cvernon, Author at Marquette Associates

The Tides of Trade

As globalization has slowed in recent years, geopolitical and geoeconomic risks have reemerged across global markets. Amid disrupted shipping lanes, upended supply chains, and economic sanctions, all markets — developed or emerging — are vulnerable to some degree. While these risks are nearly impossible to eliminate, they can be managed, and efforts to minimize exposures seem to be driving a trend of regionalization across markets. To help visualize this trend, this week’s chart highlights economies (green) that may benefit from increasing regionalization based on three core constraints.

First, direct geographic access to primary shipping lanes. The OECD estimates that around 90% of all traded goods travel by sea. This suggests that countries with both direct access to shipping lanes (dashed lines) and fewer choke point exposures (blue circles) have competitive advantages over those without access or those vulnerable to bottlenecks. Second, industrial capability. Countries with greater material inputs, labor pools, and facilities inherently have a comparative advantage over those without. Third, foreign exchange purchasing power. Relative to the U.S. dollar or the euro, countries utilizing weak alternative currencies have a comparative advantage in attracting investment and in production costs. This textbook dynamic heavily suggests that denominating costs in relatively weak currencies may be the strongest differentiator between otherwise equal markets.

While there are certainly many other dynamics and constraints at play including multilateral trade agreements and demographics, direct access to shipping lanes, industrial capability, and foreign exchange rates offer three core measures to assess and expand on.

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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.

Bear Scare?

The S&P 500 index — up 9.6% on a year-to-date basis through May — recently entered into a technical bull market, mostly due to a resurgence of growth-oriented areas of the U.S. equity space like Information Technology and Communication Services. At the same time, data related to futures contracts on the index could indicate extremely bearish sentiment on the part of hedge funds and speculators. As of the end of last month, these investors and traders were net short more than 400,000 E-mini S&P 500 futures contracts — the largest such position since Bloomberg started tracking the metric in the early 2000s.

There are several potential explanations for this phenomenon. First, investors may believe the recent run of the S&P 500 is not reflective of the current economic climate and overly dependent on a small basket of securities. To that point, the year-to-date return of the benchmark would actually be negative through the end of May excluding just seven high-performing index constituents (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla). This type of sentiment could lead the index to retract meaningfully should one of these companies stumble. However, this same group of investors has maintained net long positions on similar NASDAQ futures contracts in recent time, which does not support the notion that investors are inordinately bearish on these stocks. Dynamics within S&P 500 futures markets could also be a reflection of hedge funds and other investors having a significant number of high-conviction long positions with fewer alpha short ideas, which could necessitate hedging to lower net exposures and would actually be a bullish indicator. Whatever the reason for this positioning, it is important for investors to remember that no one variable is sufficient when it comes to explaining overall market machinations. Marquette will continue to monitor equity and futures markets and advise clients accordingly based on our findings.

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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.

Out of Office: Where Real Estate Markets Stand Today

Commercial real estate is increasingly being dubbed the next shoe to drop as markets assess the fallout from the regional banking turmoil. Amid higher rates and tighter credit conditions, private real estate is now facing the same repricing dynamics that hit the equity and bond markets last year, and while further write downs are expected, the headlines are likely overblown. Fundamental and financing issues are largely concentrated within the office sector — which will likely see a correction over a longer time period but be manageable for most core real estate funds — while other sectors, including industrial and multifamily, are actually set to benefit over the next few years.

This newsletter analyzes the current commercial real estate investment landscape including valuations, fundamentals, debt markets, and private real estate returns.

Read > Out of Office: Where Real Estate Markets Stand Today

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.

If They Build It, Buyers Will Come

Stalled sale processes have become the norm in the private equity market due to several factors, including a mismatch between buyer and seller expectations around price and interest rates. Private equity owners have been forced to pivot from the traditional leveraged buyout model, now taking on less debt as they look to create an asset that will be attractive to potential acquirers. One way to do this is to build a better business, including via add-on acquisitions, which have been growing as a proportion of buyout transactions for the last several years. In 2008, add-ons accounted for 50% of deal volume. In the first quarter of 2023, that amount was close to 80%.

Add-ons offer several benefits to private equity firms. First, they are an efficient way to expand and diversify a business’s geographical footprint, customer base, and product offering. Second, add-on acquisitions tend to be smaller businesses, and thus typically less expensive than larger platform investments, allowing the private equity manager to average down the total cost of the combined investment. Third, add-ons tend to be accretive, increasing revenue, EBITDA, and EBITDA margins. Taken together, with proper integration, the end business can become a more attractive acquisition target for both large private equity firms and corporations.

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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.

Will the Summer Heat Make the Market Sweat?

With June and the Treasury’s estimated X-date quickly approaching, the debt ceiling issue came to a head over the weekend. While the spending deal reached between President Biden and House Speaker McCarthy still needs to be approved by Congress, it is an important milestone in the U.S. avoiding its first-ever default. While that worst-case scenario would have had catastrophic impacts on the economy, markets — as measured by the CBOE Volatility Index (VIX), known as the fear index — remained relatively calm. The VIX is measured using option activity and gauges the market’s appetite for volatility. Usually, the market and the VIX are negatively correlated, meaning the VIX increases as markets go down. As shown in the above chart, during times of stress, including debt ceiling uncertainty, the VIX tends to be more dynamic, with sharper jumps and falls. With markets having spent the last year heavily focused on inflation, labor markets, and the path of interest rates, which now seem at least near the peak, debt ceiling negotiations were overall taken in stride by equity markets. It is generally accepted that a VIX level above 30 indicates more investor uncertainty, which we have seen reached multiple times over the last few years, though during the month of May, the VIX peaked around 20. As noted, while the House and Senate still need to consider the bill this week, the most likely outcome is the debt ceiling bill is signed into law before the U.S. would have had to default on its debt obligations, removing one more headwind for markets this year.

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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.

Secondaries Not So Secondary Anymore

Secondary market volume has grown from $37 billion in 2016 to a high of $132 billion in 2021. Despite macroeconomic instability, 2022 was still the second-highest year on record at $108 billion. The secondary market was initially dominated by LPs in need of liquidity, selling at a significant discount. Today, the secondary market is more institutionalized and the reasons for selling on the secondary market have expanded — only 10% of sellers are selling for liquidity reasons, while 64% of deals are done for portfolio management. The increase in GP-led transactions has also added to secondary market volume.

As the secondary market has grown significantly, the space has become increasingly undercapitalized. As shown in the top chart above, the ratio of dry powder to deal volume has steadily declined over the last several years, excluding 2020 when COVID hit deal volume. There is estimated to be only about one year of dry powder available to support the growing supply in the secondary market, well below the ratio in the buyout market. The limited amount of capital relative to secondary market volume has resulted in deals trading at significant discounts, as shown in the lower chart. Buyers can be more selective and have the opportunity to purchase high quality assets at a discount. From here, while there are still challenges given the level of macro uncertainty, there is a clear opportunity for investors active in the secondary market.

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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.

Raise the Roof

Investor questions continue to mount as the U.S. nears the Treasury’s estimated debt ceiling “X-date” of June 1. While there are some signs that progress is being made between President Biden and Republican leaders, the two sides still seem far apart on a deal to raise or suspend the country’s debt limit. Failure to do so would result in the U.S. defaulting on its debt for the first time and would have significant economic consequences. According to the Council of Economic Advisors, even a brief default could lead to the loss of half a million jobs, a 0.6% contraction in real GDP, and a 0.3% increase in the unemployment rate. An extended default would be even more dire, with a forecasted loss of 8.3 million jobs, a 6.1% reduction in real GDP, and a 5% increase in the unemployment rate.¹

As shown in this week’s chart, raising or suspending the debt ceiling has become a fairly common occurrence over the last several years, though the process can be political, contentious, and last minute. This week, amid continued talks between staff, President Biden and Speaker McCarthy, along with other congressional leaders, held a meeting both sides described as “productive.” Both parties are seeking a deal to prevent default, though agreeing on the details — future spending cuts, federal aid work requirements, and clawing back unspent COVID funds, among other Republican demands — remains a delicate process. Markets are closely following the debt-ceiling developments and, while the severity of consequences from a default will hopefully lead to a timely resolution, both equity and fixed income should brace for ongoing volatility from here.

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¹Council of Economic Analysis, The Potential Economic Impacts of Various Debt Ceiling Scenarios

It’s Getting Hot in Here

If global temperatures rise more than 1.5° Celsius the planet and its inhabitants could face severe consequences as a result of climate change. In 2022 — using temperatures from 1951–1980 as a baseline — the average global temperature rise was 1.4° Celsius, pushing the planet close to its tipping point. We are already experiencing more frequent and severe heatwaves, droughts, floods, and storms as well as rising sea levels and melting ice sheets. In fact, 2015–2022 were eight of the warmest years on record. The effects of rising temperatures are impacting people, ecosystems, and economies around the world and will only intensify in the coming decades unless we can bend the emissions curve and stabilize global temperatures.

To do so, the Intergovernmental Panel on Climate Change — a scientific body established by the United Nations and comprised of hundreds of climate scientists — has urged immediate, rapid, and large-scale reductions in greenhouse gas emissions. This would require systemic changes and large investments across all sectors of the economy, especially within energy, agriculture, transportation, heavy industry, and buildings.

For investors who are so inclined, there are a variety of methods to assist the cause, particularly for reducing portfolio-level climate risks as well as leveraging assets to foster society wide-decarbonization that aligns with a net zero future. Approaches can include engaging high-emitting companies to set science-based emissions reduction targets and create climate transition plans, increasing investments in “climate solutions” such as renewable energy infrastructure, assessing portfolios and assets for exposures to physical and transition-related climate risks, and subjecting a portfolio to climate-related stress tests and scenario analysis. Of course, all of these approaches involve trade-offs between risk, return, and impact; investors will ultimately have to decide the appropriate balance among these principles based upon overall portfolio and organizational goals.

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Source: See IMF data on annual surface temperature changes

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.

¹Council of Economic Analysis, The Potential Economic Impacts of Various Debt Ceiling Scenarios

Source: See IMF data on annual surface temperature changes

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