cvernon, Author at Marquette Associates

Market Volatility Moves in Both Directions

The last week in the markets has seen a huge increase in market volatility. This week’s chart examines the largest daily moves (the ten worst and ten best) in the S&P 500 index since 1950, in an effort to provide some historical context to the recent volatility. As the chart shows, the recent market moves are not unprecedented, but they are historic. Over a course of just six trading days, the S&P 500 had three of its worst — and one of its best — days in the last 70 years. Beyond just the magnitude of the market moves, this week’s chart attempts to highlight a few important reminders for investors.

First, market volatility tends to move in both directions. We have color-coded the market moves by event, and it is worth noting that in the wake of the 1987 stock market crash, the Global Financial Crisis, and the recent volatility around the coronavirus, U.S. equity markets have seen some of the worst — and best — days ever. While all this volatility clearly creates opportunities for rebalancing, the market volatility can create a significant amount of short-term timing risk. This is one reason why clients should consider gradual rebalancing over a period of days or weeks to limit the risk of short-term market volatility.

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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 Spike in the Cost to Insure High Yield Bonds From Default

As the number of new coronavirus cases outside of China continues to rise and the oil price war between Saudi Arabia and Russia ensues, spreads of credit default swaps have widened hand-in-hand with the spreads of high yield bonds. Our chart this week will examine what this means for investors.

A credit default swap (CDS) is a derivative security that insures against default on a bond. In other words, the price of a CDS shows the market’s projection of the issuer’s likelihood of defaulting. Referred to as a spread, the price of a CDS is tracked in basis points, similar to the spread of a bond. Currently, the broad high yield CDS index, called the high yield CDX,¹ has a spread of 551bp as shown in the gray line. This means that a CDX investor must pay $5.51 per year to insure $100 worth of the high yield bond index from default. This is a near-term high, as the CDX’s spread was as low as 275bp in early January when it cost only $2.75 per year to insure $100 worth of the high yield bond index from default. But it is not as high as the point it reached in mid-February 2016, the peak of the U.S. shale crisis when it cost $5.89 per year to insure $100 worth of the high yield bond index from default.

A high spread for the CDX index means that the market is assigning a higher average likelihood of default to high yield bonds today as a result of the forward economic fallout from lower expected corporate earnings due to the coronavirus as well as the difficulties energy companies will have to endure due to the low price of oil. However, this high CDX spread also suggests attractive prices of the underlying bonds. Shown in the blue line, option-adjusted spreads for high yield bonds have widened to well above long term averages, signifying a compelling opportunity. With the U.S. consumer still on strong footing, high yield issuer fundamentals remaining moderate, and China in recovery mode as their coronavirus cases are declining and capacity utilization is rising, we would encourage investors to consider adding to their high yield allocations through dollar-cost averaging over the next few quarters, in accordance with the adage “buy fear, sell greed.”

Print PDF > A Spike in the Cost to Insure High Yield Bonds from Default

¹Inception of the high yield CDX was in 2012, while inception of the high yield bond index was in 1994

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.

Fed Cuts Rates 50bp to Fight Coronavirus Effects

This morning, the Federal Reserve cut short term interest rates by 50bp to defend against the global economic effects of the coronavirus outbreak. The previous three cuts occurred throughout 2019 as a result of combatting the global slowdown due to the U.S.-China tariff negotiations. This latest cut was a surprise for the markets as going into the day Fed Funds futures showed a strong probability of one rate cut in each of the Fed’s March, June, and September Federal Open Market Committee meetings this year.

This week’s chart shows that the rate cut brings the Fed Funds target range upper limit now to 1.25% (not shown is the lower limit now at 1.00%), juxtaposed against the VIX, which is a measure of the S&P 500’s expected volatility that spiked over the last few days.

It is unclear what the ramifications of this central bank action might be on the markets in the short-term, as the Fed’s signal of apparent concern may cause a fear-induced sell-off in the markets. This is what we are seeing so far, as the S&P 500 is off 2.8% for the day while the 10-year U.S. Treasury fell from yesterday’s close of 1.10% to 1.02% at today’s close. However, the longer-term effects should be stimulative as lower rates will make it easier for businesses and consumers to borrow and refinance their debts as well as ease their interest expense burdens.

The hope is that this cut will reduce short-term economic headwinds to the global economy and combat the onset of a recession. While it is impossible to predict when the outbreak will be contained, the number of new cases in source country China is declining and the coronavirus fatality rate remains low at 3%.

The global fatality rate is especially low for individuals not of elderly age. The latest data provided by global insurer Natixis and the Chinese Center for Disease Control & Prevention show that the fatality rate for individuals under 60 years of age is less than 1.3%, with those under age 50 seeing a fatality rate less than 0.4%.

As such, the U.S. Treasury yield curve is still upward sloping in both the 2-year vs. the 10-year and the 2-year vs. the 30-year, showing no signal of an impending recession. In contrast, both these measures were downward sloping going into the tech crisis in 2000 and housing crisis in 2008.

However, we may expect persistent short-term volatility as China recently released its Purchasing Managers’ Index (PMI). A PMI below 50 signals a contraction, and China’s latest PMI is at 30, the lowest it has ever been. To preemptively combat this potential economic slowdown, the Fed’s 50bp rate cut should provide a boost to the U.S. and global economy and we would expect central banks around the world to likely follow suit.

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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.

March 2: Coronavirus Update and Portfolio Guidance

Last week was a painful one for the equity markets as fears about the coronavirus drove investors out of stocks and markets into correction territory. The following newsletter summarizes last week’s developments and provides specific commentary on what to watch for across the major asset classes that constitute investor portfolios.

Read > March 2: Coronavirus Update and Portfolio Guidance

As always, please reach out to your consultant or our research team for more details about any of the information presented in this update. For more Marquette coverage on coronavirus, reference our previous newsletter (January 28) and Chart of the Week posts (February 13, February 21, February 26).

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.

Coronavirus Roils the Equity Markets

U.S. equities recently experienced a sharp three-day sell-off as the market digested the potential for short-term disruptions to economic growth and company earnings due to the Coronavirus (COVID-19). With new health figures coming out daily, it is easy to become alarmed. However, as our Chart of the Week from February 13th highlighted, prior health crises have been proven to be non-events longer-term for equity markets. Similar outbreaks in the past caused short-term sell-offs in equity markets but longer-term saw positive market performance.

This week’s chart shows calendar year returns for the S&P 500 along with the max drawdown that occurred in each respective year. As of February 25, 2020, the S&P 500 has recorded a year-to-date drawdown of 7.6%. The current pullback is undeniably sharp in nature, but it is important to maintain perspective during turbulent times. Over the past 15 years, the average annual max drawdown was 14%. Many years experienced drawdowns near this level, yet still yielded a positive return for the year. On average, equities see a 5% pullback four times per year, a 10% pullback once per year, and a 20% correction once every five years.

While no one knows the full impact that the current outbreak will have to supply chains, trade, or travel, we recommend taking a long-term view to investing. The market had been looking past this current health crisis until the last few days, so a repricing of risk was inevitable. As this is an evolving situation, there is risk that the economic impact could increase and add further pressure to equities. However, the current pullback remains in-line with historical trends.

Print PDF > Coronavirus Roils the Equity 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.

Coronavirus and the U.S. Economy: Assessing the Impact

Over the last month, the world has been gripped by fears of the coronavirus and its eventual toll on the global economy. Most economists expect global economic growth to reaccelerate in the second half of the year after the virus peaks. We agree that most of the negative effects will most likely be felt in the first half of 2020.

Since January and February Chinese economic data will not be released for a few weeks, we thought it would make sense to review the current state of the economy in the United States. The table above shows leading indicators for the U.S. economy. Green denotes a healthy measure and red denotes a deteriorating measure. Some of the more stable measures over the past few years have been the 50-year low unemployment rate and inflation, which has been stable at 2%. The more volatile measures have been stock market valuations, the purchasing manufacturer’s index (“PMI”; a gauge of domestic manufacturing activity), and corporate earnings growth. Let’s start with PMI first since stock market valuation and earnings growth are more intertwined. PMIs have been under pressure since the start of the U.S.-China trade war in 2018. In January 2020, PMIs traced their way back into expansionary territory (i.e., above 50), but the coronavirus fallout may cast a cloud over manufacturing in the coming months.

What about the U.S. equity market? Last year, corporate earnings growth was virtually flat in an expensive stock market. Since then, stock market valuations¹ have come off their 2019 high but are still above the 10-year historical average of 16 times forward earnings. We believe meaningfully positive corporate earnings growth will be needed to support such an above-average market valuation. The most obvious way to ensure that is to have a strong U.S. consumer. Consumer confidence has steadily increased throughout this business cycle and right now consumers are as confident as they have ever been. Since the U.S. consumer drives two-thirds of the economy, we will be closely monitoring the consumer for weakening sentiment through measures like retail sales, revolving debt defaults, overall debt level, and other telling data. While we expect some metrics to potentially soften due to the coronavirus, we expect most to be positive by year-end. Ultimately, much like SARS and MERS, the virus’s bark will be much worse than its bite on the U.S. economy and equity market.

Print PDF > Coronavirus and the U.S. Economy: Assessing the Impact

¹ As measured by forward P/E
² FactSet Expected Earnings Growth for 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.

The Future of Investing: Sustainability and ESG Integration

With 2020 underway, sustainable investing continues to be a trending topic, although the concept of incorporating environmental, social, and governance (ESG) metrics into an investment thesis is not new. ESG integration is returns-focused and incorporates long-term sustainability factors into the investment research process to identify companies with higher return potential.

In this white paper, we examine the current ESG landscape, including the various movements that have preceded ESG integration, recent strides by American corporations, fiduciary guidance, and the growing response by investment managers to meet investor demand, especially in reporting and performance measurement. We also present our approach to incorporating ESG into our manager evaluation process and the best practices our team looks for when performing due diligence for ESG-mandated strategies.

Read > The Future of Investing: Sustainability and ESG Integration

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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