Author: cvernon

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.

Down to the Wire: An Update on the 2023 U.S. Debt Ceiling Crisis

In February of this year, Marquette published a Perspectives piece entitled Is the Sky Falling? that detailed the history of the United States debt ceiling, as well as the early innings of negotiations surrounding its possible increase or suspension given the fact that the $31.4 trillion limit was reached on January 19. In the months since, the Treasury Department has been forced to resort to “extraordinary measures” in order to prevent the U.S. from defaulting on its obligations, including suspending sales of state and local government series Treasury securities. Those measures, however, will likely be exhausted in the very near future according to the nonpartisan Congressional Budget Office (perhaps as early as June), at which point the federal government will ultimately be unable to pay its obligations fully and, as a result, have to delay making payments for some activities and/or default on its debt obligations. This is commonly referred to as the x-date. It is worth pointing out that a number of large Wall Street firms have brought their forecasts of this date forward in recent days.

This newsletter analyzes potential repercussions of a U.S. default and options for a resolution of the debt limit impasse in Congress.

Read > Down to the Wire: An Update on the 2023 U.S. Debt Ceiling Crisis

 

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.

The Eagle Has Fallen

When First Republic Bank’s 84 branches opened Monday morning, they belonged to the since-failed bank in signage alone after a tumultuous several weeks marked by depositor flight and a portfolio of loans that had dropped substantially in value amid rising interest rates. Three of the four largest U.S. bank failures have occurred in the past two months, with First Republic, now the second-largest bank to fail in U.S. history, behind only the 2008 collapse of Washington Mutual, the latest.

Despite an initial $30 billion lifeline from the U.S.’s largest banks in the wake of the Silicon Valley Bank (SVB) collapse, First Republic went on to lose more than $100 billion in deposits during March. Regulators took control of First Republic and oversaw a sale to JPMorgan Chase on Monday morning. JPMorgan, already the nation’s largest bank, will take on all $92 billion of deposits remaining at First Republic and “substantially all” of its assets, including $173 billion of loans and approximately $30 billion of securities. As part of the agreement, the FDIC will cover some of First Republic’s loan losses and provide JPMorgan with $50 billion in financing, with the deal estimated to cost the FDIC roughly $13 billion. JPMorgan will also return the $25 billion in uninsured deposits its large peers deposited into First Republic as part of the Treasury’s March plan to prop up the bank.

While the U.S. banking system is not yet out of the woods, the demise of First Republic, another regional lender with a concentrated depositor base and an investment portfolio that was overly exposed to rising rates, does not come as a surprise and does not change the contagion narrative. Markets have remained calm with generally solid earnings reports from other regional banks and ongoing support from the FDIC. While overall macro uncertainty remains, the risk of a broader breakdown in the U.S. banking system does not seem to be an imminent threat.

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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.

Unleashing the Power of AI

The launch of ChatGPT — a chatbot technology that can mimic human-like understanding and generate well-crafted, conversational responses — marks a pivotal moment for artificial intelligence (AI). Similar to the mainframe era of the 1950s, the rise of PCs in the 1980s and 1990s, and more recently the mobile and cloud era, AI could become the next technology platform that drives significant productivity gains and transforms our world.

The advancement of AI systems has resulted in increased adoption of the technology by various organizations, including businesses and governments. While the integration of AI within the economy brings excitement, it also raises questions about its impact on productivity, the potential displacement of human workers, and whether it will be used ethically. While limited adoption prevents us from being able to fully measure the effects AI could have on the workplace, the chart above summarizes the cost savings and revenue benefits noted by firms that have implemented AI within their organizations. On the cost side, the functions most widely benefiting from AI adoption were supply chain management (52%), service operations (45%), strategy and corporate finance (43%), and risk (43%). On the revenue side, respondents broadly saw increases in marketing and sales (70%), product and/or service development (70%), and strategy and corporate finance (65%). While there are fair criticisms of AI, the potential benefits are clear. As we continue to navigate the rapidly evolving landscape of AI, we must work to ensure that this powerful technology is harnessed in a way that benefits both individuals and society as a whole. By doing so, we can unlock the full potential of AI as the next transformative technology platform.

Not Summer Yet

It seems only fitting that I write this as snow is falling the day after it was a beautiful 80° and sunny; a harsh reminder that our Midwest summer is still a ways off. All in all, it was a mild winter by Chicago standards with only a few days of brutal cold and even fewer with measurable snow. Nonetheless, the freedom to comfortably wear shorts and soak up the sun last weekend was hopefully a preview of another glorious summer to come. But we’re not there yet.

The same could be said for capital markets. For anyone who read our market preview, the common narrative was “wait for the second half of the year” — which naturally coincides with summer in the northern hemisphere — please forgive me for taking advantage of the low-hanging parallel. Running with the analogy laid out above, though, the parallels are easy. If an investor hibernated during the first quarter and awoke to what markets delivered for returns, the results would be pleasing. Almost every major index across stocks and bonds was positive, with growth stocks roaring back. However, the temptation to focus exclusively on returns without regard for the environment would not only be irresponsible but a genesis for unhealthy expectations.

In this edition:

  • The murky economic outlook:
    • Regional banking crisis recap
    • Labor market update
    • Recession probability
  • Fixed income confidence
  • Equities’ surprising returns
  • Hedge fund opportunities
  • Real estate uncertainty

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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.

1Q 2023 Market Insights Video

This video is a recording of a live webinar held April 20 by Marquette’s research team, featuring in-depth analysis of the first quarter of 2023 and themes we’ll be monitoring in the coming months.

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.

GICS Reclassifies Away From Tech, Again

The Global Industry Classification Standards (GICS) were established in 1999 by MSCI and S&P Dow Jones Indices to categorize publicly-traded equities. Broadly accepted across the industry, the GICS classification system undergoes an annual review, which has resulted in only 12 updates to the classification system since inception. These updates can have significant impacts on the underlying performance drivers of sectors as well as the concentration of sector-specific indices. The Technology sector has been meaningfully impacted by the two most recent updates. In 2018, GICS broke the Technology sector up to create the Communication Services sector, which includes FAANG stocks Meta, Netflix, and Alphabet. While the update was less consequential this year, it again relocated some of the Tech sector’s largest constituents, increasing its concentration to new highs.

Effective after the close on March 17, 2023, 14 firms were reclassified, impacting five GICS sectors. Notably, Visa and Mastercard, previously two of the five largest Technology companies, along with PayPal, Fiserv, and others, were reclassified as Financials. As a result, the Financials sector is now more exposed to growth factors, including, on the margin, valuation risk from rising rates. The Technology sector, conversely, has become even more concentrated in two mega-cap stocks — Apple and Microsoft. The resultant weighting and concentration changes will impact active manager attribution metrics as well as the exposures achieved via sector-specific ETFs and are important for investors to be aware of. Lastly, while not implemented this year, another key proposal discussed concerned renewable energy companies. These stocks are generally categorized within the Energy and Utilities sectors, and future changes could represent another meaningful shift in GICS classifications.

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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.

Power Concentrated in the Hands of a Few

2022, marred by macro uncertainty and aggressive rate hikes, marked the worst year for the S&P 500 since the Global Financial Crisis. Given the sensitivity of growth stocks to increasing rates, technology-related equities underperformed and significantly detracted from the S&P 500 given the group’s large index weighting. In the first quarter, however, technology rebounded strongly — with the Information Technology sector up almost 22% and Communication Services up 20.5%, relative to the broad index +7.5%.

FAANG, comprised of Meta (formerly Facebook), Apple, Amazon, Netflix, and Alphabet (Google), is a well-known group of five large tech stocks. Although only five companies, the group contributes significantly to the performance of the S&P 500, positively or negatively, given the aggregate market capitalization of the stocks. The group reached its largest combined weighting in the index — 19.9% — at the height of COVID in August 2020, before retreating to a still-outsized 13.4% in early January 2023. Amid tech’s first quarter rally, FAANG alone drove almost half of the S&P’s 7.5% return and ended the quarter at 15.9% of the index. While there are many different macro and micro factors at play, the path of these mega-cap tech stocks will continue to be a key determinant of index 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.

Direct Lending is Eating the World

In 2011, Marc Andreessen famously proclaimed that software is eating the world, meaning more and more industries and businesses are relying on software for their operations. This statement has since proved incredibly accurate, as evidenced by our daily dependence on software applications. What was said about software over a decade ago can be said about direct lending today, supported by the growing percentage of companies that rely on direct lenders or private credit managers to finance their operations. Direct lending is a form of financing where borrowers receive loans directly from lenders, without intermediaries such as banks or financial institutions. In this type of lending, borrowers can access funds more quickly and with more flexibility than via traditional lending channels. The terms and conditions of the loans are typically negotiated directly between the borrower and lender, allowing for greater customization and potentially more favorable rates for borrowers.

A number of different supply and demand tailwinds have contributed to the growth of direct lending, including a shift in banking practices post-GFC, including Dodd-Frank legislation and Basel III, the growth of private equity and its preference for direct lending financing, and the investment premiums inherent to the asset class. From here, Marquette expects direct lending to continue to grow, providing attractive investment opportunities for clients. The fallout from the failure of Silicon Valley Bank and the issues facing regional banks may continue to force small and mid-sized borrowers into the arms of private credit lenders. Private equity managers, who tend to prefer financing provided by non-bank institutions over those influenced by the mercurial nature of traditional capital markets as well as the certainty of execution offered by direct lenders, are armed with a record nearly $2 trillion in dry powder.¹ And lastly, we believe institutional investors will continue to allocate to direct lenders and private credit given the attractive risk-adjusted returns and portfolio diversification benefits the asset class provides, particularly in today’s challenging market environment.

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¹Thomas, Dylan. “Global Private Equity Dry Powder Approaches $2 Trillion.” S&P Global, December 21, 2022.

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.