Covenant Weekly Market Synopsis as of July 8, 2016

July 11, 2016

Domestic equities recorded gains last week approaching new highs, even as the yields on US Treasuries (USTs) plumbed new lows. Outside of the U.S. however, the picture was less rosy as the effects of Brexit rippled through equity markets: Europe (-1.5%), Japan (-4.2%), Emerging Markets (-1.2%), and Frontier Markets (-0.4%). Precious metals continued to receive investor attention, while industrial metals such as copper declined (generally a negative indicator for industrial activity). The energy complex also took a hit last week with the price of WTI Crude falling 6% to $45.41 per barrel and Natural Gas falling by a similar amount.

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“Lola” – “It’s a mixed up, muddled up, shook up world” sang Ray Davies of the English rock band The Kinks in the group’s iconic 1970 hit song “Lola”. Of course the song’s subject matter was not financial markets (much darker, in fact), but the lyrics admirably capture the current environment. In today’s reality the surreal has become the norm as central bankers and investors are increasingly recognizing that monetary policy has limits and ultra-low, or negative interest rates, do not stimulate economic activity nor inflation. They may actually impede both: there is an estimated $11.7 trillion of global debt securities with negative yields, yet the global economy is sputtering and sustained modest inflation remains elusive, especially in those countries with the most negative interest rates (i.e. Japan). Central bank forecasting, which has about as good a track record as your local weatherman’s seven-day outlook in the best of times, has deteriorated further as their favored financial models simply do not work in today’s shook up world (see St. Louis Fed President James Bullard’s recent adoption of a new forecasting method). Meanwhile, investors are piling into anything that offers a yield, chasing numbers and pushing up valuations of “stodgy” stocks, such as utilities. The result: on Friday the S&P 500 closed just 0.04% below its all-time high, even as the 10-year UST touched an all-time low of 1.366%. Indeed, it’s a mixed up, muddled up world and though prices keep rising, it’s not a time to be complacent.

Disruptors – Spent last week in California, meeting with a variety of investment managers. By far the most intriguing meetings were with emerging managers operating in the private lending sector. These managers epitomize entrepreneurialism, from their visionary goals to disrupt traditional lenders to their offices where they are transforming theoretical business models into practical applications (and revenue). In summary, these firms are seeking to capitalize on the confluence of two trends:

· Consumers increasing use of, and comfort with, technology as a platform for conducting transactions; and

· A lack of credit supply from traditional financial sources, namely banks.

The offices consist of industrial austerity, creative energy, and shared workspaces where computer programmers are designing sophisticated algorithms to underwrite loans, while simultaneously creating simple, intuitive interfaces for consumers to request those loans. You are more likely to see a pinball machine in these offices than the mahogany desks favored by traditional bankers. Demand for credit remains robust, while at the same time the sources of credit are waning. The opportunity is to provide that credit, be paid for the risks you are taking, and generate good returns for investors and clients. These entrepreneurial disruptors sense opportunity, as do we.

Economic Data Wrap-Up: The ISM Non-Manufacturing index rose to 56.5 in June (vs. consensus estimate of 53.3), the highest in seven months. Much of the gains came from business activity and new orders sub-indices, which is a good sign for current and future business conditions. One thing to note however, is that this survey was conducted prior to the UK referendum. June’s Nonfarm payrolls jumped a hefty 287k, well above expectations and likely a contributing factor to Friday’s equity market rally. However, following May’s wildly disappointing job’s number (11k based on revisions), job growth is averaging only 151k in the second quarter which is consistent with the slowing trend in jobs creation witnessed over the last several months. Much of the job growth has come in the healthcare and leisure sectors, but sustained employment growth in manufacturing and construction sectors is necessary to propel the economy forward at an improved pace.

Be well and Godspeed,