Author: cvernon

Brazil Eases Into the Fall

On August 2, Brazil’s central bank cut its benchmark interest rate by 50 basis points, from 13.75% to 13.25%. This marks the country’s first rate cut in over three years and is in stark contrast to moves made by Brazilian policymakers in recent time. To that point, between February 2021 and July 2022, Brazil increased its key rate from 2.00% to 13.75%, representing the most aggressive monetary tightening by any central bank during this period. The August cut was made possible by a moderate domestic inflation rate of 3.2%, which sits well below the country’s post-pandemic peak of 12.1% exhibited in April of last year. Brazilian authorities have indicated that additional cuts are likely in the near future, thanks in large part to an improving consumer price outlook and longer-term inflation expectations that continue to fall. These dynamics place the country ahead of much of the globe when it comes to the cycle of interest rates, as many nations, particularly those in the developed world, continue to fight elevated inflation via restrictive monetary policy. Alternatively, other Latin American countries like Chile, Mexico, and Peru have either lowered rates in recent time or are expected to embark on easing campaigns within the coming months.

As it relates to performance, Brazilian equities have been a bright spot within the emerging markets space in 2023 and have significantly outpaced the MSCI EM index on a year-to-date basis through the end of July (22.6% vs. 11.4%). Expectations of a shift in monetary policy which has now come to fruition, coupled with better-than-expected fiscal and political outlooks, have boosted sentiment and helped fuel these strong returns. Should monetary conditions continue to ease, Brazil and its Latin American peers may continue to provide an attractive opportunity set for investors going forward.

Revisiting the Banking Industry

Though the regional banking turmoil that surfaced in March has largely faded into the background, Moody’s brought focus back to the sector last week when the rating agency downgraded 10 regional banks one notch (all remain investment grade). Moody’s also placed six larger lenders under review for a potential downgrade and cut the outlook for another 11 banks from stable to negative, indicating their ratings could be downgraded in the future. The rating agency cited interest rate and asset-liability management risks, as well as growing profitability pressures and expectations for a mild U.S. recession in early 2024 as reasons for these changes. Similar to Fitch’s downgrade of U.S. credit the week prior, the timing of these moves is being critiqued as deposit flows have generally stabilized since March, the Federal Reserve is likely at or near peak rates, and a soft landing appears increasingly likely.

Bank stocks pulled back modestly on the news, after notably outperforming the broader market in July. From here, a number of moving pieces remain at play. These include sensitivity of the banking industry to commercial real estate issues, tighter lending standards, and potentially higher-for-longer rates, though it is important to note that overall credit quality remains strong and the banking system remains well capitalized. Though the Moody’s downgrades may have little practical impact, they do serve as a reminder — especially after the strong performance of equities since the start of the year — that a number of uncertainties remain and, therefore, market volatility along with elevated dispersion could likely continue for the remainder of 2023.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Honey, I Shrunk the Money Supply

M2 money supply, as defined by the Federal Reserve, includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers’ checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds. M2 rapidly increased throughout 2020 and 2021 amid COVID-related monetary stimulus, to a peak of almost $22 trillion in July 2022. As the economy reopened and inflation accelerated — with headline CPI hitting a peak of 9% year-over-year in June 2022 — the Fed responded with a series of rate hikes and quantitative tightening measures. The result has been a rapid decrease in the money supply, with M2 down 3.6% year-over-year as of June 2023. The effects of the swift reduction in M2 have likely only begun to be felt, but a continued contraction — facilitated by higher-for-longer rates and continued quantitative tightening — could help cool inflation further and contribute to a soft landing for the economy.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Observations from Across the Pond

Marquette regularly sends a senior member of our research team abroad as part of ongoing manager sourcing and due diligence efforts. These trips include update meetings with investment managers with whom Marquette has existing relationships as well as on-site visits with potential new manager recommendations. The cadence of these trips was severely impacted by the COVID-19 pandemic, but with international travel now almost back to normal, Marquette sent Senior Research Analyst Evan Frazier on a whirlwind tour of Europe earlier this summer. Over the course of almost a week, Evan met with eight investment management firms across three cities.

In this newsletter, Evan shares the perspectives, as well as more anecdotal information, he gained while on the ground in Europe, including insights on the region’s economy, the corporate landscape, and the unique set of opportunities and challenges currently facing international markets.

Read > Observations from Across the Pond

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

When the Bill Comes Due

The U.S. economy has proved more resilient than expected this year, buoyed by ongoing consumer strength. Labor market dynamics and pandemic-era savings have allowed consumers to continue to spend despite higher costs. Those excess savings, however, are projected to be fully depleted by the fourth quarter. On top of that, millions of Americans will soon have another monthly charge to factor into budgets, as student loan payments are set to resume in October for the first time in years.
Collectively, U.S. consumers owe $1.6 trillion in education debt, with monthly payments averaging $200–$300. The CARES Act put student loan payments on hold in 2020, saving consumers approximately $185 billion over the last three years.¹

Moreover, the pause in payments brought delinquency rates to historic lows, which helped improve borrowers’ credit scores, enabling them to take on additional debt. As a result, some consumers are now facing greater obligations that may detract from spending on goods and services. Apollo Global Management estimates that student loan payments alone could reduce consumer spending — which makes up two-thirds of U.S. GDP — by more than $100 billion per year. Whether the U.S. tips into recession remains to be seen, but evolving dynamics like the depletion of excess savings and the resumption of student loan payments could change current trajectories. We will continue to watch these factors and their impact on the macroeconomic outlook closely.

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¹Goldman Sachs via The New York Times, Student Loan Pause is Ending, With Consequences for Economy

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Fitch Downgrades U.S. Credit

Fitch Ratings unexpectedly downgraded the U.S. government’s credit rating one notch from AAA to AA+ on August 1, 2023. This is only the second downgrade in history, after S&P Global Ratings, then Standard & Poor’s, made the same adjustment shortly after the 2011 debt ceiling crisis; S&P has maintained the AA+ rating since. Moody’s — the third major U.S. rating agency — still has the U.S. at its highest Aaa rating. Fitch noted the downgrade reflects expected fiscal deterioration over the next three years, the country’s high and growing debt burden, and an erosion in governance over the last several years, marked by bipartisan standoffs and last-minute resolutions. The downgrade and timing have drawn criticism from the Biden administration and economists, citing economic strength and the minuscule risk of the U.S. actually missing any debt payments.

While in practice the downgrade will likely have minimal impact, with the U.S. government broadly considered one of the safest borrowers, markets are reacting. Treasuries initially rallied on the news, anticipating the same flight to quality seen in 2011, though that sentiment reversed this morning, with yields at one point breaching a key resistance level of 4.1% — a level last seen in November 2022. Also likely contributing to the move today is the Treasury Department’s announced plans to sell a higher-than-expected amount of longer-dated securities next week, as it works to replenish the Treasury General Account (reference Marquette’s recent newsletter for additional context). The U.S. dollar initially dipped on the news but has since rallied and is up on the day amid higher yields. U.S. equities, after a steep run, are down modestly today, with growth equities leading the group lower.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Emerging From the Depths: An Overview of the Emerging Market Debt Opportunity Set

Emerging market debt (EMD) has earned a checkered reputation at best from institutional investors. The asset class is large, complex, and comes with unique risks that can lead to “throwing the baby out with the bath water” when things go wrong. 2022 was a challenging year for investors across asset classes, and emerging markets headlines ranging from the meltdown in Chinese property developers to Russia’s invasion of Ukraine only complicated the investment case for EMD. That said, historically the asset class has tended to rebound strongly from drawdown events, and that has so far been the case this year.

This newsletter revisits the dynamics of emerging markets debt, reviews 2022 performance, and discusses the investment opportunity from here.

Read > Emerging From the Depths: An Overview of the Emerging Market Debt Opportunity Set

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Emerging Opportunities Beyond China

Equity performance in China, with the MSCI China Index down 5.5% through the first half of the year, has disappointed amid hopes for a strong post-COVID recovery. While macro data started the year strong, momentum quickly waned, with a cautious consumer and a slowdown in manufacturing. China’s property sector troubles have continued, and U.S./China tensions remain, with the U.S. moving toward stricter regulation and reduced investment in the Chinese technology sector in 2024. Along with human rights concerns and the general unpredictability of the Chinese government, the debate around China’s investability continues on.

Take China out of the emerging markets picture, however, and the story is different. The MSCI Emerging Markets Index excluding China — the largest single country weight in the index at nearly 30%¹ — has outperformed the broader benchmark since late 2021. Latin American countries like Brazil and Mexico — almost 6% and 3% weights in the index, respectively — have benefited from central banks that began their monetary policy tightening cycle earlier. Additionally, as renewable energy trends continue, Latin American regions rich in natural resources should see exports grow. Nearshoring trends have also benefitted emerging market countries such as Taiwan — the second largest country weight in the index at nearly 16% — and Mexico, with the latter exporting nearly as much to the U.S. as China, something not seen since 2003. And in India — the third largest country weighting in the MSCI EM Index at approximately 15% — government reform programs have drawn in significant investor flows.

Looking into the second half of the year, the evolving macro picture in China, including any potential stimulus, will continue to be a driving factor of overall MSCI EM performance. And outside of China, there are a number of interesting trends playing out across the emerging markets space that should present investment opportunities for active managers.

 

¹All country weights as of June 30, 2023

The FTC vs. M&A

Higher interest rates have broadly impacted capital markets, including M&A deal flow given the significant increase in financing costs. Along with that, elevated regulatory risk has been another headwind for the space.

Since her appointment as Chair of the Federal Trade Commission (FTC) in June 2021, Lina Khan has emerged as one of the most aggressive anti-trust leaders the U.S. and Wall Street have seen in some time. For large corporations seeking growth via M&A, the regulatory requirements for FTC approval have increased significantly. Deals that would likely have been approved with ease in prior administrations now face costly lawsuits, injunctions, and other challenges by the Commission. Coupled with higher financing costs, the FTC’s aggressive agenda has significantly prolonged the timeline for deals to close. In the second quarter of 2023, completed M&A deal volumes came in at mere $95 billion, just above the $83 billion of deals closed at the height of COVID in the second quarter 2022. At the same time, the volume of pending deals awaiting regulatory approval has substantially increased, reaching $183 billion in the second quarter.

The FTC’s actions have had a clear impact on the M&A environment, leading to significantly wider deal spreads in 2023 amid increased uncertainty. This is both an opportunity and a risk for hedge funds specializing in merger arbitrage. While deal spreads appear attractive, they come with heightened risks that require expertise to successfully navigate. For investors, selecting experienced managers with a proven track record of success across different regulatory regimes is critical to achieving favorable risk-adjusted returns.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Halftime Adjustments

For anyone who regularly reads these letters, recall the market preview edition opined on the outlook for asset classes in 2023, particularly the likelihood of each delivering positive returns for the upcoming year. Given that we are halfway through the year, we would like to use this letter to make “halftime adjustments” to our outlook; with NFL training camps set to open later this month, we couldn’t resist the urge to borrow a football term. We hope this is a quick beach read as you enjoy your summer vacations and prepare for the second half of the year.

This edition re-assesses the outlook for fixed income, equities, and real estate for the second half of 2023.

Read > Halftime Adjustments

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.