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Lebenthal Asset Management’s quarterly Economic and Market Outlook provides insight into the economy and perspective on equity, fixed income and international markets.
Lebenthal Asset Management James B. Lebenthal, CFA John CareyDr. Vijay Chopra, CFARon DeutschBarbara DoranPeter FiversonDr. Leila HeckmanMichael D. JamisonChris Liu, CFARobert MorganDr. John MullinGregory SerbeChase SmithDavid Yucius
A S S E T M A N A G E M E N T
ECONOMIC AND MARKET OUTLOOKJANUARY 2016
THE U.S. ECONOMYIn December 2015, the Federal Reserve (the “Fed”) finally began the process of
increasing short term interest rates, raising the Federal Funds rate from a range of
0% to 0.25% to a range of 0.25% to 0.50%.
As this was the first increase in the Fed Funds rate since June 2006, the longest
interval ever, and the first to come after the crisis-era policy implementation, the
Fed was very careful to telegraph that a rate increase was coming, that it would be
minimal, and that future increases would be made in a very deliberative fashion.
In its post-meeting statement, the Federal Open Market Committee said that it
expected “economic conditions will evolve in a manner that will warrant only gradual
increases in the federal funds rate; the federal funds rate is likely to remain, for
some time, below levels that are expected to prevail in the longer run. However,
LEBENTHAL ASSET MANAGEMENT lebenthal.com/assetmanagement 1 January 2016
LEBENTHAL ASSET MANAGEMENT
the actual path of the federal funds rate will depend on the economic outlook as
informed by incoming data.” It is our opinion that the current Board will continue to
be clear about providing policy expectations, without giving an inflexible timetable
for their actions.
As for longer term Treasurys, we saw that in the summer and fall of 2013, when former
Fed Chair Bernanke indicated that there could be a wind-down to Quantitative Easing,
Treasury yields increased. The ten-year Treasury yield went from approximately
1.65% to 3.0%, and the thirty-year Treasury rose from approximately 2.86% to 3.96%.
With this “taper tantrum” in mind, Chair Janet Yellen has been very cautious in her
communications. Thus, we do expect an increase in longer rates, but without the
sharp volatility of 2013. Current rates are hovering around 2.25% for the ten year
Treasury and 3% for the thirty-year Bond. Given the current low level of inflation we
expect a more gradual rise in rates.
We believe the U.S. economy will continue to expand at a 2 to 2.5% rate in real
terms during 2016. Growth will be led, once again, by continuing high levels
of automobile sales, housing activities (new construction across the board,
remodeling and renovations) and general consumer spending on goods and
services, along with life experiences, i.e. cruises, dining, yoga, etc. In our opinion,
the U.S. stock market will achieve new record levels next year as result of the
economic growth and higher corporate earnings that we are forecasting.
Notwithstanding our optimistic outlook, a number of risks have begun to bubble up that bear close monitoring and that we believe may cause higher levels of volatility in 2016:
+ First, several of the most aggressive and leveraged investment funds in high
yield bonds, where many investors sought above-average yields, have recently
run into trouble. Last month the Third Avenue Focused Credit Fund suspended
redemptions so that its remaining $789 million of assets can be liquidated in a
more orderly manner and not be forced to sell its remaining investments at fire
sale prices. It was the fund’s significant degree of aggressiveness that was the
primary cause of action; more than 50% of its assets were unrated, while another
28% was rated CCC. At this point, we believe that this headline-catching news
will be contained to the riskiest investments and not cause a general contagion in
the high yield bond market. For example, the Third Avenue Focused Credit Fund
declined 27% for the year to date until it was closed last month while the SPDR
Barclays High Yield Exchange Traded Fund (JNK), which is more representative
of the general junk bond market, has declined a more modest 8.2% for the year
through December 23, 2015’s closing price. Our outlook is subject to revision as
events in this sector evolve.
A S S E T M A N A G E M E N T
lebenthal.com/assetmanagement 2January 2016
SPENDING ON LIFE EXPERIENCES
CONSUMER GOODS & SERVICES
HOUSINGACTIVITIES
AUTO SALES
U.S. ECONOMIC GROWTH
+ Second, the negative effects of the significant decline in energy and other
commodity prices have just begun to be reflected in reduced capital spending,
dividend cuts, layoffs and bankruptcies in these sectors. Again, it’s the most
aggressive and leveraged companies that have been forced to take these actions.
We believe that these negative effects will likely continue and accelerate next
year as future energy production hedges run off and spot energy and other
commodity prices remain low. Similar to our opinion about the high yield bond
market, we believe that these negative effects will be contained to the riskiest
and most leveraged companies in the energy and commodity industries. It is also
our opinion that the pain that is occurring now and will likely accelerate next year
is the beginning of the healing process for companies to right-size themselves
to operate profitably in the new, lower pricing environment. As this process
continues, we believe that global supply will eventually be reduced enough to
meet demand and spot energy and commodity prices stabilize and begin to
recover. In the meantime, the decline in gasoline prices over the past one and
one-half years has put a meaningful amount of unexpected cash in consumers’
pockets.
+ Finally, we are mindful of the narrowness of the investment performance of the
S&P 500 Index during 2015. The total return for the S&P 500 Index was essentially
flat last year, but the attribution of returns was asymmetric: The total return of
the 10 largest stocks in the Index was up 17%, while the other 490 stocks were
down 5%. In order for the U.S. stock market to achieve our forecast of new record
levels next year, we expect the rally to be more broadly-based and include many
value-oriented stocks in cyclical, energy, industrial and transportation sectors
that declined significantly during 2015. In fact, we believe that a number of
investments in these sectors present attractive long-term opportunities that may
become even more compelling next year.
The bottom line is that we recommend staying the course while being alert and
vigilant to the risks that have begun to materialize as described above.
Notwithstanding our expectation of increased equity market volatility, we believe
that 2016 will be a rewarding year for domestic equity investors.
LEBENTHAL ASSET MANAGEMENTA S S E T M A N A G E M E N T
lebenthal.com/assetmanagement 3January 2016
S&P 500 INDEX VS. TOP 10 LARGEST TOTAL RETURN(YTD performance)
A TALE OF TWO MARKETSSource: Strategas Research/Bloomberg
2015
Jan Jan
90
95
100
105
110
115
120
Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2016
10 Largest S&P500 Stocks
S&P 500
S&P ex. 10 Largest Stocks
+17%
-1%
-5%
INTERNATIONAL EQUITIESRegional divergences in monetary policy, exchange rates and the impact of weak
commodity prices have created attractive investment opportunities in international
equities. Even as the Federal Reserve begins to tighten monetary policy, the
European Central Bank (ECB), the Bank of Japan and the People’s Bank of China are
expected to maintain loose monetary policy. The sharp moves in global commodity
prices and exchange rates have created headwinds for several markets and tailwinds
for others. Our country allocation is positioned to benefit from these divergences.
The IMF is forecasting 2016 GDP growth of 1.5% in the Eurozone and 0.6% in Japan.
Despite the weak growth forecasts, we expect the equity markets to benefit from
loose monetary policy in those regions. The ECB recently extended its Quantitative
Easing for another six months through March 2017, and lowered the overnight
deposit rate to -0.30% from -0.20%. Japan has been pursuing quantitative easing
aggressively—even engaging in open market equity purchases. The key Asian markets
of China and India are expected to grow in 2016 at 6.8% and 7.3%, respectively, while
commodity exporters Brazil and Russia are forecast to see GDP declines of -3%
and -3.8%, respectively.
We are overweighted in regions and markets where valuations are attractive and
there are tailwinds from easy monetary policy, low real exchange rates and the
decline in commodity prices. These include Continental Europe, Japan and select
Eastern European markets. We are generally underweighted in countries with large
commodity exposure, such as Australia and Canada in the developed markets and
Latin America and the Mideast in the emerging markets.
Within Continental Europe, we are overweight in the peripheral markets of
Italy, Spain and Ireland. All three markets benefit from lower commodity prices,
undervalued real exchange rates and positive revisions to their GDP over the last six
months. In addition, Spain has attractive valuations. Sweden, a market outside the euro zone, continues to be overweighted based on its undervalued real exchange rate, low beta risk and positive price momentum. The UK is underweighted despite reasonable valuations as the British pound is overvalued relative to its trading partners and the market has had weak price momentum.
Japan remains an overweight based on a 23% undervalued real exchange rate,
which should be positive for its export sector and earnings, a tailwind from weak
energy and mineral prices which it imports, and a strong year-over-year local
currency price momentum.
LEBENTHAL ASSET MANAGEMENTA S S E T M A N A G E M E N T
lebenthal.com/assetmanagement 4January 2016
THE U.K. IS UNDERWEIGHTED
WE ARE OVERWEIGHT IN THE PERIPHERAL MARKETS OF ITALY, SPAIN
& IRELAND, AS WELL AS SWEDEN
LEBENTHAL ASSET MANAGEMENTA S S E T M A N A G E M E N T
Our emerging market outlook is shaped by the sharp decline in commodity prices,
and the prospects for weaker growth in China. In spite of the reasonable valuations of
emerging markets overall, we continue to be cautious since most markets have seen
downgrades to GDP growth forecasts over the last 6 months, and have higher risk
with widening sovereign spreads and high volatility.
Economic growth in China has slowed as it transitions from an “investment driven” to
“consumption driven” economy. In order to achieve this, the Chinese policy makers
face the difficult challenge of shutting down unprofitable firms and reorienting the
economy, while at the same time avoiding a collapse in output. Due to the correction
in the market earlier in the year, valuations are more attractive, and as a major
importer of commodities, China is benefiting from the collapse in commodity prices.
Despite these positives, we are underweight in China as the real exchange rate is overvalued, and an important risk measure – changes in sovereign yield spreads
over their two year average – has widened. China is also posing a challenge to
other emerging Asian economies due to extensive trade linkages leading us to
underweight Indonesia, Malaysia, Taiwan and Thailand.
We are overweighted in several markets in Eastern Europe, such as Poland and
Hungary, due to attractive valuations and stable GDP forecasts for 2016.
We are cautious on Latin America, which remains stuck in a slow growth mode with
very weak export commodity prices and continued downward GDP growth revisions.
Brazil’s economy has been particularly hurt, with downgrades to its 2016 GDP
growth forecasts of 2.7% over the last six months. Brazil is currently a value trap;
despite the appearance of cheap valuations, the market scores poorly on growth,
risk and momentum.
FIXED INCOMEMUNICIPAL BOND MARKET Now that the Federal Reserve has shifted monetary policy, municipal bonds will
react to these gradual increases in interest rates. The elements that we feel are
more specific to the demand for municipal bonds are the upcoming election, the
perception of the credit quality of municipal bonds and potential climate issues.
While it is way too early to know who the standard bearers are going to be for each
party, a Democratic victory will likely bring renewed discussion of tax increases
on the wealthy to benefit the lower-income and middle classes. When taxes are
lebenthal.com/assetmanagement 5January 2016
JAPAN REMAINS OVERWEIGHTED
WE ARE UNDERWEIGHT IN CHINA
LEBENTHAL ASSET MANAGEMENTA S S E T M A N A G E M E N T
lebenthal.com/assetmanagement 6
increased, the value of tax exemption increases proportionately. In addition to the
national races, there are local elections to consider. These add the possibility of state
or local tax increases. For those states that exempt their bonds from their in-state
taxation, tax free bonds become even more desirable. We feel this will give more
strength to municipal bonds in a time when the bond market will see potential price
erosion as rates increase.
Creditworthiness is always an issue in the $3.7 trillion municipal bond market.
2015 has seen bitter political battles in several states, with the Commonwealth of
Pennsylvania only recently enacting a budget that was due last July, and the State
of Illinois still without a final budget. Despite the dramatic and partisan headlines,
we have tended to take a longer perspective. There were not massive defaults in the
recent recession. Even though several California cities, Jefferson County, Alabama,
and Detroit have had to use Chapter 9 of the bankruptcy laws, this is still the
exception. The vast majority of bonds are paid principal and interest on time. Thus,
we believe that it is positive when the press examines budget issues, when pension
problems are in the spotlight, and liability funding is questioned. This type of inquiry
leads to resolution. The financial troubles of Puerto Rico are dramatic, but they serve
as a warning for other municipalities. If Puerto Rico could get into trouble, could our
city or state be doing the same thing? Again, the more light is shined upon a financial
practice, the better the long term outcome will be.
There is a growing concern in the municipal bond market regarding the possible
effects of global climate change and energy production. It is too soon to assess the
impact on municipal power plants and water and sewer systems, but they could grow
in magnitude over the coming years as aging facilities must be brought up to future
safety and emissions standards.
From a technical perspective, it is likely that there will be less supply in 2016 than
2015. As rates increase, there may be less refunding of older higher coupon bonds.
We have also noticed that municipalities have been very reluctant to issue bonds
without a bona fide purpose. Infrastructure needs rebuilding, but without the
Federal Government as partner, big projects are not going to get started. Here in
the northeast, there is a desperate need for an additional railroad tunnel under the
Hudson River. The existing tunnel is over 100 years old and rail traffic continues
to increase with the growth of New York City. After years of stasis, it appears that
enough Federal funds are finally going to be forthcoming to be able to build it. The
Tappan Zee Bridge replacement structure could not have been built without Federal
funds to supplement New York Thruway toll revenues. This damper on excess supply
should help the market provide stability during a time of general volatility.
In summary, despite the possible impact of higher rates on bond prices, negative
headlines from Puerto Rico, and other issues in the financial press, we continue to be
constructive on the value of tax-exempt bonds. In our opinion, the vast majority of
municipalities will continue to fund debt service without interruption and meet their
obligations promptly. This should help the market to stay attractive to bond investors.
CORPORATE FIXED INCOMEThe past year has been volatile for credit markets. Problems that started in the
energy sector have spread to much of the market with weak liquidity acting as
kerosene on a brushfire. The combination of high volumes of corporate bond issuance,
increasing susceptibility to retail outflows and shrinking broker dealer balance
sheets has created a problematic liquidity backdrop. This has exacerbated the moves
in corporate bond prices and created opportunities going into the new year.
January 2016
It is positive when the press examines budget issues, when pension problems are in the spotlight, and liability funding is questioned
LEBENTHAL ASSET MANAGEMENTA S S E T M A N A G E M E N T
lebenthal.com/assetmanagement 7January 2016
About Lebenthal Asset Management
Lebenthal Asset Management manages equity and tax-exempt and taxable bond portfolios for high net worth individuals, institutions, and non-profit organizations. The firm is head-quartered in New York City, with a legacy that is rooted in Lebenthal & Co., founded in 1925 by Louis and Sayra Lebenthal.
The information contained in this document is based on data received from third parties which we believe to be reliable and accurate. Lebenthal, however, has not independently verified the informa-tion and does not otherwise give any warranty as to the truth, accuracy, or completeness of such third party data, and it should not be relied upon as such. The material is not intended to be a formal research report and does not constitute an offer to sell, or a solicitation of any offer to buy or sell, securities or currencies of any entity or government. Any opinions expressed herein are our current opinions only. In addition, it should not be assumed that any of the securities and/or strategies discussed herein were or will prove to be profitable. Past performance is no guarantee of future results and any strategies described herein which have the potential for profit also present the possibility of loss. There are no guarantees that any risk man-agement strategies or investment strategies described herein will be successful notwithstanding any efforts to mitigate risk. International investing presents certain risks not associated with investing solely in the U.S., such as currency fluctuation, political and economic change, social unrest, changes in government regulations, differences in accounting, and the lesser degree of accurate public information available. Please refer to your Brokerage Account statement from your custodian as your official account statement for performance information and account activity. Lebenthal Asset Management, LLC, is a wholly owned subsidiary of “Lebenthal Holdings, LLC". Lebenthal Asset Management, LLC is an SEC Registered Investment Adviser under the Investment Advisers Act of 1940 (“Advisers Act”). Lebenthal & Co., LLC is a Registered Broker-Dealer and Mem-ber FINRA & SIPC. © Copyright 2016, Lebenthal Asset Management, LLC. All Rights Reserved. This report may not be reproduced, distributed or transmitted in whole or in part in any media without the express written permission of Lebenthal Asset Management, LLC.
The recent sell-off in high-yield bonds has hit equity exchange-traded funds linked
to the securities, including the SPDR Barclays High Yield Bond ETF and the iShares
iBoxx $ High Yield Corporate Bond ETF. The decline coincided with travails in at
least three funds last month. Lucidus Capital Partners, founded in 2009, said it had
liquidated its portfolio and plans to return the $900 million it has under management
to investors next month. Just like the previously mentioned Third Avenue Focused
Credit Fund, Stone Lion Capital Partners also stopped returning cash to investors,
after clients sought redemptions that could not be met in current market conditions.
We feel that much like 2015 has been a stockpickers’ market, where industry and
security selection has been paramount, the corporate credit market presents the
same kind of environment going into 2016. While energy is about 16 % of the high
yield market, there has been a negative halo effect on much of the rest of the market.
We feel that there will be many opportunities to lock in attractive yields as most
credit levels have seen their spreads to Treasurys widen this quarter. The higher
quality end of high yield (the BB credits) is, we believe, the area of best risk-adjusted
return in high yield, while investment grade bonds look best in BBB area. With the
Fed now raising rates, there will also be opportunities to buy closed end funds.
Many of these funds are trading at discounts to their net asset value, which makes
for a compelling opportunity going into 2016.
With the Fed now raising rates, there will also be opportunities to buy closed end funds
Lebenthal Lisanti Capital Growth is a New York based, woman-owned investment management firm specializing in small and SMID cap growth investing. The firm advises the Lebenthal Lisanti Small Cap Growth Fund (ASCGX) and serves the institutional marketplace through separate accounts for public plan, corporate, endowment and foundation clients.
Mary Lisanti, Portfolio Manager
ECONOMIC AND MARKET OUTLOOKJANUARY 2016
U.S. SMALL CAP STOCKSWe continue to be positive on the outlook for smaller cap growth stocks in 2016.
We expect it to continue to be a stockpickers’ market, although we do expect the
opportunity set to be slightly different from prior years.
The last few years have belonged to the unit growth stories. Because unit growth has
been so hard to find, those companies that could grow revenues at extremely high
rates would see their stocks amply rewarded; this occurred regardless of whether the
company made money or the valuation was reasonable. It was, to some extent, “any
price for growth.” The prospect of the Federal Reserve continuing to raise rates, we
think, begins to change the landscape. As we look out over the next year, we believe
several changes will occur which will be very significant for the smaller-cap end of
the market. In addition to the Fed raising rates, it is likely that in the first part of 2016
we will be at the low in global growth, but the prospect of China’s GDP stabilizing
and European QE having some impact does imply that global GDP prospects will
look a bit higher as we exit 2016.
We believe that the combination of the Federal Reserve raising rates and global GDP
stabilizing, if not lifting a bit, implies that small caps have to make their money “the
old fashioned way”—they have to earn it. In this scenario, earnings growth will be the
driver of returns, more so than multiple expansion. We also believe that while the first
half of the year might continue to belong to the domestically focused companies, it is
possible that more internationally oriented companies, such as those in the industrial
space, might do a bit better in the second half of 2016, particularly as we look out
to 2017. If this scenario does indeed turn out to be accurate, then certain parts of
LEBENTHAL LISANTI CAPITAL GROWTH lebenthal-lisanticg.com 8January 2016
LEBENTHAL LISANTI CAPITAL GROWTH lebenthal-lisanticg.com 9
the small cap market that have done very well might struggle a bit—for example,
biotechnology companies.
From where we sit, the earnings growth for the small cap growth market, as
measured by the Russell 2000 Growth Index, still looks very healthy. Estimates call
for earnings growth on the order of 30% or so in 2016, which would be better than
the S&P 500. Keep in mind that this growth is not distributed evenly—the fastest
growers will far outpace that number. As always, what drives earnings growth in
the smaller cap end of the market is creativity and innovation. We see no shortage
of that in the companies we research; if anything, we believe that creativity and
innovation are accelerating as companies gain confidence that we will not see a
repeat of 2008-2009.
We think the biggest “upside surprise” in the smaller end of the market could be
the return of investor confidence, as the global economy stabilizes, the dislocations
caused by the drop in energy prices are absorbed by the economy, and we get
potentially a bit more stability in the political landscape with the election of a new
President. (As an aside, we are heartened by the recently passed Federal spending
bill, which contains several items that are positive for smaller companies: the repeal
of the “medical device tax” for several years, and the delay of the implementation
of the “Cadillac tax” for healthcare until 2020. If one puts that together with the
$305 billion highway spending bill signed by President Obama in December, you
could almost imagine that government is actually beginning to focus on helping the
economy grow). If investor confidence increases, and time horizons lengthen, then
smaller capitalization stocks could do better than we expect in 2016—making it even
more fun for stockpickers.
IMPORTANT INFORMATION: Effective March 2, 2015, the Fund changed its Adviser, formerly, AH Lisanti Capital Growth, LLC, to Lebenthal Lisanti Capital Growth, LLC, and its name, formerly the Adams Harkness Small Cap Growth Fund, to the Lebenthal Lisanti Small Cap Growth Fund.
Before investing, you should carefully consider the Fund’s investment objectives, risks, charges, and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling (800) 441-7031. Please read the prospectus carefully before you invest.
An investment in the Fund is subject to risk, including the possible loss of principal amount invested. The Fund invests in smaller companies, which carry greater risk than is associated with larger companies for various reasons such as narrower markets, limited financial resources and less liquid stock.
The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe. It includes those Russell 2000 companies with higher price-to-value ratios and higher forecasted growth values. One cannot invest directly in an index.
Foreside Fund Services, LLC is the distributor for the Lebenthal Lisanti Small Cap Growth Fund.
The information contained in this document is based on data received from third parties which we believe to be reliable and accurate. Lebenthal, however, has not independently verified the information and does not otherwise give any warranty as to the truth, accuracy, or completeness of such third party data, and it should not be relied upon as such. The material is not intended to be a formal research report and does not constitute an offer to sell, or a solicitation of any offer to buy or sell, securities or currencies of any entity or government. Any opinions expressed herein are our current opinions only. In addition, it should not be assumed that any of the securities and/or strategies discussed herein were or will prove to be profitable. Past performance is no guarantee of future results and any strategies de-scribed herein which have the potential for profit also present the possibility of loss. There are no guarantees that any risk management strategies or invest-ment strategies described herein will be successful notwithstanding any efforts to mitigate risk. International investing presents certain risks not associated with investing solely in the U.S., such as currency fluctuation, political and economic change, social unrest, changes in government regulations, differences in accounting, and the lesser degree of accurate public information available. Please refer to your Brokerage Account statement from your custodian as your official account statement for performance information and account activity. Lebenthal Lisanti Capital Growth, LLC is an SEC Registered Investment Adviser under the Investment Advisers Act of 1940 (“Advisers Act”). Lebenthal Lisanti is a separate legal entity from Lebenthal Asset Management. Lebenthal Asset Management maintains a minority interest in Lebenthal Lisanti Capital Growth. © Copyright 2016, Lebenthal Lisanti Capital Growth, LLC. All Rights Reserved. This report may not be reproduced, distributed or transmitted in whole or in part in any media without the express written permission of Lebenthal Asset Management, LLC.
January 2016
We think the biggest “upside surprise” in the smaller end of the market could be the return of investor confidence