Economic and Investment Overview First Quarter, 2011

Transcription

1 Economic and Investment Overview First Quarter, 2011

2 Atlantic Trust Private Wealth Management includes Atlantic Trust Company, a division of Invesco National Trust Company (a limited-purpose national trust company), and Stein Roe Investment Counsel, Inc. (a registered investment adviser), both of which are wholly-owned subsidiaries of Atlantic Trust Group, Inc. This document is intended for educational purposes only and the material presented should not be construed as an offer or recommendation to buy or sell any security. Concepts expressed are current as of the date of this newsletter only and may change without notice. Such concepts are the opinions of our investment professionals, many of whom are Chartered Financial Analysts (CFA ). The Chartered Financial Analysts (CFA ) designation is globally recognized and attests to a charterholder s success in a rigorous and comprehensive study program in the field of investment management and research analysis. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP and CERTIFIED FINANCIAL PLANNER in the U.S. There is no guarantee that these views will come to pass. Past performance does not guarantee future comparable results. To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Atlantic Trust does not provide legal advice, and the information contained herein should only be used in consultation with your legal, accounting and tax advisers. To the extent that information contained herein is derived from third-party sources, although we believe the sources to be reliable, we cannot guarantee their accuracy. Investment Products Offered are Not FDIC-Insured, May Lose Value and are Not Bank Guaranteed. 2 For Public Use 01/11 Economic and Investment Overview

3 Economic and Investment Overview Executive Summary U.S. Economy Economy enters 2011 with momentum Ongoing deleveraging process will cap upside: moderate growth rate expected Risks: Housing market and China slowdown DC Focus: Deficit reduction package Equities 2010: A solid year for equities Better economic and policy news sparked second half rally 2011 Outlook: Moderate gains achievable, driven by EPS growth and reasonable valuations Active equity management, with an emphasis on quality companies, is well suited to excel in current market conditions Bonds Munis will have more headline risk ahead; focus on ultra-high credit quality Unfunded public pension obligations key long-term muni credit issue QE2: Bad for bonds and yields have risen QE2: Fed s goal of deflation fighting is working Asset Allocation Themes U.S. Equities: Favored areas are large-caps and long/short hedge funds Embrace emerging markets exposure: equities, local currency debt, commodities and U.S. stocks with high EM sales component Raise enhanced yield allocations: EM and senior bank debt, energy MLPs and diversified equity income Private equity: Distressed and turnaround situations most attractive 3 For Public Use 01/11 Economic and Investment Overview

4 Economy A Solid Turn into the New Year The economy gained strength in the final months of 2010, boosting optimism for the 2011 outlook. Importantly, the recession fears that swelled over the summer have subsided. Three factors have lifted the U.S. economy in recent months: Stronger consumer spending, as the job market stabilized Accelerating export growth due to a weak dollar A rebound in manufacturing activity While the recent upswing in the business cycle is encouraging, the secular weight of debt will act as a constraint on the economy s potential in After a brisk start to the year, we anticipate a return to a 2.5% trend growth rate for real GDP. The two major risks for the economy are a relapse in the housing market and a significant slowdown in China and other emerging economies. While neither is a likely outcome, we rate the housing issue as the bigger concern. Inflation remains very low, with the core rate running below 1%. Since the Fed s quantitative easing step in November, inflation expectations have risen on the belief that government policy will produce price pressures in the future. Consumer Spending Source: Bloomberg L.P., Dec 2010 Case-Shiller Home Price Index Source: Bloomberg L.P., Oct For Public Use 01/11 Economic and Investment Overview

5 Politics and Policy Washington Remains a Focal Point for Investors in 2011 Passage of a two-year extension of the Bush tax cut rates provides short-term clarity for investors. This was accompanied by some business tax cuts, a payroll tax holiday and extension of longterm jobless benefits. This holiday stimulus package will provide a slight boost to economic activity in 2011 but at a potentially steep price. The provisions will add nearly $900 billion to the already burgeoning national debt. Deficit reduction will be the critical policy issue for market sentiment in the first half of the year. There is strong public sentiment to address the issue. With the GOP takeover of the House of Representatives, both parties will share the praise or blame for the economy and direction of the deficit. Despite major philosophical differences between the parties, there is an opening for at least a modest deficit reduction package to pass in the months ahead. The window will close later in the year as jockeying for the 2012 election cycle begins. Record Gap Between Federal Spending & Receipts Source: Ned Davis Research, Inc., Oct 2010-Apr 2014 estimate, as of Sept 2010 Surge in Government Debt (Public Debt Securities Issued by Gov t as % of GDP) Source: Ned Davis Research, Inc., Dec For Public Use 01/11 Economic and Investment Overview

6 Bonds Municipalities Is there a Greece, or a Lehman or a subprime mortgagor in our midst? Certainly a heavy load of obligations and a constrained stream of revenues exist, but we do not anticipate a wave of defaults. As we have noted before, revenues are now growing. In fact, a larger number of states are seeing revenues come in at or above earlier estimates according to the National Association of State Budget Officers. Traditional debt service is small relative to the economies of the states. The issue of unfunded pension obligations is a serious long term issue, and will require difficult political decisions to reign in costs. Revenue sources will be diminished at the margin with the expiration of Federal stimulus funds. At the same time, expenses will face pressure from Medicaid. The odds of a fiscal mistake rises any time these forces move in opposite directions. A high credit quality focus continues to be the best approach to investing in the muni market. State & Local Revenue Growth Source: Bureau of Economic Analysis, Sept 2010 Interest Payments as a % of Tax Receipts Source: Bureau of Economic Analysis, Sept For Public Use 01/11 Economic and Investment Overview

7 Bonds QE2 Based on the behavior of the U.S. Treasury market, most observers would judge the quantitative easing policy of the Fed a failure. Since the November 3 announcement of the Fed s plan to buy an additional $600 billion in government debt, the yield on a 10-year Treasury has increased by nearly a full percentage point. However, the Fed made its objective clear when it stated that the level of inflation was below the level consistent with its dual mandate to foster maximum employment and price stability. According to the TIPS market, inflation expectations have increased to more normal levels and the Fed has avoided the ditch of deflation. Continued weakness of the job market makes it likely that the full QE2 program will be implemented through June. Sharp Rise in Treasury Yields Source: Bloomberg L.P., Dec 2010 Rising Inflation Expectations Source: Bloomberg L.P., Dec For Public Use 01/11 Economic and Investment Overview

8 Stock Market Second Half Rally on Easing Macro Concerns Considering all of the various worries that had to be overcome during the year, investors in domestic equities can look back on 2010 with considerable satisfaction. After a mid-year correction driven by European sovereign debt fears and disappointing economic news at home, stocks staged one of the better short-term rallies in recent memory. The S&P 500 rose by some 20% from September 1 to year-end, ended at its high for the year, and provided a 15% total return for 2010 as a whole. Recent strength in the market was attributable primarily to four developments: a rebound in economic data as the second half progressed; earnings that exceeded analysts expectations; the mid-term elections that created bipartisan power sharing, and the deal on tax rates for 2011 and 2012 worked out between President Obama and Congress. These developments have encouraged investors and drawn some of the money previously on the sidelines into the equity market. A Difficult First Half for Stocks Here and Abroad Source: Bloomberg L.P., Jun 2010 Gives Way to a Strong Second Half Rally Source: Bloomberg L.P., Dec For Public Use 01/11 Economic and Investment Overview

9 Stock Market Stock Market Outlook With the recovery in the economy and the cessation of asset write-downs, earnings showed a strong rebound of more than 40% in In spite of rising stock prices, global valuations remain moderate by historical standards. As earnings estimates have been revised up, multiples on expected profits have remained below their long-term averages. For the U.S., we estimate that earnings on the S&P 500 will rise by about 10% in In this scenario, the P/E multiple on expected forward earnings is still less than 14. Extremely high correlations among stocks made 2010 a difficult year for active managers to keep pace with their benchmarks. This trend began to break down late last year, and we expect stock selection to again be a critical determinant of performance in S&P 500: Upward Earnings Path Expected Source: Thomson Financial Estimates, Sept 2010 % of S&P Stocks Moving in the Same Direction (6-Month Moving Average) Source: Strategas, Dec 31, For Public Use 01/11 Economic and Investment Overview

10 Emerging Markets Investment Climate The MSCI Emerging Markets Index rose 7.3% during the fourth quarter, besting its developed international markets counterpart by just over 70 basis points. Emerging markets have been a point of emphasis for our asset allocation recommendations since early The MSCI Emerging Markets Index rose 19.2% in 2010, more than doubling returns for developed international markets as represented by the MSCI EAFE Index. Since the market bottomed in March 2009, emerging markets have been a key beneficiary of investors increasing allocations to growth assets. Most developed economies lagged as they remained burdened by high fiscal deficits, weak economic growth and unemployment. In 2009 and 2010, the Asset Allocation Committee believed that EM valuations were unjustifiably discounted. After two years of outperformance, this is less the case now. However, P/E s remain reasonable, and the fundamental outlook is superior to the rest of the world. The balance sheets of governments and consumers in EM countries remain healthy and economies remain vibrant. EM countries will likely account for the majority of global GDP growth in The IMF has estimated that emerging markets GDP will grow an average of 7.1% in 2010 and 6.4% in 2011, well above the 2.7% and 2.2% growth estimated for developed markets. Average Projected Real GDP Growth ( ) Source: IMF World Economic Outlook, Oct For Public Use 01/11 Economic and Investment Overview

11 Hedge Funds Strategy Review & Outlook All four major hedge fund strategies posted positive performance in 2010 led by the relative value and equity long/short strategies. All strategies have generated positive rolling threeyear returns. Equity Long/Short: After lagging for most of the year, this strategy posted a strong fourth quarter as equity markets rallied and correlations declined. As expected, the decline in correlation created a fertile environment for fundamental stock selection. We expect this trend to continue in Event-Driven: We have a positive outlook on this strategy due to record levels of cash on corporate balance sheets, which should increase corporate activity such as acquisitions and share buybacks. Relative Value: The dislocations of 2008 created a fertile ground for this strategy in We now have a neutral view. Macro: After generating positive returns in 2008, Macro has been lackluster over the last two years. Global macroeconomic uncertainty is to blame and is expected to continue. Hedge Fund Strategy 3-Year Performance Source: Bloomberg L.P., HFRI Indices, HFRX Index estimates used for Dec 2010 Equity Long/Short Performance Drivers & Outlook Source: Atlantic Trust Views and Outlook, Scores range from 1-5, Dec 2010 Cumulative 3-Year All Strategies 9.1% 20.0% -19.0% 6.0% Equity Long/Short 11.3% 24.6% -26.7% 1.7% Event-Driven 9.7% 25.0% -21.8% 7.2% Relative Value 11.3% 25.8% -18.0% 14.7% Macro 5.4% 4.3% 4.8% 15.3% 2011 Outlook 2010 Score 2009 Score 2008 Score Stock Selection Market Direction Market Timing Asset Allocation AVERAGE SCORE For Public Use 01/11 Economic and Investment Overview

12 Investment Strategy Seeking Alternative Sources of Portfolio Income In this persistent low interest rate environment, income generation from traditional bonds is on the decline. Investors seeking to replace this income should avoid doing so by extending maturities and focus on researched alternative income sources The Asset Allocation Committee (AAC) recommends two alternative fixed income investments with attractive yields and improving fundamentals: Emerging market debt Floating rate senior bank debt Equity dividend yields have become competitive with bond yields. After two years of strong equity price appreciation, we believe dividend income will form a rising share of total stock returns over the next couple of years. Dividend yields are below historical averages. There is substantial room for strong dividend growth in light of the recovery in corporate profits and cash flows, as well as the 2-year extension of the historically low 15% tax rate on dividends. The AAC recommends two higher income equitylinked strategies (recently approved on the AT platform): Energy Master Limited Partnerships (MLPs) Diversified equity income strategies S&P 500 Yields Remain Below Historical Average Source: Strategas, Thomson Financial, Jan 2011 and after estimate, Dec 2010 Asset Yield Comparison as of 12/31/2010 Source: Bloomberg L.P.; Lipper and Alerian Indexes, Dec For Public Use 01/11 Economic and Investment Overview