cvernon, Author at Marquette Associates

Fundamental Disconnect: Understanding the Nature and Impact of Recent Frenzied Trading

In recent years, most major brokerage firms have participated in a “race to the bottom” with respect to commissions on equity purchases and sales, as well as options trades. This phenomenon, in tandem with the rise in popularity of app-based trading platforms like Robinhood, has afforded retail investors greater access to capital markets. While the democratization of the investment world is beneficial in many respects, it can also lead to irrational behavior and a decoupling of asset prices and fundamentals.

In this newsletter, we analyze the recent frenzied trading activity that has grabbed the headlines, including a summary of what has happened so far and a look at the impact and implications of this behavior.

Read > Fundamental Disconnect: Understanding the Nature and Impact of Recent Frenzied Trading

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.

Record Flows: Another Headwind for Active Management

Fund flows, which measure the net movement of assets into and out of investment vehicles like mutual funds and exchange-traded funds (“ETFs”), can provide a window into investor behavior and are often an indication of investor sentiment. Strong inflows can indicate optimism within a particular asset class or investment style, while outflows may suggest pessimism on the part of investors. That said, a robust market is not always supported by investor inflows, as underlying fund flows and market index performance frequently deviate. This phenomenon was on display in 2020 and merits further evaluation.

The S&P 500 index posted a double-digit return in 2020 and closed the year at an all-time high, despite record-breaking outflows from U.S. equity funds. Nearly $241 billion flew out of domestic equity funds in 2020, a figure that is more than four times the previous calendar year record set in 2015. Perhaps unsurprisingly, these outflows centered predominately around actively managed products, a trend that has been persistent since 2014. Active funds saw net outflows in every month of 2020, while passive funds enjoyed bursts of investor interest, with extreme net inflows in both March (after the market bottomed) and November (due to positive coronavirus vaccine news). Investor preference for ETFs over mutual funds is particularly noteworthy. ETFs have risen in popularity as a lower-cost alternative to mutual fund investing and carry little-to-no investment minimum with real-time pricing. In November, passive ETFs saw a staggering net inflow of more than $54 billion, which is $12 billion more than the last monthly record set in December of 2016. This historic net inflow provided a tailwind to an already optimistic investor base and propelled indices like the Russell 2000 index, which tracks the U.S. small-cap market, to post its strongest returning month on record.

Hefty inflows for passive vehicles, like those in November, can have unfortunate implications for active investment managers. Many of these investment professionals are constructing a relatively small basket of securities with the intent to outperform a benchmark, often with less risk, over the long term. Commonly, these managers focus on quality metrics like top line growth, gross margins, earnings, and lower debt levels to drive outperformance. When a wave of inflows hits passive products, we see a “rising tide lifts all boats” phenomenon that is largely detached from underlying stock fundamentals. This can cause a short-term price dislocation and distortion of investor sentiment. Ultimately, the immediate impact of fund flows is temporary, but the continued trend away from active management may pose a greater threat to the asset management industry if portfolio managers fail to improve benchmark-relative performance.

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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.

Bubble, Bubble, Toil, and Trouble

In Shakespeare’s Scottish play Macbeth, three witches prophesize the protagonist’s imminent rise and fall. This week, Deutsche Bank released its mid-January survey highlighting 627 global market professionals’ feelings of the market’s current state. The survey’s arguably most somber statistic showed that 89% of respondents believe there are currently bubbles in the financial markets. As seen in previous events, we know that bubbles have dire consequences for financial markets. In particular, U.S. tech stocks and Bitcoin were the two assets that respondents believe are the most likely bubbles waiting for a correction. As of January 19th, Bitcoin has soared over 320% and the Nasdaq index is up over 43% in the past year. Due to digital currencies’ nascency, particularly Bitcoin, it is almost impossible to glean any insight from past performance.

Moreover, much of Bitcoin’s future value will be driven by its overall acceptance by financial institutions and its finite supply. Alternatively, investors have decades of Nasdaq data and have experienced market bubbles such as the Dot-com Bubble and the Global Financial Crisis. If history is our guide, the Nasdaq’s current PE ratio of approximately 26 is mild relative to a P/E ratio of 70 seen in 2006 and a fraction of its peak of 175 witnessed in 2000.¹ While a P/E ratio is not a perfect gauge for market bubbles, neither is recent strong performance. Since 1975, of the ten years that the Nasdaq has eclipsed a 30% positive return, only two of the years was the index negative the following year, 1981 and 2000.

If the Deutsche Bank survey is correct, this might be the most well-forecasted bubble in financial history, and if we have learned anything from previous financial bubbles, we know they are tough to predict. Macbeth’s witches were able to predict the future down to the smallest details with powers not held by financial market harbingers. Regardless, surveys give investors powerful insight into the mood and sentiment of financial professionals, but it is up to them to plan accordingly. Much has been learned over the past year as 2020 will remain front of mind for investors for years to come. Since the market bottom in March, many asset classes have benefited from a swift and steady rally, posting strong gains in 2020. Furthermore, the market has felt disconnected from the overall economy, which continues to struggle with the fallout of the COVID pandemic and has caused investors to question, “How long can this continue?” Driven by record-low interest rates, investors allocating to risk assets should remain mindful of future return expectations and potential volatility at current valuation levels.

Print PDF > Bubble, Bubble, Toil, and Trouble

¹ Bloomberg

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.

2021 Market Preview

2020 was a year like no other and has left investors across the world wondering what the future looks like. Will vaccines prove effective in halting a pandemic that spread like wildfire across the globe? What will the impact of a new administration in Washington be on economies and markets? How much additional stimulus will be injected into the economy? And most broadly, will things ever get back to “normal”? While there are no easy answers to these questions, 2021 promises to be another volatile year, most especially until there has been sufficient roll-out and distribution of vaccines to contain the COVID-19 outbreak that continues to haunt economic growth across the globe.

Remarkably, 2020 ended up as a positive year for financial markets despite a massive sell-off in the equity and credit markets during February and March. Paradoxically, 2021 may be a less eventful year but at the same time a lower overall return environment, given that much of the optimism about economic re-openings and stimulus has already been priced into the markets. Nonetheless, there are a variety of factors worth monitoring over the next year which will directly impact market returns. Similar to past years, we offer our 2021 market preview newsletters for each of the primary asset classes we cover, with in-depth analysis of last year’s performance as well as trends, themes, opportunities, and risks to watch for in 2021.

We hope these materials can assist you and your committees as you plan for the coming year and beyond. We have also produced a 2021 Market Preview video if you would like to hear a high-level summary of the market previews. Should you have any questions about anything related to these materials, please feel free to reach out to any of us for further assistance. Here’s to a return to normalcy in 2021!

U.S. Economy: Are Better Days Ahead?
by Brandon Von Feldt, CFA, Research Analyst

Fixed Income: Poised for Further Recovery with Undertones of Exuberance
by Ben Mohr, CFA, Director of Fixed Income

U.S. Equities: Birth of a New Market
by Samantha T. Grant, CFA, CAIA, Assistant Vice President,
Colleen Flannery, Research Analyst, U.S. Equities, and
Evan Frazier, CAIA, Research Analyst, U.S. Equities

Non-U.S. Equities: Constructive but Cautious
by David Hernandez, CFA, Senior Research Analyst, Non-U.S. Equities, and
Nicole Johnson-Barnes, CFA, Senior Research Analyst, Global Equities

Hedge Funds: Poised for Another Record Year?
by Joe McGuane, CFA, Senior Research Analyst, Alternatives
and Jessica Noviskis, CFA, Senior Research Analyst, Hedge Funds

Real Estate: Finding the New Normal
by Will DuPree, Senior Research Analyst, Real Assets

Infrastructure: An Evolving Opportunity Set, but an Essential Allocation
by Will DuPree, Senior Research Analyst, Real Assets

Private Equity: Both Quality and Growth Shine Brightly in 2020
by Derek Schmidt, CFA, CAIA, Director of Private Equity

Private Credit: Two Steps Forward, One Step Back
by Brett Graffy, CAIA, Research Analyst

Download the combined files > Traditional and Alternatives

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.

2021 Market Preview Video

This video coincides with our 2021 Market Preview newsletters and provides a high-level summary of each, including analysis of last year’s performance as well as trends, themes, opportunities, and risks to watch for in 2021.

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 notified when we publish new videos here.
For more information, questions, or feedback, please send us an email.

Glass Half Full?

As we are beginning to see a possible finish line on the COVID-19 front, there is an expectation in the market that vaccine-assisted re-openings globally will bring about a return to pre-pandemic economic productivity levels. The “Great Lockdown” of 2020 caused many countries around the world to enter a deep recession, which, like former hard resets, has impacted societal behaviors (i.e., social distancing) and reframed business operations and outlooks (i.e., increased safety measures and focus on supply chain). It is fair to say that some industries and segments of the market may have been permanently changed by the pandemic, be it in a positive or negative manner. While we welcome the return to normalcy — or even the new normal — it is important for investors to be mindful of a few things with respect to this economic reversal: 1) the market has largely priced in this turnaround story, 2) continued accommodative monetary policy and large fiscal stimulus packages are providing the support to restart the economic engine, and 3) any hiccups in national inoculation plans and vaccine distribution could sidetrack progress.

Hence, our glass is half full when it comes to sustaining global growth expectations in 2021. As shown in today’s chart, the IMF’s estimate of the global GDP growth rate is expected to come in at -4.4% for 2020. This is a less severe contraction than estimated in June 2020, which showed a more dire COVID-19 impact on economic activity. For 2021, the global GDP growth rate is projected to lampoon to +5.2%, due to a wide negative output gap and a gradually immunized workforce. Of note, China is the only country expected to post a positive GDP growth rate for 2020 and 2021, as it continues to show leadership in restoring and maintaining economic activity. As 2021 plays out, the actual growth numbers across the globe versus what has been projected will be followed and reported upon closely and will undoubtedly have an impact on financial markets. Among vaccine roll-out, efficacy, a new administration in Washington, and a host of other geopolitical factors, global GDP bears watching, especially the first half of the year.

Print PDF > Glass Half Full?

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.

Tech Bubble Revisited? Contrasting the Current Landscape with the Dot-Com Boom and Bust

Continued strong performance of technology-oriented stocks through disparate economic environments, elevated valuations, and increasing concentration within the growth space have caused many to draw parallels between present-day conditions and those of the late 1990s. Some feel as though investor exuberance surrounding innovative companies is irrational, and that 2021 could bring with it a paradigm shift in terms of sentiment and market leadership.

This newsletter seeks to assess the extent to which the current equity landscape mirrors the Dot-com Bubble with an analysis of performance, sector concentration, profitability fundamentals, and valuations.

Read > Tech Bubble Revisited? Contrasting the Current Landscape with the Dot-Com Boom and Bust

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 Velocity Stifling Inflation Amid Record Growth of Money Supply?

Inflation has remained well below 3% in the United States for nearly a decade despite a record economic expansion and supportive monetary policy. Even after unprecedented alterations to the macroeconomic landscape in recent months, investors have not seen the significant price level increases that might have been expected in theory. This puzzling situation may be at least partially explained by the current relationship between money supply and velocity.

When it comes to economic relief efforts in the U.S. during 2020, no entity has been more active than the Federal Reserve, which has increasingly relied on open market operations with short-term interest rates near zero. Since the start of the pandemic, the Fed has purchased $3.5 trillion in Treasuries, corporate bonds, and mortgage-backed securities, and recently announced its intention to press forward with $120 billion per month in additional bond buying. The central bank’s balance sheet has now ballooned to over $7 trillion. As a result, M2 — a measure of the total money supply that includes narrow money, cash equivalents, and short-term deposits — spiked by roughly 25% in 2020, a record year-over-year growth figure.¹ The recent M2 surge has been accompanied by a decrease in the velocity of money, calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock. Put simply, velocity denotes the rate of turnover in the money supply and is a gauge of economic health, as higher velocity is usually associated with more robust economic activity. Since the beginning of 2020, money velocity has fallen by more than 20%, indicating a strong preference for saving vs. spending on the part of the American consumer since the outbreak of COVID-19.

The relationship between money supply and velocity has significant implications for security markets going forward, particularly as it relates to inflation. Investors have long been confounded by the absence of inflation in the U.S. since low interest rates and M2 growth should lead to higher price levels all else equal. Part of the reason for the lack of inflation could be lower levels of money velocity, which has largely declined since 2000 amid three significant recessions in the United States. The recent plunge in velocity may signal to central bankers that expansionary efforts could be continued in the near term without the risk of significant price level increases. As the economic recovery continues, however, velocity will necessarily rise, which could lead to interest rate hikes and the tapering of the Fed balance sheet to prevent runaway inflation. Investors should be cognizant of the possibility of restrictive monetary policy in the coming years as the world lifts itself out of recession.

Print PDF > Is Velocity Stifling Inflation Amid Record Growth of Money Supply

¹As measured on November 30, 2020

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 TIPS Be an Effective Inflation Hedge for Portfolios?

With the COVID vaccine’s worldwide distribution and adoption starting last week, many investors are aiming to project an inflation outlook driven by the return of furloughed workers and impending economic recovery and adjust portfolios with inflation protection in mind.

In this newsletter, we examine how key asset classes in institutional portfolios behave in rising or declining inflation environments, and ultimately determine the best asset classes that serve as inflation hedges while also providing strong total return and efficiency ratios. In particular, we investigate if TIPS (Treasury Inflation-Protected Securities) offer superior inflation protection compared to other common portfolio constituents.

Read > Can TIPS Be an Effective Inflation Hedge for Portfolios?

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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