Author: cvernon

How to Launder Your Volatility

Hi, James Torgerson here! Volatility can be an unsightly blemish on portfolios and lead to inferior risk-adjusted returns. Private credit is just the thing investors need to launder away the pesky volatility that drags down Sharpe ratios! Those looking for an easy way to remove the stains of volatility from their portfolios should look no further! Call the number at the bottom of your screen now! Smoother portfolio returns await!

While the above may sound like a cheesy infomercial, an allocation to private credit can indeed provide numerous benefits, including an income premium, stricter covenants, and attractive long-term returns. Additionally, the frequency with which private credit portfolios are marked (primarily monthly or quarterly) can lead to smoother headline volatility and higher risk-adjusted returns when compared to public credit.

While there is no publicly traded private credit index, listed Business Development Companies (BDCs) can be used as a proxy for the asset class. Listed BDCs are exchange-traded investment vehicles that hold private loans to small-to-mid-sized companies and can offer insights into the differences between the stated volatility of public and private credit portfolios. The chart above shows the cumulative returns for both the publicly listed MVIS US BDC (which is valued on a daily basis) and the Cliffwater Direct Lending (which is valued on a quarterly basis) indices. Additionally, the chart shows the Sharpe ratios (i.e., risk-adjusted returns) for these indices, as well as that of bank loans, which are often used as another proxy for direct lending. While the cumulative returns for the BDC and direct lending indices are directionally similar, the publicly traded BDC index exhibits significantly more volatility than the private index (even though the underlying assets are relatively similar in terms of credit risk). Further, when measured from the beginning of 2010 through the end of March, the Sharpe ratio of the direct lending index is 3.3, while the publicly traded BDC and leveraged loan indices show Sharpe ratios of 0.4 and 0.8, respectively, for that time period. Clearly, by listing privately and employing a valuation lag, private credit is able to launder away a significant percentage of a portfolio’s volatility.

To be clear, private credit likely has a place in many institutional portfolios, and it is important to remember that the asset class is comprised of much more than just direct lending. However, as the asset class continues to grow and retail investor participation increases, readers should be aware that lower private credit fund-level volatility does not necessarily mean lower volatility of underlying assets.

The New Face of Emerging Markets

The MSCI Emerging Markets Index has undergone a significant structural transformation in recent years. For much of the past decade, China dominated the benchmark, but Taiwan now represents the largest country in the index at roughly 27%, with South Korea close behind at around 23%. After reaching nearly 40% at the end of 2020, China’s weight in the index now sits below 20%. This shift has largely been driven by the strength of Taiwan and South Korea in the semiconductor space and the global AI infrastructure buildout. For example, Taiwan Semiconductor Manufacturing Company (TSMC), the world’s leading contract chip manufacturer and a critical supplier of the advanced semiconductors used in AI accelerators, has seen its revenues, margins, and market capitalization expand significantly in the last five years. TSMC now represents nearly 15% of the MSCI Emerging Markets Index. Additionally, South Korean companies Samsung and SK Hynix have become global leaders in memory semiconductors, particularly high-bandwidth memory chips, which are essential for training and operating large AI models. Samsung and SK Hynix constitute roughly 9% and 7% of the MSCI Emerging Markets Index, respectively.

This change in index leadership carries important implications for investors. Strong performance of a relatively small group of semiconductor companies has led to an uptick in concentration within passive emerging market funds and tied benchmark performance more closely to AI-related chip demand. The lower weighting of China in the index, meanwhile, reflects both weaker relative performance for Chinese companies and the broader investor preference for markets more directly connected to AI infrastructure spending. As a result of these trends, the MSCI Emerging Markets Index increasingly reflects advanced semiconductor leadership rather than the diversified growth of emerging economies, heightening both country- and company-specific risks. For instance, geopolitical tensions involving Taiwan, supply chain disruptions, or a meaningful slowdown in AI capital expenditures could materially alter recent performance trends. This dynamic reflects a broader shift in where value creation is occurring across emerging markets and is likely to persist as long as AI-related semiconductor demand remains strong.

The Best and Worst of Times

The classic novel A Tale of Two Cities by Charles Dickens begins with the line “It was the best of times, it was the worst of times…” While Dickens was describing the extreme contradictions of the late 18th century leading up to the French Revolution (i.e., comfort for the aristocracy and hardship for the poor), this line could just as easily apply to the current economic environment in the United States, which is marked by a stark divergence between consumer confidence and investor behavior. Specifically, recent University of Michigan consumer sentiment readings have fallen to some of the weakest levels in decades, reflecting persistent frustration on the part of many Americans over inflation, elevated interest rates, high gasoline prices, and job security. Consumers remain particularly sensitive to the cumulative impact of several years of higher prices, even as headline inflation has moderated from its post-pandemic peaks. Surveys from both the University of Michigan and the Conference Board suggest U.S. households are increasingly worried about future economic conditions and weakness in the labor market. At the same time, equity markets have largely shaken off these concerns given enthusiasm surrounding artificial intelligence and expectations for longer-term productivity gains. Indeed, the S&P 500 Index has notched gains of more than 17% in each of the last three full calendar years and has advanced more than 9% in 2026 as of this writing. This strong performance has led to higher equity market valuations. As can be seen in this week’s chart, the Shiller Cyclically Adjusted Price-to-Earnings (CAPE) Ratio for the S&P 500 Index, which compares prices to average inflation-adjusted earnings over the prior 10 years to smooth out short-term volatility, sits at roughly 42. This figure is well above historical average levels and signals that investors continue to pay a significant premium for future earnings growth despite weaker consumer sentiment. Many have described this dynamic as a “tale of two markets,” as investors reward companies with outsized earnings potential and the ability to generate technological disruption even as households cut back on discretionary spending and grow more cautious about the economy.

A major driver of the divergence described above is the way in which financial asset ownership is distributed in the United States. A recent estimate from the Federal Reserve indicates that the top 10% of American households own roughly 90% of all U.S. corporate equities and mutual fund shares, meaning recent market gains have created a wealth effect that continues to support spending among affluent consumers, even as lower- and middle-income households face significant pressures. This divergence also highlights the forward-looking nature of financial markets, as equity investors are often pricing in anticipated earnings growth and future monetary policy as opposed to current economic conditions. Most consumers, on the other hand, respond more directly to present-day realities such as grocery bills, gasoline prices, and the perceived stability of the labor market. Whether this sentiment gap ultimately closes due to consumer confidence that is recalled to life or equity valuations that face the guillotine of market repricing remains one of the key questions facing investors in the near term.

The “Magnificent One”

Over the last few years, equity markets have been defined by a group of stocks often referred to as the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla). These stocks represent roughly 34% of the S&P 500 Index, leading to meaningful concentration risk and an outsized influence on overall index returns. In fixed income, on the other hand, the Bloomberg U.S. Aggregate Bond Index could be referred to as the “Magnificent One” given the extent to which it serves as a bellwether for the broader asset class. The index is comprised of four sub-indices: Treasuries, Government-Related, Corporates, and Securitized. Like the S&P 500 Index, however, this benchmark is not immune to concentration risk, as issuers that borrow the most maintain the largest weights within the index. More than 80% of the securitized sector, for instance, is comprised of Fannie Mae and Freddie Mac mortgage-backed securities, while Ginnie Mae mortgage-backed securities represent an additional 10% of this sector.

Prior to 2008, securitized bonds were the largest component of the index, fueled by the growth of the mortgage market and the issuance of mortgage-backed securities by Fannie Mae and Freddie Mac. Following the Global Financial Crisis, the U.S. Treasury embarked on a borrowing bonanza, with Treasury issuance surging to $760 billion in the 2008 fiscal year. Net borrowing jumped again in 2018 after the passage of the 2017 Tax Cuts and Jobs Act and continued to rise through the COVID-19 pandemic. The U.S. budget deficit is now expected to widen to more than $3 trillion in the next 10 years, and these dynamics have impacted the constitution of the Bloomberg U.S. Aggregate Bond Index. While not all Treasuries are eligible for index inclusion, the overall weight of Treasuries in the benchmark has grown from roughly 25% to 46% over the last two decades and could climb higher in the years ahead. Treasuries are not the only source of U.S. government risk in the Bloomberg U.S. Aggregate Bond Index. As noted above, the securitized sector is heavily exposed to bonds issued by government-sponsored entities (e.g., Ginnie Mae, Fannie Mae, and Freddie Mac). Ginnie Mae mortgage-backed securities are supported by the full faith and credit of the U.S. government, while securities issued by Fannie Mae and Freddie Mac have an effective government guarantee since the entities were placed under conservatorship in the wake of the Global Financial Crisis. Taken together, securities issued or guaranteed in some way by the U.S. government currently exceed 70% of the Bloomberg U.S. Aggregate Bond Index. While a default by the U.S. government is highly unlikely, prices of government-related securities can move adversely in response to persistent deficits, rising debt levels, higher interest costs, inflationary pressures, and geopolitical developments.

Concentration risk within the fixed income space can be reduced via active management, as actively managed strategies have greater flexibility in terms of sector positioning and diversification. To that point, a common trade among bond managers with an active focus is to strategically underweight Treasuries and Agency mortgage-backed securities in favor of corporate and structured credit exposures. This approach reduces investor exposure to the U.S. government and increases yield due to higher spread risk relative to a passive portfolio. Additional sources of diversification that active strategies can provide include non-dollar exposures (e.g., developed and emerging markets) and below-investment-grade credit.

A Renewed Focus on Renewables

In addition to the humanitarian toll of the conflict in Iran, the world is currently confronting the impact that trade disruptions in the Strait of Hormuz are having on energy markets. To this point, oil importing nations in Asia are bearing the brunt of these disruptions, with many of these countries instituting measures like school and work closures, transportation restrictions, and manufacturing cutbacks in order to save on fuel costs. These dynamics underscore the strategic importance of energy independence and could ultimately result in meaningful shifts in how various countries power their economies.

While the conflict may lead governments to see the value of diversifying energy sources in a new light, the search for alternatives to fossil fuels is not new. Along with environmental concerns, reliance on finite resources imposes limitations on power generation capacity. Those limits are at odds with groundbreaking technological advancements in artificial intelligence, which are propelled by infrastructure that requires vast amounts of energy to operate. As illustrated in the chart above, more than half of newly installed energy capacity in the last five years has come from renewable sources like solar and wind, and that share is still increasing. Countries like China and Brazil are leaders on this front, with 58% and 87% of their energy capacity additions coming from renewables last year, respectively. Opportunities for investment should continue to emerge as countries around the world commit capital to expanding renewable energy infrastructure, making this a trend worth monitoring for investors going forward.

The Fed Tackles Succession Planning

The leadership structure of the Federal Reserve is intentionally designed to promote continuity, independence, and institutional stability across political cycles. Specifically, the seven members of the central bank’s Board of Governors serve staggered 14-year terms, while the Chair is appointed to a renewable four-year term by the president and confirmed by the Senate. In this context, the nomination of Kevin Warsh by the Trump administration earlier this year to lead the Fed marks a potential inflection point for U.S. monetary policy leadership. Warsh brings a combination of public- and private-sector experience, having served as a Federal Reserve governor during the Global Financial Crisis, worked in mergers and acquisitions at Morgan Stanley, and later advised policymakers and investors as a fellow at the Hoover Institution and lecturer at Stanford. Warsh’s nomination, first announced in late January and now nearing final Senate confirmation, comes as Jerome Powell is set to end his term as Chair in the coming days, concluding a tenure defined by extraordinary economic shocks and aggressive policy responses. Recent developments have effectively cleared the path for this transition, with Warsh expected to assume the role shortly after Powell’s term expires, even as Powell has indicated he intends to remain on the Board of Governors through 2028 in a move aimed at preserving institutional continuity. Against this backdrop, Warsh is in position to take the helm of a Federal Reserve that has recently undergone a historic tightening cycle and is now navigating the late stages of the inflation fight, setting the stage for what is likely to be an evolution (rather than a reset) of policy direction.

This Too Shall Reconstitute

Rooted in medieval Persian Sufi thought, the adage “this too shall pass” speaks to the fleeting and impermanent nature of the human condition. For investors, this aphorism can serve as a useful framework for understanding the constantly evolving composition of the upper end of the U.S. equity market. As this week’s chart shows, the top 10 constituents of the S&P 500 Index have changed dramatically over the last 40 years, with each new decade seeing both additions to and subtractions from this basket of companies.

In 1985, the top of the S&P 500 Index was heavily weighted toward industrial conglomerates, energy producers, and legacy financial and telecommunications firms such as IBM, Exxon, AT&T, and General Electric. This composition reflected an economy still anchored in manufacturing, physical infrastructure, and regulated industries with durable but relatively slow-moving competitive dynamics. Capital intensity, domestic scale, and regulatory barriers to entry helped entrench incumbents, allowing a small set of diversified conglomerates and commodity-linked businesses to dominate equity indices. As can be observed in this week’s chart, the top 10 constituents represented roughly 21% of the S&P 500 Index in 1985. In contrast, the top 10 constituents at the end of last year represented more than 40% of the benchmark, with technology-oriented companies like NVIDIA, Apple, Microsoft, Alphabet, Amazon, and Meta topping the benchmark and accounting for an outsized share of index earnings and returns in recent years.

The transition between these two regimes did not occur abruptly but rather through decades of structural changes, including the rise of the digital economy, the decline in manufacturing’s share of GDP, and the increasing importance of intangible assets such as software, data, and intellectual property. Indeed, the 1990s and early 2000s saw the rise and consolidation of the internet economy, which led to the reshaping of information, communication, and commerce. The years following the Global Financial Crisis further accelerated the dominance of scalable, asset-light business models, while low interest rates and abundant liquidity disproportionately benefited high-growth technology firms. At the same time, several former index leaders either stagnated, were disrupted, or lost relative economic relevance, leading to a gradual but persistent turnover at the top of the index.

Against this backdrop, the current composition of the S&P 500 Index should not be viewed as fixed, but rather as a snapshot of a specific moment in time. If history is any indication, the next decade will likely bring another reshuffling of top index constituents as new technologies, industries, and business models emerge. For investors, this suggests that maintaining broadly diversified equity exposure while remaining disciplined around rebalancing is prudent, as market leadership, however dominant it appears at a given time, has historically been transient rather than permanent.

Let’s Hear It for Latin America

Latin American equity markets have shown remarkable strength in 2026. After a strong start to the year, the MSCI Emerging Markets Latin America Index corrected by only 4% in March amid a broad, more pronounced market pullback due in large part to the conflict in Iran. Brazil, which represents the largest economy in Latin America, was uniquely positioned to handle commodity market disruptions given its status as a net exporter of crude oil and a world leader in renewable energy utilization. Indeed, almost 90% of Brazilian electricity is generated via hydropower, wind, and solar sources, so the nation has been able to withstand recent energy shocks better than many other Western nations. The Central Bank of Brazil also cut interest rates for the first time in two years in March, though additional rate cuts that were anticipated at the start of this year are now more uncertain. Investors have also looked on Latin American financial institutions with favor in recent time, as banks across the region (e.g., Creditcorp in Peru, Itaú in Brazil, and Grupo Financiero Banorte in Mexico) are outperforming their global peers on a year-to-date basis due to attractive earnings projections. Additionally, significant foreign investment in the Brazilian economy has led to higher volumes and earnings for B3, the Brazilian stock exchange.

Global markets have stabilized in April, with the S&P 500 Index now trading near calendar year highs and developed international equities also exhibiting renewed strength. At the same time, Latin American equities have continued their upward trajectory, with the MSCI Emerging Markets Latin America Index now up more than 20% since the start of 2026. Following strong performance in 2025 and after having avoided a major drawdown in the wake of the Iran conflict, investors may want to keep a close eye on Latin American stocks as the year progresses.

We’ve Seen This Before

Diversify. Rebalance. Stay invested. Every one of these letters has concluded with that same advice in some shape or form. It’s not particularly shiny and new, but the best documented path to a successful long-term investment program. The last eight weeks are another data point in support of these practices.

In this edition:

  • Impact of U.S.–Iran conflict on oil prices, interest rates, and equity markets
  • Volatility and drawdowns in the market cycle
  • Equity market rotation
  • Magnificent 7 detraction and increased market breadth
  • Slowdown in non-U.S. equities

The Sorrows of Young Workers

Entry-level jobs have traditionally served as the primary bridge between education and stable employment, offering young workers a foothold from which to build skills and careers. That bridge now appears to be in a precarious position, however, as data points show that unemployment among recent college graduates has risen meaningfully in just a few years (even as headline labor market indicators remain relatively stable). Indeed, the unemployment rate for recent college graduates was 5.6% at the end of last year, compared to a more moderate figure of 4.2% for the entire United States.

Several factors could explain this situation. First, the nature of entry-level work is changing, as positions that once required little experience increasingly demand that applicants possess prior skills, internships, or even several years of relevant work. This dynamic leaves many new graduates caught in a paradox: unable to gain experience because they lack it. Hiring trends reinforce this challenge. Employer demand for early-career talent has flattened, and companies appear more reluctant to invest in training, instead favoring candidates who can contribute immediately. The result is a bottleneck at the bottom of the labor market, where supply continues to grow but opportunities do not keep pace. Broader economic forces are compounding these pressures. Technological change, particularly the increasing adoption of automation and artificial intelligence, is reshaping the types of tasks firms are willing to assign to junior workers. In many cases, routine or entry-level responsibilities are being automated or consolidated into higher-skill roles. At the same time, hiring has become more selective and uneven across industries, with growth concentrated in sectors that are less accessible to many recent graduates. Research from regional Federal Reserve banks underscores that these trends are not merely cyclical but may reflect longer-term shifts in how labor markets function. When entry-level hiring weakens, career progression slows, wage growth is delayed, and workforce participation may decline as discouraged workers step back from job searches. Over time, this can erode productivity and limit economic dynamism, as fewer workers gain the early-career experience needed to move into more advanced roles. The implications extend beyond individual job seekers to the broader economy, which depends on a steady pipeline of talent development.

Taken together, these dynamics point to a labor market that is still strong on the surface but potentially fragile beneath it. A robust economy is not defined solely by low unemployment or steady job creation, but also by the accessibility of opportunity across all stages of a worker’s career. Ensuring a sufficient supply of true entry-level roles (i.e., positions that offer training, mobility, and a pathway forward) may therefore be critical not just for today’s graduates, but for sustaining long-term economic growth.