The Good

Real GDP for the U.S. came in at 3.7% for the second quarter. Over the summer, monthly payroll gains averaged 221,000, and the jobless rate dropped to 5.1% as reported after the September unemployment report.

The Bad

The full effects of the China yuan devaluation which happened at the end of June was felt during the second quarter. Commodity prices continued to sell off. Asian, emerging market, European and U.S. markets sold off with slower growth the new prospect globally. The S&P 500 was down 6.94% during the quarter.

The Ugly

The humanitarian crisis is roiling Europe. Tens of thousands of people are leaving the war torn mid-east and heading to the borders of Germany, Poland, and Hungary. The European Union (EU) is trying to find places to disperse the refugees across the EU countries. Chancellor Merkel of Germany has estimated that as many as 800,000 refugees will attempt to live in Germany this year. The costs to her country to educate, house and feed the masses will be in the billions.

The Rate Hike

There is a scene in the iconic Clint Eastwood movie bearing the title of this article, in which Tuco (played by Eli Wallach), having fled to a shanty town, takes a bath in a ramshackle hotel and is surprised by a bounty hunter. As the bounty hunter talks and holds his gun on the outlaw, Tuco shoots and kills the would-be assassin with a gun he’s been hiding under the bubble bath. Tuco then mutters the classic line, “When you have to shoot, shoot. Don’t talk.”

Which brings us to the FOMC and the September confab. Yellen, if you’re going to raise rates, raise rates, don’t talk. In our view, this was a complete misstep by the Fed. They have done nothing but talk about raising rates in 2015 and, even though the market was split on the outcome, the status quo and the way it was communicated after the meeting did more harm than good. The result? Equity markets sold off, Treasury bonds rallied.

If you have read my previous market updates, I have been in the “lower for longer” camp for years. I did not think a rate hike was in the cards in 2015. But with so much talk about the 2015 rate hike by all the Fed governors as they grab TV and print time, I thought they were boxed in and had to raise.

After all, domestic activity continues to lead the Fed in the direction of a rate hike. So what was new that caused them to blink? Apparently heightened downside risks to global growth. For years we were told it was employment and inflation mandates. Now apparently, global concerns are on the agenda too. The real issue is how do you normalize interest rate policy when QE was not a normal policy?

The Year in U.S. Treasury Interest Rates
12/31/2014 3/31/2015 6/30/2015 9/30/2015
2 year 0.66% 0.55% 0.64% 0.63%
5 year 1.65% 1.37% 1.63% 1.35%
7 year 1.97% 1.70% 2.08% 2.73%
10 year 2.17% 1.92% 2.35% 2.03%
30 year 2.75% 2.53% 3.12% 2.85%
Source: Bloomberg

The yield curve had steepened through the first two quarters of the year but by the third quarter, two-year bonds to 30-year bonds narrowed 26 basis points. Global growth concerns and Fed rhetoric on the rate hike is driving divergent outcomes on the yield curve. The two-year bond hovers near 60 basis points, positioned for a possible rate hike in 2015. The 10- and 30-year bonds have rallied, focused on the possibility of slower U.S. growth moving forward.

European Bond Yield Rally
5 year 10 year
6/30/2015 9/30/2015 6/30/2015 9/30/2015
France 0.32% 0.21% 1.19% 0.98%
Germany 0.07% 0.00% 0.76% 0.58%
Italy 1.24% 0.74% 2.33% 1.72%
Spain 1.12% 0.88% 2.30% 1.88%
Portugal 1.68% 1.13% 2.98% 2.38%
Source: Bloomberg

European interest rates moved lower. The China yuan devaluation, economic slowdown in China and commodity weakness contributed to a volatile quarter in 10-year interest rates across Europe. The final move lower in yields appeared to be as a result of the U.S. Environmental Protection Agency (EPA) issuing a Notice of Violation of the Clean Air Act to German automaker Volkswagen. The EPA charged that the German automaker had equipped vehicles having turbo charged diesel engines with software that resulted in the engines testing as having low enough emissions to meet the U.S. standards. Under non-test circumstances, emissions from these cars were up to 35 times higher. Volkswagen stock plunged over the last days of the quarter, sending the German DAX lower along with the rest of Europe’s bourses. The result was EU bonds rallied into September 30th.

The Portfolios at a Glance

The third quarter can tend to be rocky in the municipal market. Low coupon re-investment and maturities coupled with the summer doldrums can lead to some adjustment in prices. This year that was not the case as equities sold off and Treasury bonds rallied. All supply was absorbed but municipals did lag Treasuries, and the spreads on municipal bonds widened out versus Treasuries.

The structure we like in municipals is quality AA names with 4% coupons due in the 2025 to 2030 range with shorter calls in the 2021 to 2023 range. In our opinion and being in the “lower for longer camp,” buying bonds at 120 to 140% of Treasuries is a value.

In taxable bonds, BBB credit spreads continued to widen out. High yield was very weak as dropping of commodity prices is really taking a toll on bonds in the oil and natural gas space. Looking at the quarter, the place to be was long duration and 100% Treasuries. Our portfolios weakened into the end of September as the proverbial “window dressing” occurred and Treasury bonds rallied hard. We plan to continue to build par in our portfolios and welcome the wider BBB spreads. Who doesn’t want more yield and income?

Past performance is not indicative of future results. This is not a recommendation to buy or sell a particular security. Please see attached disclosures.

The opinions expressed are those of the Clark Capital Management Group Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. There are no guarantee of the future performance of any Clark Capital Investments portfolio. Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies. For educational use only. This information is not intended to serve as investment advice. This material is not intended to be relied upon as a forecast or research. The Investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. Past performance does not guarantee future results.

The Dow Jones Industrial Average is a stock market index that shows how 30 large publicly owned companies based in the U.S. have traded during a standard trading session in the stock market.

The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performers of developed markets outside the U.S. and Canada.

The MSCI Emerging Markets Index is a freefloat-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.

The Russell 3000® Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market.

The Barclays U.S. Government and Credit Bond Index measures the performance of U.S. dollar denominated U.S. Treasuries, government-related, and investment grade U.S. corporate securities that have a remaining maturity of greater than 1 year. In addition, the securities have $250 million or more of outstanding face value, and must be fixed rate and non-convertible.

The Barclays U.S. Corporate High-Yield Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

The Barclays 30-Year U.S. Treasury Bellwethers Index is a universe of Treasury bonds, and used as a benchmark against the market for long-term maturity fixed-income securities. The index assumes reinvestment of all distributions and interest payments.

The Barclays 10-Year U.S. Treasury Bellwethers Index is a universe of Treasury bonds, and used as a benchmark against the market for long-term maturity fixed-income securities. The index assumes reinvestment of all distributions and interest payments.

The Barclays 5-Year Municipal Bond Index is the 5 Year (4-6) component of the Municipal Bond index. It is a rules-based, market-value-weighted index engineered for the tax-exempt bond market. The index tracks general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds rated Baa3/BBB- or higher by at least two of the ratings agencies.

Index returns include the reinvestment of income and dividends. The returns for these unmanaged indexes do not include any transaction costs, management fees or other costs. It is not possible to make an investment directly in any index.

Morningstar is the largest independent research organization serving more than 5.2 million individual investors, 210,000 Financial Advisors, and 1,700 institutional clients around the world.

For each separate account with at least a three-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a separate account’s monthly performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of separate accounts in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. The Overall Morningstar Rating for a separate account is derived from a weighted average of the performance figures associated with its three-, five- and ten-year Morningstar Rating metrics.

© 2012 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. Not every client’s account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment.

Clark Capital Management Group, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security, sector or industry. There is no assurance that any securities, sectors or industries discussed herein will be included in an account’s portfolio. Asset allocation will vary and the samples shown may not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices and which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk. The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities. The Barclays Capital U.S. Aggregate Bond Index is a market capitalization-weighted index, meaning the securities in the index are weighted according to the market size of each bond type. Most U.S. traded investment grade bonds are represented. Municipal bonds, and Treasury Inflation-Protected Securities are excluded, due to tax treatment issues. The index includes Treasury securities, Government agency bonds, Mortgage-backed bonds, Corporate bonds, and a small amount of foreign bonds traded in U.S. The Barclays Capital Aggregate Bond Index is an intermediate term index.

The volatility (beta) of a client’s portfolio may be greater or less than its respective benchmark. It is not possible to invest in these indices.

Clark Capital Management Group, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Clark Capital’s advisory services and fees can be found in its Form ADV which is available upon request.