Key U.S. Economic News
■ Nonfarm payrolls increased only +80,000 in June. We’ve averaged only +75,000 payroll gains per month in the second quarter, the weakest job growth seen in two years. The unemployment rate held at 8.2% and there was no change in the participation rate. The broader U-6 measure of unemployment ticked up to 14.9%.
■ In June the manufacturing PMI fell into contraction territory for the first time since July 2009, falling -3.8 points to 49.7%. The new orders component fell an astonishing -12.3 points to 47.8%. Only seven industries reported growth, while nine reported contraction. The prices component also fell significantly, declining -10.5 points to 37.0%.
■ The non-manufacturing PMI declined -1.6 points to 52.1% in June, still indicating growth but at a slower rate. Twelve industries reported growth while five reported contraction. The business activity component fell but remained in expansionary territory and the employment component increased 1.5 points.
■ Real disposable personal income increased +0.3% in May, while real personal consumption expenditures increased +0.1%. The personal savings rate ticked up to 3.9%. Year-over-year real consumer spending has increased at a muted +1.9% rate.
■ Retail sales fell -0.2% in May, and April’s sales were revised downward to a -0.2% decline. However, retail sales remain +5.3% above May 2011 levels.
■ Inflationary pressures continued to recede on lower energy prices.
□ The Consumer Price Index fell -0.3% on lower gasoline prices, bringing the year-over-year change down to +1.7%. The core CPI, which excludes food and energy, rose +0.2% on higher shelter prices. The core CPI is up +2.3% over the last 12 months.
□ The Producer Price Index fell -1.0%. Over the last 12 months, the PPI has increased only +0.7%.
■ Industrial production edged down -0.1% in May on lower manufacturing production. Industrial production is 4.7% above its year-ago level and at 97.3% of its 2007 average. Capacity utilization fell -0.2% to 79.0%, still 1.3 percentage points below its long-run average.
■ The housing market remains weak, but appears to have bottomed.
□ Housing starts fell -4.8% to a SAAR of 708,000; however, the weakness was in the multi-family sector as single family housing starts increased +3.2% to 516,000. Housing starts remain well below peak levels.
□ Existing home sales fell -1.5% to a SAAR of 4.55 million. Distressed homes accounted for 25% of sales in May, down from 31% a year ago.
□ New home sales increased 7.6% to a SAAR of 369,000, boosted by strong sales in the Northeast.
□ The S&P/Case-Shiller 20-City Home Price Index increased +1.3% in April after seven consecutive months of falling prices. Year-over-year, home prices have fallen -1.9%.
■ The Confidence Board’s Leading Economic Index increased +0.3% in May, reversing April’s slight decline.
Key U.S. Policy News
■ At their June meeting, the FOMC decided to extend “Operation Twist” through the end of 2012, purchasing approximately $267 billion of longer dated U.S. Treasuries (6-30 year maturities) while selling the same amount of shorter dated securities (maturities of less than three years). The Fed downgraded its growth, inflation and employment projections for 2012 and 2013 and left the door open to further stimulus if the data warrants. Federal Reserve Bank of Richmond President Jeffrey Lacker, the lone dissenter, does not believe the extension would spur economic growth and could instead stoke inflation.
■ The Supreme Court upheld the Affordable Care Act in a 5-4 decision based on Congress’ taxing power, but struck down the Medicaid expansion portion of the bill.
Key Market Data and Events
Annualized for periods greater than one year. Past performance is no guarantee of future results. Source: FactSet, Red Rocks Capital, Hedge Fund Research. Total returns as of 6/30/12.
■ While most asset classes have posted positive returns through the first half of 2012, it has been a volatile ride. Risk assets were on a tear in the first quarter, but concerns regarding Europe’s sovereign debt crisis and tepid economic growth dominated in March and April, resulting in a flight to safety and a sell-off in global equity markets. Investors began to embrace risk again in June and markets rallied, but still ended with a second quarter loss.
■ In the second quarter, defensive sectors (telecom, utilities, staples, healthcare) outperformed, while financials and information technology were the worst performing sectors. Year-to-date energy is the only S&P sector with a negative return (-2.3%) while telecom has been the top performing sector (+16.5%).
■ Large cap stocks edged out small caps in the second quarter and for the year-to-date period. Mid cap stocks have underperformed so far this year.
■ From a style perspective value led growth in the second quarter, but growth still leads value year-to-date. Stocks with high dividend yield have been rewarded as investors continue to be starved for yield in this environment.
■ The U.S. dollar enjoyed safe haven status in the second quarter, gaining over 3% versus developed market currencies.
■ International equities continue to lag U.S. equities. Over the last three years the S&P 500 Index has outperformed the MSCI EAFE Index by 10 percentage points on an annualized basis. The events in the Eurozone weighed on their equity markets, with Germany, Portugal, Spain, Italy and Greece all experiencing double-digit declines in the second quarter.
■ At the EU summit at the end of June, European leaders came to some agreement on policy options going forward. They discussed moving toward common banking supervision, the direct recapitalization of banks, the abandonment of the seniority requirement for the loan to Spain, and the potential use of the ESM to purchasing peripheral sovereign bonds. The markets reacted favorably to the news; however, it is unclear to what extent the proposal will actually be implemented.
■ Emerging markets exhibited mixed performance. Despite the growth concerns, China was a relative outperformer in the second quarter. The remainder of the BRICs (Brazil, Russia, and India) lagged and were also hurt by depreciating currencies. Colombia, Thailand and Mexico have been the strongest performing markets so far this year.
■ Consistent with the risk-off mentality that dominated most of the second quarter, the bond market provided strong returns as rates hit historic lows. The yield on the 10-year U.S. Treasury fell to a record low 1.47% on June 1, while the 30-year bond yield fell to 2.53%.
■ The Barclays Aggregate gained for the sixth consecutive quarter and has risen in 14 of the last 15 quarters. All major sectors posted gains, led by Treasuries. Despite spread widening during the quarter, high yield was able to generate a positive return.
■ Hedge funds posted another disappointing quarter of returns. CTA funds continue to struggle in this type of volatile environment. Credit arbitrage funds have been the best performers so far this year.
■ REITs have been the beneficiary of investor demand for yield. U.S. and Asia REITs produced gains in the second quarter, while the asset class has delivered 15% returns year-to-date.
■ Commodity indexes were negative in the second quarter on concerns of slowing global growth. Crude oil declined more than -20% and copper declined -10% during the quarter. Gold reacted negatively to the lack of announcement of additional quantitative easing by the Federal Reserve. Natural gas moved higher, as did wheat and grains.
Outlook
After the “risk on” environment to start the year, global equity prices pushed sharply higher and forced credit spreads tighter, risk assets pulled back in the second quarter. The deepening crisis in the Eurozone and evidence of slower global growth weighed on the global financial markets and drove investors to the relative safety of the U.S. government bond markets.
Some positive factors remain, but the macro risks continue to dominate. We expect continued sluggish growth in the U.S. because of ongoing deleveraging, regulatory uncertainty and the looming fiscal cliff in 2013. The effect of the fiscal cliff is estimated to be north of 3% of GDP, which would push the economy into recession. While U.S. corporations are in good shape with strong earnings and high levels of cash on their balance sheets, they are hesitant to put it to work because of the uncertain environment. Employment growth has been weaker, and we still lack sustained growth in real personal incomes, both of which are key to greater levels of consumption and stronger economic growth going forward. While the Federal Reserve remains accommodative and stands ready to act further, the effectiveness of their monetary policy tools is diminishing.
The Eurozone has begun to take steps toward addressing their sovereign debt crisis, but more needs to be done. Policymakers must also contend with a deepening recession in the region, which will send debt/GDP ratios even higher. The need for a bailout of Spanish banks prompted leaders to announce somewhat more aggressive measures at their recent summit. It remains unclear whether these policy options will actually be put into place; however, it appears that Europe is beginning to lay out a path forward, which is a positive. Now actions need to follow.
While growth in developed markets is weak, growth in emerging markets has also slowed. Investors continue to watch China’s actions to see whether a hard landing can be averted. Brazil’s economy has slowed meaningfully as well. Unlike developed economies, emerging economies still have room to ease to promote growth. One positive corollary of a slowdown in global growth is receding inflationary pressures and lower commodity prices. Lower retail gas prices are a boost to the disposable incomes of consumers.
The unresolved macro risks will keep the markets susceptible to bouts of volatility as we enter the second half of the year. The U.S. Presidential election will likely add to that volatility. Because of massive government intervention in the global financial markets, we will continue to be susceptible to event risk. As a result, our portfolios will continue to be positioned with a modestly defensive bias. However, we seek to take advantage of high conviction opportunities and strategies within asset classes as increased volatility often leads to opportunities. We feel that a broadly diversified portfolio and actively managed approach can best navigate the current investing environment.
Notable Numbers
The Home Stretch – The S&P 500 closed at its calendar year high in the second half of the year 73% of the time since 1950. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market (source: BTN Research).
Costs A Lot - Just 1 in 9 retirees (11%) surveyed indicated that their post-retirement expenses were less than they had expected. 22,000 retirees participated in the poll (source: Consumer Reports).
Most Pay On Time – 8 out of every 9 mortgages in the USA (88.9%) are “current and performing” as of 3/31/12, i.e., the borrower is current with his/her monthly mortgage payment (source: OCC).
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This newsletter is intended to provide opinions and analysis of the general conditions of the market and economy, but is not intended to provide personalized investment advice. Statements referring to future actions or events, such as the future financial performance of certain asset classes or market segments, are based on the current expectations and projections about future events provided by various. sources, including Brinker Capital's Investment Management Group. These statements are not guarantees of future performance and actual events may differ materially from those discussed. This commentary includes statistical information obtained from various third-party sources. Brinker Capital believes those sources to be accurate and reliable; however, we are not responsible for errors by third-party sources on which we reasonably rely. Performance data represents general indexes representative of certain asset classes and are not indicative of actual past performance of any specific portfolio managed or sponsored by Brinker Capital.
Appendix
*Returns as of 6/30/12. Annualized for periods greater than one year. Past performance is no guarantee of future results.
*Price Return. Source: FactSet
Glossary
Barclays Capital Municipal Bond Index – A benchmark index that includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than two years) selected from issues larger than $50 million.
Barclays Capital U.S. Aggregate Bond Index – An unmanaged market-value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities, with maturities of at least one year.
Barclays Capital U.S. TIPS Index (Treasury Inflation-Protected Securities) –The Barclays U.S. TIPS Index consists of inflation-protection securities issued by the U.S. Treasury.
Commercial Mortgage-Backed Securities (CMBS) – a type of mortgage-backed security that is secured by the loan on a commercial property. (Source: Investopedia.com)
Consumer Price Index (CPI) – The CPI or Consumer Price Index is a measure of the cost of goods purchased by average U.S. household. It is calculated by the U.S. government's Bureau of Labor Statistics. (Source: About.com)
Developed Markets (DM) – Markets that are associated with nations that are considered to be developed. In order for a developed market to exist, the nations involved with the market must be considered to be somewhat stable in terms of economy and governmental structure. (Source: Wisegeek.com)
Dow Jones/UBS Commodity Index – A rolling commodities index composed of futures contracts on 19 physical commodities traded on U.S. exchanges. The Index serves as a liquid and diversified benchmark for the commodities asset class.
DJIA (Dow Jones Industrial Average) – The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ. The DJIA was invented by Charles Dow back in 1896.
Dow Jones U.S. Total Stock Market – The Dow Jones U.S. Total Stock Market Index represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The Index was created in 1974.
Emerging Markets (EM) – A foreign economy with a low to middle per capita income that is developing in response to the spread of capitalism and has created its own stock market. Analogous to small growth companies, emerging markets have high potential as well as high risk. Such countries constitute approximately 80% of the global population, and represent about 20% of the world's economies. (Sources: Answers.com, Investopedia.com)
FTSE EPRA/NAREIT Global Real Estate (Financial Times and London Stock Exchange European Public Real Estate Association/National Association of Real Estate Investment Trusts®) –The FTSE EPRA/NAREIT Global Real Estate Index is designed to represent general trends in eligible listed real estate stocks worldwide. Relevant real estate activities are defined as the ownership, trading and development of income-producing real estate. Only closed-end companies listed on an official stock exchange are included in the Index.
HFRX Global Hedge Fund Index (Hedge Fund Research Inc.) – The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It comprises eight strategies: convertible arbitrage, distressed securities, equity hedge, equity market neutral, event driven, macro, merger arbitrage, and relative value arbitrage. The strategies are asset-weighted based on the distribution of assets in the hedge fund industry.
ISM Manufacturing Index – A monthly index released by the Institute of Supply Management which tracks the amount of manufacturing activity that occurred in the previous month. This data is considered a very important and trusted economic measure. If the Index has a value below 50, due to a decrease in activity, it tends to indicate an economic recession, especially if the trend continues over several months. A value substantially above 50 likely indicates a time of economic growth. The values for the Index can be between 0 and 100.
ISM Non-Manufacturing Index – ISM Non-Manufacturing Index is a gauge of business conditions in non-manufacturing industries, based on measures of employment trends, prices and new orders. Though non-manufacturing sectors make up the majority of the economy, the ISM Non-Manufacturing has less market impact because non-manufacturing data tends to be more cyclical and predictable. However, these sectors do account for a considerable portion of CPI. As a result, the figure gives insight into conditions which can impact output growth and inflationary pressures.
ISM Non-Manufacturing PMI - ISM Non-Manufacturing Purchasing Managers' Index (PMI) is an index based on the survey of around 400 purchasing managers excluding the manufacturing industry. It often asks to rate business conditions including employment, production, prices, and new orders. (source: http://www.forexyard.com/es/calendar/428)
LIBOR (London Interbank Offered Rate) – The interest rate offered by a specific group of London banks for U.S. dollar deposits of a stated maturity. LIBOR is used as a base index for setting rates of some adjustable rate financial instruments, including Adjustable Rate Mortgages (ARMs) and other loans.
Long Bond – bond that matures in more than 10 years (Source: Investopedia.com)
M2 Money Supply – measure of total money supply. Includes saving and other time deposits. It is a broader measure that reflects money’s function as a store of value. (Sources: Library of Economics and Liberty, www.econlib.org; www.About.com)
Merrill Lynch 3-7 Year Municipal Bond Index – The Merrill Lynch 3-7 year municipal bond index us a subset of The Merrill Lynch U.S. Municipal Securities Index including all securities with a remaining term to final maturity greater than or equal to 3 years and less than 7 years.
Metropolitan Statistical Area (MSA) – a geographic entities defined by the U.S. Office of Management and Budget (OMB) for use by Federal statistical agencies in collecting, tabulating, and publishing Federal statistics. A metro area contains a core urban area of 50,000 or more population and consists of one or more counties and includes the counties containing the core urban area, as well as any adjacent counties that have a high degree of social and economic integration (as measured by commuting to work) with the urban core. (Source: U.S. Census Bureau)
Mortgage-Backed Security (MBS) – a type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities must be grouped in one of the top two ratings as determined by a accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. (Source: Investopedia.com)
MSCI All Country World ex-U.S. (Morgan Stanley Capital International) –The MSCI All Country World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets, except the U.S. The Index consists of 47 country indices comprising 22 developed and 25 emerging market country indices.
MSCI EAFE (Morgan Stanley Capital International Europe, Australasia and Far East) –The MSCI EAFE Index is recognized as the preeminent benchmark in the United States to measure international equity performance. It comprises 21 MSCI country indices, representing the developed markets outside of North America: Europe, Australasia and the Far East.
MSCI Emerging Markets (Morgan Stanley Capital International) –The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. As of June 2006, the MSCI Emerging Markets Index consisted of the following 25 emerging market country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
NASDAQ (National Association of Securities Dealers Automated Quotations) – The NASDAQ Composite Index is a market-capitalization-weighted, unmanaged index that is designed to represent the performance of the National Association of Securities Dealers Quotation System, which includes more than 5,000 stocks traded only over the counter and not on an exchange. The Index does not include the reinvestment of dividends.
Personal Consumption Expenditure (PCE) – A measure of price changes in consumer goods and services. Personal consumption expenditures consist of the actual and imputed expenditures of households; the measure includes data pertaining to durables, non-durables and services. It is essentially a measure of goods and services targeted toward individuals and consumed by individuals. (Source: Investopedia.com, 2010.)
Red Rocks Listed Private Equity Index – The Red Rocks Listed Private Equity Index is designed to track the performance of the largest and most liquid publicly traded private equity firms principally invested in the United States and publicly traded private equity portfolios with principal investments in the United States. The publicly traded stocks within the Index are traded on any nationally recognized exchange worldwide.
Russell 1000 – Measures the performance of the 1,000 largest companies in the Russell 3000 Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index. As of the latest reconstitution, the average market capitalization was approximately $13.9 billion; the median market capitalization was approximately $4.9 billion. The smallest company in the Index had an approximate market capitalization of $2.0 billion.
Russell 1000 Growth – Measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.
Russell 1000 Value – Measures the performance of Russell 1000 companies with lower price-to-book ratios and forecasted growth values.
Russell Mid Cap – Measures the performance of the 800 smallest companies in the Russell 1000 Index, which represents approximately 30% of the total market capitalization of the Russell 1000 Index. As of the latest reconstitution, the average market capitalization was approximately $5.3 billion; the median market capitalization was approximately $3.9 billion. The largest company in the Index had an approximate market capitalization of $14.9 billion.
Russell Mid Cap Growth – Measures the performance of those Russell Midcap companies with higher price-to-book ratios and higher forecasted growth values. The stocks are also members of the Russell 1000 Growth Index.
Russell Mid Cap Value – Measures the performance of those Russell Midcap companies with lower price-to-book ratios and lower forecasted growth values. The stocks are also members of the Russell 1000 Value Index.
Russell 2500 – Measures the performance of the 2,500 smallest companies in the Russell 3000 Index.
Russell 2500 Growth – Measures the performance of those Russell 2500 companies with higher price-to-book ratios and higher forecasted growth values.
Russell 2500 Value – Measures the performance of Russell 2500 companies with lower price-to-book ratios and forecasted growth values.
Russell Small Cap – Measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index. As of the latest reconstitution, the average market capitalization was approximately $762.8 million; the median market capitalization was approximately $613.5 million. The largest company in the Index had an approximate market capitalization of $2.0 billion and a smallest of $218.4 million.
Russell Small Cap Growth – Measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.
Russell Small Cap Value – Measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.
S&P 500 (Standard & Poor's 500 Index) – An index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Companies included in the Index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor's. The S&P 500 is a market-value-weighted index -- each stock's weight in the Index is proportionate to its market value.
Seasonally Adjusted Annual Rate (SAAR) – rate adjustment used for economic or business data that attempts to remove the seasonal variation in data. Calculated by dividing the unadjusted annual rate for the month by its seasonality factor and crated an adjusted annual rate for the month. (Source: Investopedia.com)
Standard & Poor’s/Case-Shiller Home Price Index – The S&P/Case-Shiller Home Price Index measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. The Index uses the repeat sales pricing technique to measure housing markets. The Index is calculated monthly and published with a two-month lag.
TED Spread (acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract) – the difference between the interest rates on interbank loans and short-term U.S. government debt. It is an indicator of perceived credit risk in the general economy.
Troubled Assets Relief Program (TARP) – A program in which the federal government can buy bad assets from financial institutions, with the government getting stock warrants in return.
VIX (Market Volatility Index) – An index designed to track market volatility as an independent entity. The Market Volatility Index is calculated based on option activity and is used as an indicator of investor sentiment, with high values implying pessimism and low values implying optimism.
