Author: cvernon

Emerging Markets: Why Your Active Manager May Be Underperforming

2022 has been a challenging year for investors as both bonds and equities have produced substantial losses. This unusual environment is the product of a kaleidoscope of macro headwinds that have unfolded throughout the year. Against this backdrop, active emerging markets equity managers have generally failed to protect to the downside, with the average manager underperforming the index year to date through September.

There are several potential reasons why active managers have struggled in 2022. The Russian invasion of Ukraine in February caught most market participants off guard and resulted in substantial losses. China’s underperformance relative to the broader index has also served as a headwind for many investors. China is the largest exposure in the MSCI EM Index at 31% and has been challenging for managers to navigate this year given the country’s Zero-COVID Policy, property sector struggles, and negative investor sentiment amid geopolitical tensions. And lastly, the factor environment has dramatically shifted this year, with both Growth and Quality underperforming the broad benchmark. This newsletter further explores the impact that the underperformance of Quality has had on active manager returns this year.

Read > Emerging Markets: Why Your Active Manager May Be Underperforming

 

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.

Keeping the Lights On

While overall fundamentals for U.S. equity benchmarks have remained mostly resilient this year amid a painful repricing of risk assets, earnings growth has actually been concentrated in just a few areas of the market. The blended year-over-year earnings growth rate for the S&P 500 index during the third quarter of 2022 is 2.2% (with roughly half of companies reporting at the time of this writing), though only four sectors of the index have reported growth in earnings for the period. The Energy space stands out especially among these sectors, with its earnings up a massive 134% year-over-year amid strong demand for natural resources and continued commodity price inflation. Were the sector to be excluded from the S&P 500 index, earnings for the benchmark would be down 5.1% on a year-over-year basis, despite the fact that Energy accounts for less than 6.0% of the index. This trend is expected to continue into the fourth quarter, during which total earnings growth for the index is expected to be roughly 0.5%, with a decline of 3.5% excluding the Energy sector. For the full calendar year, S&P 500 index earnings are expected to grow 6.1% and decline 0.6% without Energy stocks.

Examining data below the index level is always important when assessing the health of equity markets and company fundamentals. To that point, simply looking at earnings figures for the S&P 500 index in aggregate obscures the fact that growth-oriented spaces of the benchmark like Communication Services and Information Technology, which are expected to post year-over-year earnings declines of 22.2% and 2.1% in the third quarter, respectively, are experiencing significant headwinds amid ongoing interest rate and inflationary pressures. These trends, however, are expected to reverse beginning in the second quarter of next year when, against tough compares, the Energy space is projected to become a detractor to overall earnings growth for the S&P 500 index while the rest of the benchmark grows earnings at a positive rate. With all of this in mind, investors should continue to employ a prudent approach to diversification across asset classes, geographies, and economic sectors, which will help position portfolios for success as market leadership rotates.

Print PDF > Keeping the Lights On

 

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.

Q3 2022 Market Insights Video

This video is a recording of a live webinar held October 27th by Marquette’s research team, featuring in-depth analysis of the third quarter of 2022 and risks and opportunities to monitor 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.

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For more information, questions, or feedback, please send us an email.

When Not to Quit

One of the oft-touted advantages of investing in private equity is the opportunity to buy in at a discount to public markets. This valuation discount, as measured by EV/EBITDA multiples, has persisted since 2012, widening to nearly 60% in 2020.¹ Since that peak, the discount has narrowed significantly as public market equities have sold off. While this may give some cause to pause, it is interesting to consider what transpired for investors between 2009 and 2012, on the heels of a near-meltdown of the financial system. With equities down sharply into 2009, the denominator effect boosted percentage allocations to private equity within investor portfolios. The instinctive reaction (and in some cases, forced action) may have been to abstain from new private equity investments beginning in 2009 so as not to exacerbate the over-allocation. This may sound familiar to private equity investors in 2022.

With hindsight being 20/20, these corrections to annual capital commitments ultimately resulted in an under-allocation to private equity, and thus underperforming portfolios over the next decade, as public markets and public market allocations snapped back. Furthermore, while private equity will likely not see the type of drawdown that public markets have seen, we do expect valuations to pull back, creating attractive entry points for managers with dry powder to deploy capital. While investors should be mindful of any liquidity constraints and maximum allocations to private markets, those that are able to remain steadfast in their annual commitment pacing schedules may find themselves in a better position once the public markets settle. Marquette believes that a successful private equity program is one that is consistently diversified by vintage year over time and highly selective in terms of manager partnerships.

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¹Pitchbook, as of June 30, 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.

The Forgotten Man

While there has been no shortage of recent headlines dissecting the sorry state of the economy and markets, the average U.S. consumer is occasionally overlooked in that narrative. Year-to-date, the Federal Reserve has increased the federal funds rate by 300bps. As the Fed raises rates, the prime rate, or rate set by commercial banks, increases in tandem. For the average Joe, this means any interest rates that are not fixed increase as well, including credit card rates and adjustable mortgage rates. Consumers in the market for a home or vehicle also face higher fixed rates on new loans. This year, rates have reached highs not seen in years: mortgage rates — currently at 6.9% for a 30-year fixed loan — have not been this high since 2002, auto rates at 5.5% are the highest in more than 10 years, and credit card rates — at 16.3% — have never been this high in a data series dating back to 1994.

In an environment where the average consumer is already paying higher prices for fuel, food, and other staples due to soaring inflation, increasing credit card and auto loan rates add to the burden. While consumer spending has so far been fairly resilient to rising prices, the underlying dynamics are not sustainable. According to a Forbes survey from June 2022,¹ 67% of Americans have dipped into their savings for spending, with 31% either depleting their savings or using a significant portion of it. With all eyes on U.S. GDP, it is important to remember that consumer spending makes up 70% of the economy, and the health of the average Joe is what will determine our path from here.

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¹Forbes Advisor OnePoll survey, June 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.

It’s Always Darkest Before the Dawn

Diversification has been said to be the only free lunch in investments. Since the inception of the Lehman/Barclays/Bloomberg Aggregate index,¹ there have been only 18 of 187 quarters (9.6% frequency) with negative returns in both the bond and equity markets, as measured by the Aggregate and S&P 500 indices, respectively. Comparable results are seen in the monthly data: Of 561 months, only 83 times did both the fixed income and equity markets deliver a negative total return (15.2% frequency). Over the last 45+ years, there has never been a calendar year that recorded negative returns in both indices, though that looks likely to change this year.

This newsletter analyzes 2022’s equity and bond market performance and the importance of diversification and discipline amid such negative momentum.

Read > It’s Always Darkest Before the Dawn

¹Actual data goes back to 1986; backfilled data back to 1976

 

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.

Fighting Fire with Oil

Lower oil prices, primarily via lower gasoline prices, were a key contributor to headline CPI moving off peak in July and August. Since late September, however, oil and gasoline prices have started to rise again. In early October, OPEC+ — comprised of the 13 OPEC members and 10 additional major oil-exporting countries, including Russia — agreed to steep oil production cuts, decreasing supply in an already stressed market. The total production cut is estimated to be around 2 million barrels per day (bpd), approximately 2% of global supply and the biggest production cut since the start of the COVID pandemic.

The move is expected to prop oil prices back up — as similar production cuts have done historically — after the commodity had fallen considerably over the last three months amid fears of a global recession, the stronger dollar, and higher interest rates. Higher energy prices would weigh on European countries, which are more heavily reliant on Russian oil and already facing recession, as well as the U.S. consumer, with oil accounting for roughly half of the retail price of gasoline. Earlier this year Federal Reserve Chair Jerome Powell quantified the impact of higher oil prices, noting every $10 per barrel increase in the price of crude raises inflation by 0.2% and sets back economic growth by 0.1%. The decision also adds to already heightened geopolitical tensions, with President Biden pursuing consequences for Saudi Arabia, the de facto leader of OPEC, following the announcement. This evolving situation is one more unknown variable to monitor as we look for macroeconomic clarity.

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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.

A Tale of Two Markets

Leveraged loans have been the asset class of choice this year, with fixed income investors drawn to the floating-rate nature of these securities in a rising rate environment. Investors have piled into the asset class since the beginning of 2021 at the expense of other segments of the market, including high yield bonds. High yield bonds are typically the first to show signs of deterioration in stressed credit markets and tend to be subject to more volatile trading patterns. Below the surface, however, the overall quality of the loan market has deteriorated relative to high yield and changes at the issuer level have impacted the perceived safety of the asset class. Investors who have flocked to loans may need to pause and consider that it could be the loan market — not high yield — that signals trouble on the horizon.

This newsletter provides background on leveraged loans and analyzes historical and recent performance and flows, shifts in quality, and seniority and covenants.

Read > A Tale of Two Markets

 

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.

Inflation: Expectations Matter

The announcement of another 75 basis point rate hike at last week’s FOMC meeting reaffirmed the Federal Reserve’s unwavering commitment to reducing inflation. One of the key variables the Fed watches to help it determine the path of rates is expected inflation. Inflation can become a self-fulfilling prophecy if consumers start pricing future inflation into their decision-making and businesses start making anticipatory adjustments to their prices and behavior. To combat this, the Fed strives to anchor expectations around a 2% target inflation rate. When long-term inflation forecasts deviate from that 2% target it means inflation expectations are not well-anchored, i.e., people believe that a short-term rise in inflation could lead to higher price levels longer-term.

Inflation expectations have moved further away from the 2% target over the course of 2022, something the Fed recognizes as a potential roadblock in navigating the current inflationary environment. Indeed, Fed Chair Jerome Powell stressed the importance of “expeditiously continuing to raise rates” to “ensure that longer-term inflation expectations remain well-anchored” at the June FOMC press conference.¹ With higher-than-anticipated August CPI figures, however — headline inflation of 8.3% and core inflation that reaccelerated to 6.3% — inflation expectations may remain higher for longer. Headline inflation is moving in the right direction, but core inflation, which remains well above Fed targets, tends to be stickier and may further complicate the Fed’s task. While there are no crystal balls, longer-term inflation expectations will continue to bear monitoring as investors search for potential indicators of a market bottom.

Print PDF > Inflation: Expectations Matter

¹ Lee, J., Powell, T., & Wessel, D. (2022, June 27). What are inflation expectations? Why do they matter? The Brookings Institute. Retrieved September 28, 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.

Livestream Videos: 2022 Investment Symposium

The presentations by our research team from Marquette’s 2022 Investment Symposium livestream on September 23rd are now available. Please feel free to reach out to any of the presenters should you have any questions.

View each talk in the player above — use the upper-right list icon to access a specific presentation.

 

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. Past performance is not indicative of future results. For full disclosure information, please refer to the end of each presentation. Marquette is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Marquette including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request.