Following the Federal Reserve

To spur borrowing and boost the economy, the Federal Reserve cut the federal funds target rate to near zero at the end of 2008. More recently, the Fed disclosed that it is unlikely to raise rates until late 2014. In January 2012, the central bank released detailed forecasts for the federal funds rate — and stated a specific goal for the rate of inflation (2%) — for the first time in its history.^1–2

The Federal Reserve and the Federal Open Market Committee (FOMC) operate under a dual mandate to conduct monetary policies that foster maximum employment and price stability. In response to the financial crisis, lingering economic weakness, and high unemployment, the Fed has taken a series of unconventional steps.

Meet the Committee

The FOMC meets eight times a year. Projections for economic growth, unemployment, and inflation are collected from all seven members of the Board of Governors of the Federal Reserve System (including Chairman Ben Bernanke) and 12 regional Reserve Bank presidents ahead of scheduled FOMC meetings.

Behind closed doors, participants discuss how economic conditions are likely to change and which policy responses might be appropriate given the economic outlook. The 12 committee members — including all seven governors, the president of the Federal Reserve Bank of New York, and four of the remaining 11 Reserve Bank presidents (on a rotating basis) — vote on specific policy actions proposed during the meeting. Quarterly projections are typically released after their two-day meetings.

Portfolio Moves

During the 2008 credit crisis, the Fed helped stabilize the banking system by making emergency loans to banks and businesses and buying up “toxic” securities whose values had plummeted. The central bank was criticized by some people for putting itself in a position to sustain losses, but so far Fed holdings have generated profits.³

The central bank now holds almost $2.9 trillion of Treasuries, agency debt, and other securities, much of which was acquired through bond-buying programs known as quantitative easing and QE2.⁴

In September 2011, the Fed announced a plan to help drive down long-term rates further. “Operation Twist” involved trading $400 billion of short-term Treasuries for new ones with longer maturities. If the economy falters in 2012, a third round of monetary stimulus remains a possibility.⁵

Communication Matters

One of the most powerful tools the Fed has at its disposal is communication. Traditionally, speeches made by FOMC participants, published economic projections, and the official statements released after each FOMC meeting have been used to inform the public.

Chairman Bernanke began holding press conferences after FOMC meetings in 2011, and detailed rate forecasts followed in January 2012.⁶ This marks quite a shift from the early 1990s, when the Fed didn’t even announce when (or by how much) rates had been adjusted.⁷

Bernanke believes that greater transparency and the clarity gained from forecasts could push down long-term rates and help shape the expectations and behavior of investors, businesses, and households — and managing the public’s expectations could make the Fed’s policy moves more effective.⁸

Investors should remember that future Fed actions will depend on economic conditions. If inflation rises more than expected, higher interest rates will likely follow, despite any previous forecasts.

All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest.

1) Federal Reserve, 2012
2, 6) CNNMoney, January 25, 2012
3) The Wall Street Journal, January 10, 2012
4) CNNMoney, January 10, 2012
5) The Wall Street Journal, September 21, 2011
7–8) The Wall Street Journal, January 4, 2012

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright © 2012 Emerald Connect, Inc.

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Despite the pick-up in volatility at the end of January, risk assets continued their upward ascent throughout the month. Expectations surrounding the implementation of the newly passed tax reform bill and the weakening US dollar served as positive catalysts for the month. Macroeconomic data was mixed; fourth quarter real GDP growth came in slightly below expectations but manufacturing activity accelerated and the US jobs report was positive. Although we have seen initial signs of rising inflation, levels remain subdued as low unemployment has yet to translate into meaningful wage growth. We expect the Federal Reserve (Fed) to remain on track with interest rate normalization and the positive, albeit choppy, market momentum we have seen to date indicates that markets can likely withstand an additional Fed rate hike in March.

The S&P 500 Index was up 5.7% for the month with cyclicals outperforming defensive sectors. Consumer discretionary (+9.3%) led while tax cuts and a solid job market served as positive catalysts. Information technology (+7.6%) and financials (+6.5%) also posted strong returns for the month. Utilities (-3.1%) and REITs (-2.0%) were down as traditional bond proxy sectors experienced headwinds amidst rising interest rates. Growth outperformed value and large-cap outperformed both mid-cap and small-cap equities.

Developed international equities (+5.0%) performed in line with domestic equities. Fundamentals within the Eurozone continued to improve and sentiment is high. The focus remains on European Central Bank policy and how the reduction of its quantitative easing purchases will impact markets. Emerging markets were up 8.3%. A weaker dollar and stronger demand for commodities served as tailwinds for both emerging Asia and Latin America regions.

The Bloomberg Barclays US Aggregate Index was down -1.2% for the month. Interest rates surged with 10-year Treasury yields increasing 31 basis points, ending the month at 2.7%. Tightening monetary policy and improving US growth expectations will likely continue to put upward pressure on the long end of the yield curve. High yield was the only sector to post positive returns in January, as credit spreads continued to grind tighter. Like taxable bonds, municipals were negative for the month.

We remain positive on risk assets over the intermediate-term, although we acknowledge we are in the later innings of the bull market and the second half of the business cycle. While this cycle has been longer in duration compared to history, the recovery we have experienced has been muted, supported by the extended recovery period. While our macro outlook is biased in favor of the positives, the risks must not be ignored.

We find a number of factors supportive of the economy and markets over the near-term.

Pro-growth policies of the Administration: The Trump administration has delivered a new tax plan and a more benign regulatory environment. We could see additional government spending on infrastructure in 2018.
Synchronized global economic growth: Growth in the US has started to accelerate, and growth in both developed international and emerging economies has meaningfully improved. The tax cuts could also help to boost GDP growth in 2018.
Improvement in earnings growth: Corporate earnings growth has improved globally and corporate tax reform should further benefit US-based companies.
Elevated business sentiment: Measures like CEO Confidence and NFIB Small Business Optimism are at elevated levels. This typically leads to additional project spending and hiring, which should boost growth. The corporate tax cut should also benefit business confidence and lead to increased capital spending.

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

Fed tightening: The Fed will continue to tighten monetary policy, with at least three interest rate hikes priced in for 2018. We may see tightening from other global central banks as well.
Higher inflation: Current levels of inflation are muted but inflation expectations have ticked higher and the reflationary policies of the Administration could further boost levels. Should inflation move higher, the Fed may shift to a more aggressive tightening stance.
Geopolitical risks: Geopolitical risks including trade policies and global challenges could cause short-term market volatility.

Despite the volatility experienced over the last week, the technical backdrop of the market remains favorable, credit conditions are supportive, and global economic growth is accelerating. So far President Trump’s policies are being seen as pro-growth, and business and consumer confidence are elevated. The onset of new policies under the Trump administration and actions of central banks may lead to higher volatility, but our view on risk asMarchsets remains positive over the intermediate-term. Higher volatility can lead to attractive pockets of opportunity we can take advantage of as active managers.

Brinker Capital Barometer (as of 1/5/18)

Source: Brinker Capital. Leigh Lowman, CFA, Investment Manager. 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. Indices are unmanaged and an investor cannot invest directly in an index. 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. S&P 500: 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 US 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. Bloomberg Barclays US Aggregate: A market capitalization-weighted index, maintained by Bloomberg Barclays, and is often used to represent investment grade bonds being traded in United States.

Views expressed are those of Brinker Capital, Inc. and are for informational/educational purposes. Opinions and research referring to future actions or events, such as the future financial performance of certain asset classes, indexes 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. Information contained within may be subject to change. Diversification does not assure a profit not guarantee against a loss.

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