US Equity Markets Down More Than 2%
Contrary to some opinions, today’s market selloff has little to do with the outcome of yesterday’s elections and much to do with European Central Bank head Mario Draghi’s comment that he anticipated seeing weakness in the European economy for the foreseeable future. Prior to the opening of European markets this morning (at roughly 4:00 am EST) S&P futures were actually up. Draghi also made the comment that near-term inflation was not a concern. We believe the combination of those two comments is setting the table for Draghi to further ease monetary policy in Europe tomorrow. None of this is really new news—we’ve known about Europe’s problems for some time now; but, when markets rise quickly, as ours did these past five months (up 12%), they tend to respond more violently to negative news (even when it’s already known). The S&P 500 peaked in mid-September—since then, including today’s move, it is down less than 5%. Global equity markets were up nearly 14% these past five months, and since peaking in mid-September are down less than 4%. All in, since the lows in early June, the S&P 500 is up nearly 10% and global equity markets are up more than 12%, including today’s selloff.
Impact of Election Results on the Economy, Markets and Interest Rates
Going in to yesterday’s election, the one common thread across most Americans seemed to be a general disdain for politicians, specifically incumbent politicians. Ironically, the net effect of yesterday’s elections was to maintain status quo: President Obama is still the President, Republican Congressman John Boehner is still the Speaker of the House of Representatives, and Democratic Senator Harry Reid is still the Senate Majority Leader—nothing substantive has changed. While that reality may be frustrating for some of us, in general, markets are more concerned about uncertainty than anything else. What is equally clear to us, and hopefully to the aforementioned politicians, is that neither party can claim that the American voters gave them a resounding mandate to pursue their specific agenda and policies. They somehow need to find a way to compromise a solution to the Fiscal Cliff. If they do not it will almost certainly push the domestic economy back in to a recession. The combination of tax hikes and spending cuts will have a dire impact on an already slow growing economy and employment environment. We believe they will once again arrive at some mini-compromise over the next couple months and kick the rest of the can down the road. The ultimate solution is a full rewrite of the tax code and a rethinking of entitlement programs, defense spending and social security—we can say with certainty none of those things will be done over the next two months. The other thing that didn’t change yesterday are the ongoing stimulative policies of the Federal Reserve—those policies are what have been driving this market, with an occasional derailment by politicians both at home and abroad, for the past three years.
Impact of Current Environment on Telemus’ Various Investment Strategies
Global Equities—we believe most of the changes we made in the Global Equity sleeve over the past month will provide more downside protection than the overall global equity market. Specifically, we’ve reduced our overweight in domestic large cap stock exposure and have added exposure to frontier markets and small- and mid-cap developed international markets. Our rationale was simply that domestic large cap stocks had the most to fall in a global selloff, because they’ve risen the most in recent years, and have the least to gain should the equity market rally extend. Today’s market action serves as a good confirmation of that premise: domestic large cap stocks are down more than 2%, whereas developed international, emerging and frontier markets are down less than 1.5%.
Global Fixed Income—generally speaking, what’s good for stocks is usually bad for bonds and what’s bad for stocks is usually good for bonds. We’ve kept our bond maturities relatively short to protect against rising rates. While rates have remained low, we are cognizant they can’t go much lower but they can go a lot higher—in other words, we see more downside risk than upside potential in the bond market. On a day like today our Global Fixed Income sleeve will likely increase in value. Longer-term we will be perfectly content earning our yield on the portfolio.
Real Assets—once this latest round of “Europe in the news, again” passes, we believe the US Dollar will resume its long-term decline. In such an environment our Real Asset sleeve, which is comprised of natural resources, precious metals, real estate investment trusts and energy infrastructure (pipelines), will thrive. It is designed to generate attractive dividend yields while also providing protection against the inflationary effects of a declining dollar.
Absolute Return—in theory these strategies should hold up in any environment; in practice they tend to behave like a large global balanced portfolio. As with the design of most of our strategies, we believe this sleeve will provide clients with superior downside protection while participating in upside moves.
Opportunistic—this investment strategy seeks to generate high fixed income streams through non-traditional fixed income investments such as preferred stocks, convertible bonds, senior bank loans and mortgage REITs. We hedge away the equity-like risk to lock in on the cash flow yield. Currently the sleeve is generating cash flow yields in excess of 6% (investment grade corporate bonds are yielding less than 2%). We believe the diversification and the hedged nature of how we manage the sleeve will allow it to continue generating above market yields with some additional growth potential.
Cash—always the forgotten asset class until days like this occur. Investors won’t earn much in money market funds for some time; but, they also won’t lose anything.
Overall, we believe client portfolios will perform consistent with our overriding investment philosophy: we’re in the keep rich, not the get rich, business. Our goal is to build the least risky portfolio necessary to achieve our clients’ investment goals.