Economic Outlook and Review

Transcription

1 Economic Outlook and Review 4 th Quarter, 2013 Investment Policy Committee Report November, 2013

2 Willard N. Woolbert Senior Vice President Chief Investment Officer Jonathan M. Heckscher Senior Vice President Director of Fixed Income Charles L. Sheppard, II Senior Vice President Director of Investment Research Gilpin W. Bartels Senior Vice President Portfolio Manager 2

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4 2013 Benchmark Performance Table Q Q Q Year to Date NIKKEI (Japan) S&P NASDAQ 8.51 MSCI World Equity 7.91 MSCI European Equity 6.95 High Yield Bonds 2.16 Investment Grade Bonds 0.07 MSCI Emerging Markets US Ten Year Bond Euro Gold NIKKEI (Japan) NASDAQ 4.52 S&P Euro 1.49 MSCI World Equity 0.84 MSCI European Equity High Yield Bonds -2.2 Investment Grade Bonds -2.6 US Ten Year Bond MSCI Emerging Markets Gold NASDAQ 11.2 MSCI World Equity 8.34 Gold 8.26 MSCI European Equity 8.12 NIKKEI (Japan) 6.26 MSCI Emerging Markets 5.63 S&P Euro 3.77 High Yield Bonds 2.34 US Ten Year Bond 0.61 Investment Grade Bonds 0.56 NIKKEI (Japan) NASDAQ S&P MSCI World Equity MSCI European Equity Euro 2.35 High Yield Bonds 2.26 MSCI Emerging Markets 0.47 Investment Grade Bonds -2 US Ten Year Bond Gold Source: Bloomberg LLP All data is in local currency and includes dividend/ interest reinvestment as of 9/30/13. Stocks enjoyed strong gains in the third quarter. Lifted by hopes for continued monetary stimulus and a rebound in the global economy, investors bought stocks despite slowing profit growth. Most of the domestic stock indexes moved further into record territory before pulling back late in the period. After alarming investors in May and June by signaling that it might soon cut back on its asset purchases (watch our webcast on Investing in a Tapering World ), the Federal Reserve played a strong role in bolstering sentiment in the third quarter. Early in the quarter, Fed officials managed to quell worries that they might increase short-term interest rates, while also assuring investors that they would tread carefully in allowing long-term interest rates to drift higher. Investor sentiment was also bolstered by encouraging signs on the global economy. The recession in the eurozone appeared to be coming to an end. Emerging markets economies, which have struggled in recent months, seemed to be gaining traction (or at least finding a bottom) as well. 4

5 2013 Benchmark Performance Table Q Q Q Year to Date Health Care Consumer Staples Utilities Consumer Discretionary Financials Industrials Energy Telecommunications 9.45 Materials 4.79 Technology 4.59 Financials 7.25 Consumer Discretionary 6.81 Health Care 3.83 Industrials 2.81 Technology 1.68 Telecommunications 1 Consumer Staples 0.5 Energy Materials Utilities Materials 10.3 Industrials 8.9 Consumer Discretionary 7.79 Health Care 6.82 Technology 6.62 Energy 5.15 Financials 2.87 Consumer Staples 0.8 Utilities 0.19 Telecommunications -4.4 Consumer Discretionary Health Care Industrials Financials Consumer Staples Energy Materials 13.5 Technology Utilities Telecommunications 5.69 Source: Bloomberg LLP All data is in local currency and includes dividend/ interest reinvestment as of 9/30/13. Since ten-year Treasury yields started rising on May 22, the Consumer Discretionary Sector is up 6.86%, the best performance among the ten broad market sectors over that time Worst: telecommunications (-7.2%) With China s economy stabilizing and the global outlook improving, the materials and industrials sectors led broad-based gains. More economically sensitive sectors generally registered larger returns, while defensive, dividend-heavy sectors continued to underperform. Growth outperformed value and small and mid caps led amid solid fundamentals and assurances of continued QE. REITs & MLP declined, as their high dividend yields faced ongoing competition from increased bond yields. 4 th Quarter Comment: U.S. companies are warning about third-quarter earnings at a rate lower than last quarter but still at the second highest level since 2001, leaving estimates well below what they were just three months ago. 5

6 Rank Fund Name Fund Manager Ticker 3rd Quarter YTD 1 Year 3 Years 5 Years 1 ishares Nasdaq Biotechnology E ishares/usa IBB ishares MSCI South Korea ishares/usa EWY ishares China Large-Cap ETF ishares/usa FXI Vanguard FTSE Europe ETF Vanguard ETF/USA VGK ishares Russell 2000 Growth ET ishares/usa IWO Alerian MLP ETF ALPS ETFs/USA AMLP ishares US Preferred Stock ETF ishares/usa PFF ishares 20+ Year Treasury Bond ishares/usa TLT Vanguard REIT ETF Vanguard ETF/USA VNQ ishares US Real Estate ETF ishares/usa IYR The Good So far in 2013 biotech ETFs have garnered some of the best returns of all U.S. ETFs, fueled by increasing mergers and acquisitions, promising new drugs coming to market, and more accommodative regulators willing to push all of those drugs out with greater efficiency. After an inauspicious first half, Vanguard FTSE Europe (VGK) appears to have hit bottom in late June. Since that time, VGK has catapulted 17% off its lows. And The Bad After a bull run in the first four months of the year, the U.S. Real Estate Investment Trust (REIT) industry nosedived after the onset of taper talk which pushed up interest rates sharply. Since ten-year Treasury yields started rising on May 22, the downside risk in the sector has been acute with the ishares U.S. Real Estate ETF down 13.97% and the Vanguard REIT ETF down 13.77%. That being said, both funds have outperformed the broad markets over the past month as taper talk has subsided and investors are once again seeking the yield provided by these REITS and MLP s (IYR 4.05%, VNQ 3.9%, AMLP 5.96). Source: Bloomberg LLP All data is in local currency and includes dividend/ interest reinvestment (as of 9/30/13). Dividend yield information provided by Morningstar. 6

7 1.40% 0.50% 1.40% 0.40% 1.20% 1.60% -2.10% 4.40% 7.80% 1.20% 1.50% 6.80% 4.40% 3.28% 5.80% 2.60% 8.30% 2.00% Year-Over-Year GDP Growth as of June, % 0% 8% 7 Source: Bloomberg LP

8 Most companies in the Standard & Poor s 500 Index are finding quarterly sales projections from analysts to be too high a hurdle to surpass this year. Thus far *, only 38% of the index s first 130 companies to release third-quarter results beat the average revenue estimates. Companies are meeting earnings projections far more often than sales estimates, as the chart shows. Thus far *, third-quarter profit exceeded the average analyst estimate at 65% of S&P 500 companies reporting, according to Bloomberg s data. That s just below an average of 67% for the previous eight quarters. There haven t been three consecutive quarters of readings below 50% since Bloomberg began compiling the data four years ago. While a majority of S&P 500 companies trailed sales estimates in last year s second and third quarters, 54% exceeded the average projection in the fourth quarter. * = As of 10/23/2013 8

9 Having tracked earnings growth for the first three years of the recovery, the equity markets have moved ahead since mid-2012 on an increase in valuation. We believe that the current version of QE has been an important reason for equity price appreciation. Threats to liquidity such as tapering would have an impact on the markets without a noticeable improvement in earnings. In the fourth quarter it will important to see a pick-up in economic activity to support earnings growth. 9

10 As the U.S. rally matures, value can be found in other markets. Japan and Europe look interesting to us. Japan U.S. Europe Recovery Expansion Contraction Source: Fidelity Investments (AART) through 9/30/13. 10

11 TRENDS Uneven global economy Cyclical improvement in developed markets (U.S. in mid-cycle phase). China and many emerging markets struggling to gain traction. Europe remains stagnant, but there have been signs of broad-based stabilization and early-cycle dynamics in some areas. Easy monetary policy, but perceived tighter stance from Fed and China. Market expects the Fed to start slowing the pace of Stimulus. OUTLOOK The U.S. economy remains in a slow but steady mid-cycle expansion, underpinned by incremental improvements in housing, employment, and consumer sentiment. China s sluggish recovery may be bottoming providing some lift to emerging markets. The eurozone periphery has increased competitiveness (due to falling unit labor costs), moved into current account surplus, and seen indications of financial system stabilization all of which suggest that the worst of the recession has passed. U.S. Fed policymakers remain reluctant to rein in accommodation near term Tapering pushed out to INVESTMENT IMPLICATIONS Correlations should moderate amid economic dispersion, return to fundamentals. Cyclical progress in the U.S. and other advanced economies continues to provide support for equities, but global financial turmoil and risks to China s outlook pose near-term challenges for various asset classes. Favor equities, particularly in places such as Europe with better cyclical outlook. More balanced view of bonds. Correlations between U.S. and non-u.s. stocks declined to their lowest levels since early 2009, highlighting the importance of active security selection and asset allocation. 11

12 Tapering Should Not Be Tightening The Plan? - The Fed will continue to buy assets during tapering, but at a slower tempo. A Hiccup? - In June, investors learned that QE might end sooner than they expected causing yields to spike more than the Fed anticipated. If this becomes fact, the difference in expectation would reflect tightening. Another Hiccup? The Fed may have to wait until early next year before it sees sufficient strength in the U.S. economy to begin scaling back its bond-buying, after a destructive Washington budget battle that may take a bite out of growth. Tapering Could Be Tightening Quantitative Easing The Fed expands its balance sheet by buying Treasuries and MBS. Current pace: $85 billion each month. Quantitative Accommodation The Fed maintains its balance sheet; it buys new assets to replace older ones as they mature. Quantitative Tightening The Fed contracts its balance sheet by allowing assets to mature without replacement or, more aggressively, by selling them. 12

13 The chart compares the performance of the S&P 500 in the 52 months before the central bank reversed its policy in 1983, 1986, 1994 and Source: Bloomberg LLP All data includes dividend reinvestment. The 144% rally since March 2009 is the biggest and almost triple the average of the other advances. While Fed tightening hasn t historically been a sell signal, past reversals in interest rates came after smaller stock market advances. Earnings gains and economic growth have been more muted this cycle than they have been in the past and those ultimately determine where the markets go. Once tapering starts, the market could trend lower unless there is a marked acceleration of both economic and earnings growth. 13

14 CPI has generally tracked unit labor costs. With un- and under-employment still elevated there should be little pressure on wages. While productivity growth (the other part of unit labor cost) has slowed, we expect some growth to continue to off-set what wage pressure may exist. Source: Bloomberg LLP All data is in local currency and includes dividend/ interest reinvestment. 14

15 Bonds Go Beyond the Core" "The art is not in making money, but in keeping it." - Proverb We feel a liquid portfolio that actively manages yield curve exposure affords a portfolio an opportunity to enhance return while mitigating risks. Floating Rate Bonds, Step-up Bonds, Cushion Call Bonds (aka kickers ) and certain MBS strategies can be used to mitigate interest rate risks. Municipal Term Preferred Bonds offer higher yield than traditional municipal bonds for short maturities. Bank Loan Investments can protect principal while providing enhanced yield. Think Global Whilst the U.S. may undertake a slightly reduced level of QE, Europe, the U.K. and Japan continue to ease. Japan alone is undertaking a massive level of QE, essentially equivalent to the U.S. in size. This, in itself, should be supportive of asset prices and we would suggest that any further weakness in global markets may actually provide an excellent entry point for a global bond fund with a flexible mandate. We advocate an investment in the Templeton Global Bond Fund and the Hartford World Bond Fund. 15

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17 Overweight U.S. Equities Japanese Equities In a stronger dollar world, domestic companies are likely to outperform. Markets love liquidity and the Bank of Japan s actions have and will continue to move the Japanese market. Market Neutral Pan-European Equities Senior Loans The European economy may be bottoming. The ECB is poised to further stimulate as needed (likely after the September German election). A potential rise in rates is prompting investors to gravitate to the floating-rate nature of Senior Loans, as floating rates protect investors and earn more money if rates rise. Underweight U.S. Core Bond Market Japanese Yen Emerging Market Equities Commodities It is critical to go "beyond the core" in fixed income. Floating Rate Bonds, Step-up Bonds and certain MBS strategies can be used to mitigate interest rate risks in anticipation of flat to higher rates. Bank of Japan has begun to create the liquidity required to weaken the yen. Commodity exposed emerging markets are expected to struggle. Emphasize consumption growth in these markets. 17

18 Balanced Asset Allocation U.S. Equities International Equities U.S. Fixed Income International Fixed Income Alternative Cash 2% 2% 10% 20% 52% 14% Asset Class Exchange Traded Fund (ETF) Percent Large Cap Blend ishares S&P % Large Cap Growth ishares S&P 500/BARRA Growth 12.00% Fixed Income Vanguard Total Bond Market Fund 8.00% Mid Cap Blend ishares Russell Midcap 6.00% Fixed Income Templeton Global Bond Fund 5.00% Fixed Income DoubleLine Total Return Bond Fund 5.00% Fixed Income Hartford World Bond Fund 5.00% Emerging Markets Matthews Pacific Tiger Fund 4.50% Fixed Income Vanguard Short Term Bond Fund 4.00% Japan WisdomTree Japan Equity Fund 4.00% European Equity Invesco European Growth Fund 3.00% Fixed Income Oppenheimer Senior Floating Rate Fund 3.00% Small Cap Blend ishares Russell % REIT Vanguard REIT Index Fund 1.00% Commodities SPDR Gold Trust 1.00% Cash U.S. Dollar 2.00% Process: The Investment Policy Committee (IPC) is responsible for Pennsylvania Trust s asset allocation and overall investment strategy. The IPC considers current and anticipated global economic and market conditions when developing recommendations for investment selections and strategic allocation changes for the firm s global allocation model portfolios. The IPC meets regularly to propose and discuss new policies and review current guidance to make sure it still meets the long-term needs of our clients. Positions are as of October 18,

19 Normal copyright protection applies to all commercial use of any information herein. Pennsylvania Trust is not responsible for any loss due to inaccuracies in the information provided. Nothing presented in this presentation shall be construed as investment advice. Please contact a Pennsylvania Trust officer before investing based on this document. Investments and foreign exchange can go up as well as down and involve the risk of loss. Past performance will not necessarily be repeated in the future. Pennsylvania Trust s principals or their associates may already have undertaken or may in future undertake an own account transaction in respect of any commodity, security, product or investment described in this presentation. Certain data and/or information presented in this presentation has been provided by sources believed to be reliable. However, Pennsylvania Trust has had no role in the production or review of such information and makes no warranty, either expressed or implied as to its contents, accuracy or performance. Pennsylvania Trust shall not be responsible for any loss due to inaccuracies in the information provided. Through acceptance of the receipt of this presentation, you are acknowledging your understanding and are in agreement with this. If you have any doubt about the suitability of information provided in this presentation, you should contact Pennsylvania Trust for advice, or an independent financial adviser. PENNSYLVANIA TRUST 100 Matsonford Road Five Radnor Corporate Center Suite 450 Radnor, PA info@penntrust.com 19