Author: cvernon

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.

2023 Halftime Market Insights Video

This video is a recording of a live webinar held July 19 by Marquette’s research team, featuring live, in-depth analysis of the second quarter and themes we’ll be monitoring in the second half of the year.

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.

Sign up for research alerts to be invited to future webinars and notified when we publish new videos.
For more information, questions, or feedback, please send us an email.

Credit Trash is Return Treasure

“One man’s trash is another man’s treasure” may be a cliché, but it has never been more applicable to the below-investment grade, or junk, market. As the macroeconomic backdrop has proven to be more resilient than investors feared heading into 2023, one of the primary beneficiaries has been CCC corporates — traditionally the riskiest securities within the high yield and leveraged loan markets. CCC bonds and loans are the least credit-worthy within their respective markets and tend to perform poorly in periods of economic stress. With the economy so far avoiding recession, this segment of the market has posted significant gains year-to-date. CCC bonds and loans were up 11.0% and 8.3% through the first half, respectively, notably outperforming the broader high yield and leveraged loan indices, up 5.8% and 6.3%, and especially the highest-rated, or BB, segments of each market, up 4.5% and 4.6%, respectively.

On top of better-than-feared macroeconomic conditions, other factors have contributed to the junk rally in these markets. Leveraged credit balance sheets, even amongst the lowest-rated issuers, remain well positioned to weather headwinds. High yield issuer leverage is at a 10-year low while leveraged loan issuer leverage levels are at multi-year lows with interest coverage metrics slightly below all-time highs. Defaults are expected to increase, though only to the long-term average of the asset class, assuaging fears of a wave of defaults. Additionally, market technicals have helped fuel this rally as issuance has remained light, causing what supply is out there to benefit from a continual bid due to the elevated yield on these securities. All of this said, CCCs are still typically the riskiest part of the fixed income market, and continued performance hinges on the notoriously-unpredictable 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.

More Bang for Your… EM Local Currency?

Local currency emerging markets debt has been one of the standout fixed income asset classes this year. The J.P. Morgan GBI-EM Global Diversified Index — which tracks local currency bonds issued by emerging market governments — is up nearly 5% year-to-date.¹ This compares with the Bloomberg US Agg up 2.5% over the same period. Yields for the emerging markets index peaked in the fourth quarter of 2022 and remain near multi-year highs. Local currency EM debt could stand to benefit for three reasons: higher starting yields, proactive emerging markets central banks, and emerging versus developed GDP growth differentials.

  • Real yields in EM local currency debt are at attractive levels relative to history as well as relative to developed markets. As of June 26, GBI-EM yields were 6.28%. This compares with the U.S. 10-year Treasury yield at 3.72%. This yield differential compensates investors for the higher risk and positions them to benefit from yield compression if global macro headwinds start to abate.
  • Several EM countries such as Brazil and Mexico began their rate hiking cycles much sooner than their developed market counterparts. To the extent that positions these emerging central banks to cut policy rates sooner than the rest of the world, yield compression could benefit total asset class returns.
  • EM local currency debt should benefit from higher GDP growth than is expected in developed markets. Based on projections from the International Monetary Fund, EM economies are projected to grow approximately 4% per annum through 2024. This compares to advanced economies, where real GDP is projected to grow roughly 1.5% through 2024.

In sum, a number of tailwinds could continue to position EM local currency debt for strong relative returns as the year progresses.

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¹Through June 26, 2023

 

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.