cvernon, Author at Marquette Associates

A Cup of Joe Could Break the Bank

Over the last few years, a cup of coffee has become much more expensive as the costs of the two primary beans used to make the beverage, Arabica and Robusta, have moved significantly higher. Arabica beans are often imported to the U.S. from Brazil and are used to make higher quality coffee blends, while Robusta is a cheaper type of bean often exported from Vietnam and used to make instant coffee. A variety of factors can impact the prices of these beans, including weather irregularities, demand fluctuations, supply chain disruptions, regulatory changes, and currency movements.

This year, major drivers of prices include the high demand for coffee and concerns around supply given severe weather in Brazil and Vietnam. A late August frost in Brazil impacted the newly flowering trees and, thus, the next season’s beans, while severe droughts in both countries have impacted harvests. Droughts can cause coffee tree branches to die, leaves to fall (prohibiting photosynthesis), early flower shedding, and bean damage, all of which reduce a coffee tree’s expected harvest. Aggregate demand for coffee has gradually been increasing in tandem with these issues, primarily due to the growing coffee market in China. According to the U.S. Department of Agriculture, coffee consumption has risen by roughly 150% in China over the last decade, as the drink has become more affordable, accessible, and grown in popularity among young people. This growth is projected to continue into the next season of coffee consumption, up to 6.3 million bags (132lb each) from 5.8 million bags in the 2022/2023 season.

These challenged supply/demand dynamics have been felt by investors. To that point, coffee futures prices climbed 70% in 2024 and remain well above long-term averages as traders hedge against potential production delays and the anticipation of higher coffee prices. Additionally, name brands have also felt a squeeze, as Nestlé (the parent company of brands such as Nescafé and Nespresso) announced in November its plans to increase coffee prices and make smaller packages to absorb the higher costs of coffee beans. As consumers consider alternative morning beverages like orange juice or milk to cut costs, a word of advice: A cup of coffee is worth the price!

Deficit Dangers

Large-scale government programs aimed at stabilizing the nation’s economy in the wake of the pandemic, higher interest costs, and an increase in healthcare and retirement benefit spending have fueled higher deficit levels in recent time. To that point, the nearly $2 trillion U.S. federal budget deficit in the fiscal year that ended in September represented 6.4% of GDP, which was the largest such figure ever outside wartime periods or global crises (e.g., the Global Financial Crisis, COVID-19, etc.). Based on forecasts from the Congressional Budget Office, 2025 will be the third consecutive year that the United States will see a federal budget deficit in excess of 6% of GDP. The overall national debt has ballooned to more than $36 trillion as federal spending continues to outweigh tax revenues. This week’s chart outlines these dynamics above.

There are several risks posed by excessively high debt levels, including higher inflation, lower economic activity, and the potential that the nation will be equipped with fewer financial tools to handle geopolitical challenges as a large portion of U.S. debt held is by foreign investors. One risk that incoming Treasury Secretary Scott Bessent and other officials have highlighted is “rollover risk,” or the possibility that a drop in investor appetite at Treasury auctions would render the government unable to raise cash to pay for rapidly maturing debt. Bessent has made reducing the federal deficit a top priority via a combination of spending restraint, deregulation, and tax cuts aimed at fueling economic growth. While significantly reducing the federal budget deficit over the next four years may prove challenging for policymakers, it should be noted that the U.S. did manage to shrink its fiscal gap from 9.8% of GDP in 2009 to 4.1% in 2013 at the end of the Global Financial Crisis. That said, this moderation in the deficit came during a period of extreme economic recovery, which is a decidedly different environment than the current climate. Readers should note that efforts to return the federal deficit to historical levels will likely span years and different presidential administrations, though the structural advantages of the U.S. economy provide a buffer against the risks detailed above.

2025 Market Preview Video

This video is a recording of a live webinar held January 16 by Marquette’s research team analyzing 2024 across the economy and various asset classes as well as themes we’ll be monitoring in 2025.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

Featuring:
Greg Leonberger, FSA, EA, MAAA, FCA, Partner, Director of Research
Frank Valle, CFA, CAIA, Associate Director of Fixed Income
James Torgerson, Research Analyst
Catherine Hillier, Senior Research Analyst
David Hernandez, CFA, Director of Traditional Manager Search
Evan Frazier, CFA, CAIA, Senior Research Analyst
Dennis Yu, Research Analyst
Michael Carlton, Research Analyst
Chad Sheaffer, CFA, CAIA Senior Research Analyst

If you have any questions, please send our team an email.

Back to Back!

This week’s chart details each calendar year return for the S&P 500 Index dating back to 1928, with consecutive 20%+ returns highlighted in orange. Despite a slight pullback over the last few weeks, the index posted a return of more than 20% in 2024, which represents only the fifth time in history that the benchmark has recorded such a figure in consecutive years (note that the five straight years of 20%+ returns in the 1990s are counted as one instance). As investors look ahead to 2025 and beyond, many are asking the following question: How have markets performed after such strong periods?

In the years following the first three of these instances (1937, 1956, and 1984), the S&P 500 Index notched a significantly lower return, with an average of -1.1%. Interestingly, each of these years was marked by either tighter monetary policy, inflation, decreased industrial production, higher unemployment, or some combination of these trends. As mentioned above, the late 1990s saw a staggering five consecutive years of 20%+ returns for the S&P 500 Index, fueled by a boom in investor interest in e-commerce, software, and telecommunications companies. The so-called “Dot-Com Bubble” led to widespread speculation related to unprofitable companies and a rapid expansion in market valuations, and the bursting of this bubble caused the S&P 500 Index to decline sharply in the first three years of the new millennium.

In the last two years, performance of the S&P 500 index has been largely driven by investor interest in artificial intelligence and the Information Technology sector. The Magnificent Seven stocks (Apple, Microsoft, Amazon, Alphabet, NVIDIA, Meta, and Tesla) have led the charge, accounting for over 50% of the total return for the benchmark since the beginning of 2023. As artificial intelligence becomes increasingly integrated into the global economy, these and other similar companies are expected to attract more investment and drive additional index returns. While there are some similarities between the current environment and the Dot-Com Bubble, the U.S. economy continues to show resilience and most of the winners from the last two years are well-established businesses with healthy profits. Still, history has shown us that periods of robust equity market performance do not continue forever. As the calendar changes to 2025, investors should keep this idea in mind as it relates to expectations for near-term stock returns.

Multi-Asset Credit: Taking Offense From Good to Great

Before the football season began, we authored a white paper that detailed offensive and defensive elements of a fixed income portfolio. For most investors, an aggregate (core) mandate provides defense while strategic allocations to high yield, senior secured loans, and emerging market debt (EMD) are the primary sources of offense. Relative to an aggregate benchmark, this structure has outperformed over market cycles. However, just as championship teams adjust and innovate throughout a season, so too should an investor’s portfolio.

Multi-Asset Credit (MAC) strategies are single portfolios that dynamically allocate across a broad range of global credit markets to provide higher levels of income and a diversity of fixed income exposures. These mandates can serve as a single-solution credit allocation or as a credit alpha overlay in the context of a broader credit portfolio. There is no perfect definition of MAC, but what they do offer is diversification, flexibility, and ease of access and operations. While these markets are not new, investors may be unfamiliar with the mechanics of a MAC strategy and its potential benefits.

This newsletter provides an overview of MAC, including the opportunity set, allocation structure and considerations, diversification benefits, and sample MAC manager performance.

A Damsel in Distress

An increase in defaults across below investment grade issuers, which are viewed as the weakest and riskiest, is often the “canary in the coal mine” that the economy is entering a downturn. Recently, below investment grade defaults have moved higher from record lows seen in 2021, fueled by defaults in the leveraged loan market. However, an increasingly greater share of defaults is coming in the form of distressed exchanges.

A distressed exchange is a type of out-of-court negotiation between a borrower and its creditors that occurs when the borrower is in danger of defaulting. The recent surge in the volume of distressed exchanges has come largely in the form of Liability Management Exchanges — or “LMEs” — which are voluntary proactive paths that primarily, but not always, distressed borrowers may take in lieu of a traditional default or restructuring. These types of transactions have grown in usage because of looser covenants and weaker protections on a company’s debt, particularly within the loan market, which can be seen in the above chart. On a year-to-date basis, distressed exchanges as a share of overall default volume are more than 60%, which is the highest percentage seen since at least 2000 when data became widely available. The year-over-year increase in distressed exchanges of nearly 30% is the result of the greater use of LMEs.

The proliferation of distressed exchanges may overstate the overall observed default rate. To that point, the 2024 rates (including distressed exchanges) for high yield and leveraged loans were 1.4% and 4.0%, respectively. Stripping out distressed exchanges, the 2024 default rate falls to 0.3% for high yield bonds and 1.5% for leveraged loans. While distressed exchanges are technical defaults since the terms of the debt agreement are altered, the recovery rates are more favorable for distressed exchange transactions relative to traditional defaults. Specifically, over the past 12 months, the recovery rates on distressed exchanges for high yield bonds and leveraged loans were 48.2% and 18.3% higher, respectively. Distressed exchanges, particularly LMEs, can grant a borrower the liquidity and flexibility needed to correct critical issues, and certain transactions are included in these default statistics even if there is no principal loss. At times, however, there are abusers of these transactions who are merely “kicking the can” on their debt as fundamental issues remain or increase.

Recent data points show that distressed exchanges can lead to better outcomes relative to outright defaults, but the long-term effect of their proliferation is not currently known. What is known is that, based on recent trends, the amount of distressed exchanges, and LMEs, are not going away any time soon.

Cryptocurrencies Surge Post-Election

The cryptocurrency space is making waves again after a robust post-election rally drove bitcoin over $100,000 earlier this month. While it is tempting to attribute recent performance to speculation or momentum, a deeper understanding of the dynamics that fueled this surge may help investors navigate markets in 2025 and beyond. To that point, this week’s chart outlines the year-to-date performance of Bitcoin, Ethereum, XRP, and the MarketVector Digital Assets 100 Index, a market-cap weighted benchmark comprised of the top 100 cryptocurrencies (excluding stablecoins). The vertical line represents the beginning of the post-election cryptocurrency rally.

During the months leading up to the election, broad cryptocurrency performance appears to have been largely tied to bitcoin. As bitcoin is the most established, recognized, and capitalized digital asset, it follows that its liquidity and capital base would generally define the market. However, recent divergences between bitcoin and other cryptocurrencies are less intuitive and can largely be attributed to bitcoin’s position in a space beset by regulatory ambiguity and incongruous guidance. Put simply, this year bitcoin appears to have benefited from increased regulatory clarity and investor confidence. By the end of the second quarter, aggregate assets in the top 12 bitcoin ETFs exceeded $50 billion, with the iShares Bitcoin Trust ETF accounting for nearly 40% of that figure. Additionally, the access and standards afforded by the ETFs increased investor confidence, led to modest institutional acceptance, and expanded bitcoin market dominance. Meanwhile, other cryptocurrencies like XRP have faced headwinds that have weighed on performance. Embroiled in litigation since 2020, XRP was delisted by most U.S. exchanges and, as a result, struggled to perform during most of this year despite increased cryptocurrency adoption. This dynamic is demonstrated by XRP’s losses prior to the U.S. election.

So how did these dynamics ultimately contribute to a broad post-election rally, and how could they be relevant in the future? Challenges faced by XRP and the broader cryptocurrency market have led to criticism from industry stakeholders, particularly following the collapse of FTX, which exacerbated regulatory scrutiny. Cryptocurrency advocates and industry leaders widely viewed the responses from regulators as heavy-handed, raising concerns over potential stifling of innovation. As the 2024 election cycle ramped up, stakeholders within the cryptocurrency space increasingly engaged with policymakers, pushing for clearer regulatory frameworks and a more balanced approach. This heightened engagement coincided with a surge in political spending, reflecting the industry’s efforts to influence the regulatory landscape and mitigate perceived risks. Estimates suggest that bipartisan political spending by the cryptocurrency industry during the 2024 election cycle totaled more than $320 million, outpacing the roughly $275 million spent by Elon Musk and $175 million spent by Charles Koch and affiliates.

While it is unclear how cryptocurrencies may benefit from the incoming administration, the nomination of Paul Atkins, a known digital assets advocate, for SEC Chair indicates a potential shift toward more favorable regulatory policies for the sector. Additionally, the appointment of venture capitalist and cryptocurrency proponent David Sacks as the new administration’s “crypto czar” seems to have renewed industry optimism. These and other developments suggest that the incoming administration could provide a more supportive environment for digital assets.

Reluctant to Spend

In recent years, the Chinese economy has struggled to return to pre-pandemic levels of consumption and economic growth. This lackluster rebound can be attributed to factors including prolonged lockdowns from the country’s zero-COVID policy, regulatory crackdowns on private sector companies, and pervasive weakness in the country’s property sector. Recently, the Chinese government, in tandem with the People’s Bank of China (PBOC), has enacted measures to address the country’s myriad issues. For instance, the PBOC announced a monetary easing package in the third quarter that included interest rate reductions and cuts to reserve requirement ratios for Chinese banks. While the Chinese equity market saw a sharp September rally as a result of these measures, investor excitement has since waned, with the MSCI China Index down roughly 20% over the last two months.

One key reason measures to restore growth in China have been unsuccessful is that they have failed to boost domestic demand, of which consumption plays a large part. Economic uncertainty has made Chinese households reluctant to spend and consumer confidence in China remains well below long-term average levels, a trend outlined in this week’s chart. While a general malaise contributes to this lack of confidence, there are aspects of the Chinese economy that pose unique challenges for the government as it relates to economic revitalization efforts. One such challenge is the distribution of citizens’ wealth. To that point, approximately 80% of household wealth in China is comprised of real estate assets, rendering Chinese consumers particularly vulnerable to the ongoing instability in the country’s housing market. Additionally, only 10% of Chinese citizens own stock (as opposed to 70% of U.S. citizens), meaning any propping up of the Chinese equity market by the government may not result in a commensurate increase in domestic wealth and consumer demand. Consumer confidence in China has also been hampered by the country’s high levels of youth unemployment, as the jobless rate for 16–24-year-olds exceeded 17% at the end of the third quarter. Young educated Chinese workers in particular are facing a weak job market, along with a mismatch in job availability and their skill sets. These and other challenges have plagued the Chinese government for years, and while policymakers are now taking action to address them, whether new measures are sufficient to restore business and consumer confidence in China is yet to be determined.

First-Time Buyer Beware

Over the last 20 years, U.S. homeowners’ total home equity value has risen by more than 150% to roughly $35 trillion. This meteoric rise in home prices has helped many Americans build wealth but has been hazardous for a particular demographic: first-time homebuyers. These higher prices, along with high mortgage rates (the average 30-year fixed-rate loan is around 7.0% as of this writing) and reluctant sellers, have combined to keep potential first-time buyers largely out of the housing market. In 2024, a record low 24% of U.S. home purchases were made by first-time buyers; this figure is down from 50% in 2010. The median age of first-time buyers has also increased to 38, significantly higher than a historical average that is nearly 10 years younger.

With no signs of U.S. housing prices falling, many prospective buyers will be forced to continue to rent. This dynamic should sustain tailwinds for multifamily housing rentals, to which investors can gain exposure via core ODCE funds. Indeed, as of the end of the third quarter, multifamily housing constituted nearly 30% of the NFI-ODCE index. These trends in home affordability have also led institutional investors to increasingly move into the single-family housing market. While some cities have seen a glut of multifamily supply in recent years as investor capital has poured in, broader fundamentals remain sound.

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