard to not come away with the feeling that our government will remain dysfunctional for the foreseeable future. But there is still hope. If we could just put politics aside, there are many smart, reasonable people on both sides of the aisle that could come together to devise an acceptable solution for our fiscal problems that does not stifle economic growth.

In the near term, policy uncertainty remains. The deal to avoid the fiscal cliff dealt primarily on the tax side, making the lower rates permanent except for those in the top tax bracket. However, they continued to kick the can down the road on the spending side. While Congress has agreed on a short-term extension of the debt ceiling, the issue will return mid-year. Washington will continue to be a focus for markets this year.

Below are some key items to watch for on the policy front:

  • The sequester, which consists $1.2 trillion of mandatory spending cuts over 10 years, half of which coming from the defense budget, is set to go into effect on March 1. At this point there is a high probability the cuts will happen. This will result in immediate negative headlines, but the impact of these spending cuts will not be felt for a few more months. Sequestration will also put some pressure on state and local governments as $37 billion of federal aid will be cut. A couple of months of cuts may force President Obama into a deal with the Republicans that would include some entitlement reform.
  • The continuing resolution that currently funds the government expires on March 27. No resolution could result in a complete or partial shutdown of the federal government.
  • The debt ceiling was extended until May 19, but the Treasury could stretch it out until July or August with extraordinary measures. Also included in the legislation is a requirement that both the House and the Senate produce a budget in April or their pay will be withheld.
  • The CBO will release their outlook on February 4.
  • Momentum is building for tax reform as Chairmen of the House Ways and Means Committee (Camp-R) and the Senate Finance Committee (Baucus-D) have hired dedicated staff. However, there is a lack of consensus on why we should do tax reform.
  • Ratings agencies are looking for a plan to stabilize our debt to GDP ratio at 70%. To do this we would need spending cuts closer to $2 trillion over ten years.

Looking Past the Fiscal Cliff

MagnottaAmy Magnotta, CFA, Brinker Capital

It looks like there will be some deal on the fiscal cliff that emerges from Washington before the end of the year—either (1) a large deal that includes a compromise on higher revenues, spending cuts and entitlement reforms, or (2) a smaller deal that results in a larger fiscal drag than consensus currently anticipates. Time is running out, and the market will likely be disappointed if Congress leaves for the Christmas holiday without a more specific plan in place.

In his research report today, Don Rismiller, Chief Economist at Strategas Research Partners, encouraged investors to look through the fiscal cliff and to take notice of the number of good things that are happening in the U.S. economy. Rismiller provided a dozen reasons for optimism after the fiscal cliff is resolved.

The Other Side

Positives on the Other Side of the Fiscal Cliff:

  1. The Fed has followed through on “QE4.”
  2. Additional global easing is expected (e.g., Abe & BoJ, Carney & BoE).
  3. The bond market has digested additional U.S. debt well (10-yr @ 1.8%).
  4. The U.S. dollar has held value (meaning there’s room for policy to operate).
  5. Housing has bottomed in the U.S.
  6. There’s pent-up demand for household formation (buy or rent).
  7. There’s pent-up demand being created for capex (which has already fallen).
  8. There’s likely some pent-up demand for autos (hurricane replacement).
  9. While small, nonresidential construction could increase with hurricane rebuilding.
  10. Domestic energy production continues to ramp up.
  11. Equity valuations look attractive.
  12. Equity multiples bottom before earnings, which is likely an early 2013 story.