cvernon, Author at Marquette Associates

China: Regulators, Mount Up!

Over the last year, the Chinese government has enacted a series of new regulations targeting several domestic industries including finance, health care, and real estate. In general, the policies that have garnered the most attention are those directed at Chinese technology companies and range from restrictions on the use of advertising algorithms targeting consumers to limitations on the amount of time children are permitted to spend gaming online. As displayed in this week’s chart, these new regulations, the majority of which have been codified in the last few months, have shaken equity investors and led to a significant drop in the MSCI China Index. Specifically, the benchmark lost roughly 18.2% in the third quarter of this year alone as investors scrambled to react to the new regulatory environment in China and its ramifications.

Recent efforts of Chinese government authorities mark a sea change in the country’s social and economic goals and the ways in which those goals are pursued. For decades, China was largely comfortable with encouraging economic development at all costs, however, it seems officials in Beijing have now shifted their focus to pragmatic, quality growth with an emphasis on both prosperity and sustainability ahead of National Party Congress elections in 2022. It is worth mentioning that the developments of the last several months do not constitute a new experience for Chinese companies or investors. China’s government has a history of stepping in after periods of unchecked economic growth, with the targeting of the gaming industry in 2018 serving as a recent example. That said, the significant volume of policy changes that have been enacted in the last year has caught many investors by surprise, which has led to the drawdown in Chinese equity indices described earlier.

While this type of volatility can be difficult to stomach for most market participants, it can also allow investors the chance to purchase securities at more attractive valuations. To that point, many portfolio managers with a focus on Asian markets have expressed an interest in increasing their exposure to Chinese equities over the coming months given the dislocations that have potentially arisen as a result of the recent pullback, though most still expect market fluctuations to continue in the near term. Investors with exposure to Chinese markets should remain disciplined in their approach and cognizant of both the risks and potential opportunities stemming from the current situation.

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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.

Is the 60/40 Portfolio Dead Forever?

Model portfolios — or those which adhere to a specific set of guidelines surrounding asset allocation and rebalancing — are often utilized by investors because of their rules-based nature, which eliminates the need for constant monitoring. One such model is the “60/40 portfolio,” which consists of a 60% allocation to diversified equities and a 40% allocation to a broad basket of fixed income securities. Due to the imperfect correlation between stock and bond returns, the 60/40 model has enjoyed decades of success at both providing its users with strong absolute returns and suitable protection during market drawdowns. Additionally, there is an intuitive attraction of the 60/40 portfolio due to its relative simplicity of holding just stocks and bonds as its underlying investments. That said, skepticism abounds regarding the model’s viability going forward in light of the current interest rate environment and low forecasted equity returns, particularly for those investors like endowments and foundations with specified spending requirements.

The aim of this paper is to assess the effectiveness of the 60/40 model going forward and provide guidance to investors whose spending targets require an expected return that is consistent with the historical performance of 60/40 portfolios, which has typically hovered around 8%.

Read > Is the 60/40 Portfolio Dead Forever?

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.

Can Equities Provide a Hedge Against Inflation?

Inflation has been at the forefront of the minds of many investors in recent months as higher price levels have resulted from economic reopenings and supply chain dislocations across the globe. For instance, the consumer price index — which measures the cost of a basket of goods purchased for consumption by urban households in the United States — rose 0.4% during the month of September, coming in slightly above expectations and translating to a 5.4% jump on a year-over-year basis. Notably, the yearly spike in the CPI is the most significant in over a decade. While the debate on whether current inflation levels are transitory in nature or pose a longer-term threat to the economic health of the world is of great importance and will clearly continue for some time, the question of how investors can mitigate risks stemming from price level increases through the use of different asset classes is also worth exploring.

Real assets, including commodities and real estate, are known to be robust inflation hedges due to the fact that input costs, along with property values and rental income streams, tend to rise in tandem with overall price levels. The case for equities as a guard against higher inflation can be argued by pointing out that revenues and earnings of companies with inelastic demand for their goods and services may also rise along with inflation, due to the fact that firms with strong customer bases are able to pass on price increases to end consumers with relative ease. Generally speaking, this argument has held true in recent decades, as U.S. equity indices have tended to appreciate during inflationary periods going back to the late 1970s. Specifically, and as displayed in this week’s chart, equities have demonstrated hedge-like performance characteristics during periods of moderate inflation (CPI increases of 1–10%) and have largely generated positive real returns during those time frames. It is important to note that recent performance trends are likely aberrational, as equity indices have bounced back quite strongly after pandemic-induced troughs that occurred around the same time as the beginning of the current inflationary period. During times of significant inflation (CPI increases of 10% and above), equity performance has been more mixed, with returns of various style indices usually positive (though often coming in below the prevailing inflation rate). Regardless of whether or not the current inflationary regime is transient or long-term in nature, the data clearly indicate that equities can play a role in helping to lessen the impact of price level increases on the purchasing power of investment portfolios. Prudence and diversification across the asset class spectrum can also help investors endure elevated inflation levels that may persist into the near future.

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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.

The Holiday Party Guest List

Though the leaves have only started to change color, holiday party planning is in full swing. And while ample food and drink are necessary inputs for any type of holiday celebration, it’s the guests who ultimately make the party…or break it. In a way, this dynamic isn’t all that different from the markets — at any given time, the prevailing economic and market conditions will dictate investor returns. Given this analogy, we thought it could be fun to take a survey of the “attendees” in the current market environment and see if we can draw a connection with real-life examples along with what each guest means to the success of the party…and investor. Oh, and one caveat as we go — similar to actual party planning, sometimes we don’t want to invite someone, but we have to invite this person; circling back to the financial markets, we can’t control what forces exist in the markets, but we will do our best to determine those that will be merry and those that will not. Confused? Don’t worry, I am too, but we’ll figure this as we go through the invite list.

Highlights from this edition:

The Delta variant’s impact
Consumer spending
The credit and equity markets
The coming Federal Reserve taper
Earnings peak for equities
Labor market shortages
Commodity returns
Inflation concerns
The Evergrande debt crisis

Read > The Holiday Party Guest List

Watch our Q3 2021 Market Insights Video for an in-depth analysis of the third quarter’s performance by Marquette’s research team.

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 2021 Market Insights Video

This video features an in-depth analysis of the third quarter’s performance by Marquette’s research team, reviewing general themes from the quarter and risks and opportunities to monitor through the end 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.

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Back So Soon?

Over the past decade, U.S. private equity firms have returned to market sooner and sooner. The fundraising environment for these organizations remains attractive due in large part to strong performance and the persistent gap between private and public market valuations. Furthermore, the current robust dealmaking climate, both in terms of platform investments being made and potential add-on activity throughout the period during which portfolio companies are held, means that managers are both investing their funds more quickly and holding additional capital in reserve. These factors have resulted in more frequent fundraises.

This dynamic of accelerated capital deployment introduces incremental risks for private equity investors, including increased vintage year risk with the potential for greater return dispersion throughout an economic cycle. Moreover, more frequent fundraising could put stress on a private equity firm’s team, both with respect to the investment professionals leading deals and the operational resources executing value creation plans. Finally, more frequent fundraising, if not accompanied by shorter hold periods, will require private equity firms to return to the market more regularly with less realized performance, as potential gains stemming from recently deployed capital will be largely unrealized.

The trend of private equity firms deploying capital more quickly and returning to market sooner puts pressure on limited partners to continuously think strategically about portfolio construction. Thoughtful, consistent investment pacing that is supported by a robust go-forward pipeline of compelling fund opportunities will help to mitigate many of the aforementioned risks. Additionally, a deliberate approach will allow limited partners to prioritize opportunities in which they have the most conviction, gain access to those funds, and capture the outsized return potential of private equity investments.

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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.

The Impact of the Delta Variant on the U.S. Economic Reopening

Thanks to a rollout of effective vaccines at the beginning of 2021, daily new cases of COVID-19 in the United States steadily declined from roughly 250,000 in January to 12,000 in July. That said, daily new infections then quickly reverted to over 80,000 in about one month. This uptick was mostly due to the outbreak of the Delta variant, a more contagious form of SARS-CoV-2 which now accounts for nearly all new cases in the U.S. With the nation now better prepared to combat the strain using both vaccinations and regulations including mask mandates, new daily cases of the Delta variant have since declined to around 54,000 in recent days. This week’s chart assesses the impact of the Delta variant on the domestic economic reopening by examining travel and dining trends using datasets from OpenTable — an online/mobile restaurant reservation service — and the Transportation Security Administration. To measure the scale of the economic slowdown caused by the coronavirus pandemic, the chart shows the percentage change in the number of restaurant diners and air travelers compared to pre-pandemic levels in 2019 (e.g., 10/10/21 vs. 10/10/19). Seated diners are individuals who dined at a sample of restaurants in the United States using OpenTable via online reservations, phone reservations, and walk-ins. Air travelers are those individuals who were screened by TSA agents at security checkpoints within airports in the U.S.

As can be inferred from the chart, both datasets clearly indicate a complete economic shutdown in March of 2020 following the onset of the pandemic. This was followed by an economic reopening several months later, represented by consistent upward trends in both data series leading up to June of 2021. When the Delta variant started circulating in July, seated diners and air travelers decreased by 20% and 30% in the following periods, respectively (compared to 2019 levels), marking a shift in the trends that had been exhibited in previous months. That said, both series picked back up shortly thereafter, reaching -4.8% and -18.4% in October, respectively (again, when compared to levels recorded in 2019), as daily new cases of the Delta variant have subsided. All of this is to say that the impact of the Delta variant on the U.S. economy pales in comparison to that of the original COVID-19 outbreak, as individuals and businesses alike seem better equipped to balance protection against the virus with economic activity. If daily new cases of the Delta variant continue to decline and the vaccination rate in the United States improves, the data indicate that a full economic reopening could take place in the foreseeable future.

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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.

Commodities: The Full Story

The first three quarters of 2021 have seen positive performance from a variety of asset classes ranging from U.S. and international equities to bank loans, which have exhibited returns close to their 10-year averages. However, one segment of the market that has experienced strong, aberrational performance on a year-to-date basis is commodities. Through the end of September, the S&P GSCI, a broad-based index that includes futures contracts on physical commodities, has returned 38.3% since the beginning of the year, far in excess of its long-term average. Recent performance for the asset class has largely been driven by surging demand for raw materials amid economic reopenings, coupled with pandemic-fueled supply chain dislocations, which caused the prices of many commodities to skyrocket. For instance, both lumber and copper experienced all-time highs during the first half of 2021, while agricultural commodity prices reached a 7-year peak earlier in the year as a result of strong demand for meat. Oil consumption also hit a seasonally adjusted high in July of 2021, which led to a 50% increase in the price of crude futures from the year prior. As the global economy continues to reopen, labor shortages, supply chain bottlenecks, and strong demand for raw materials will likely persist, meaning that positive performance from commodities may continue into 2022.

As investors assess the prospects of the commodities space going forward, it is important to keep historical context in mind. To that point, our chart this week examines both the 10-year annualized returns and standard deviations for eleven different asset classes to better understand the long-term performance profiles of each one. As displayed in the chart, the real estate space, as measured by the NCREIF index, has posted strong returns in the last decade as well as a low standard deviation (though the illiquid nature of the asset class may lead to some volatility smoothing). Equities have tended to exhibit higher levels of return and standard deviation than fixed income, while Small Cap indices have notched both higher returns and volatility than their larger peers across the geography spectrum. Interestingly, each of the asset classes profiled in the chart has yielded positive performance in the last 10 years with the exception of one: commodities. For the 10-year period ending September 30^th, 2021, the S&P GSCI posted an annualized return of -4.8%. Additionally, the index has experienced an annualized standard deviation of 21.4% during that same period, which is again the most extreme of any of the asset classes in the chart above. Put simply, commodities have exhibited both the lowest returns and highest levels of risk of any major asset class in the last 10 years. As investors assess recent strong performance from the space and look to the future, it is crucial to avoid recency bias and keep history in mind. Prudence dictates a diversified approach to asset allocation in order to hedge uncertainty and achieve optimal risk-adjusted returns.

Print PDF > Commodities: The Full Story

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.

China: Evergrande and Another Move Down

In August we released our newsletter China: From Leader to Laggard, in which we reviewed how China transformed from a top-performing country to a bottom-performing country between 2020 and 2021. We noted that increased regulation was a key reason for this change as new government policies have spooked investors. We highlighted that China has gone through these periods of regulatory change in the past and opined that the market would continue to be jittery over the next six to twelve months before recalibrating to the new environment.

Since then, Chinese equities have continued to fall as global investors focused their attention on Evergrande Group (Evergrande), a Chinese property developer. In this newsletter, we provide a synopsis of the Evergrande story and discuss the market risks.

Read > China: Evergrande and Another Move Down

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.

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