Author: cvernon

What Happened to International Small-Cap Equities This Year?

This year’s non-U.S. equity returns have been disappointing, particularly for developed small-cap, with the MSCI EAFE small-cap index down 17.6% through December 18th. The following is a high-level review of why the asset class has struggled so much this year.

Download PDF >

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.

Equities Continue Their Wild Ride

It has been a wild ride since the equity market peaked on September 20th. Almost three months later, the S&P 500 is down 14.0%, marking the second market correction this year. Corrections occur when the market falls more than 10% from its market peak. Investors have been caught off-guard by this year’s volatility given last year’s slow and steady rise. While we predicted that 2018 would most likely be more eventful than 2017’s record-breaking tranquility, we could not predict to what extent. Year to date, we have seen market movements in excess of 1% in one out of every five days this year, and four of the five largest Dow Jones Industrials Average point drops ever despite strong positive economic data within the United States.

Market pauses occur frequently. Since 1920, the S&P 500 has on average experienced a 5% pullback 3 times a year, a 10% correction once a year, and a 20% bear market decline every 3 years.¹ What’s important is that corrections are merely temporary movements and have little impact on returns over the long-term. Since the bottom of the market in 2009, the S&P 500 has returned over 350% cumulatively and 15% annualized. The chart above shows the S&P 500’s cumulative returns after every correction this market cycle.

Markets are constantly under pressure from external events; recent history includes 2010’s Sovereign Debt Crisis, the 2011 U.S. debt downgrade, and fear of slowing Chinese growth in the winter of 2016. Today, market returns are almost flat since February’s market correction. Returns have eventually rebounded after each correction (including the global Financial Crisis) due to the underlying fundamentals of the economy and not elements of fear.

We acknowledge that while global growth did not meet investors’ expectations in 2018, the United States continues to meet or even exceed expectations. Third quarter GDP came in at 3.5%, unemployment is a low 3.7%, personal income is up, corporate earnings are strong, and inflation is a healthy 2.2%. The fundamental backdrop is still positive for the U.S. and is a stark contrast to the market’s performance quarter-to-date. While the recent volatility can be uncomfortable, waiting for market performance to realign with economic fundamentals can be rewarding over the long-term.

Print PDF

 

¹ Fidelity Investments, Viewpoints, November 5, 2018

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.

Target Date Funds: Preparing Participants for Retirement

A pitfall for a majority of plan participants surrounding retirement planning is a lack of familiarity with investing. Participants with little to no investment experience are expected to make allocation decisions that will greatly impact their retirement. Target date funds serve as a one-stop shop for a diversified and risk-appropriate portfolio which automatically de-risks as the participant ages. These funds are managed to a specific target retirement date; when an investor chooses his or her retirement year, the portfolio is put on “autopilot” as the fund is managed and rebalanced with risk and return characteristics appropriate for that defined investment horizon. While these funds fulfill a need for simplicity in the marketplace, there are many nuances with which plan sponsors should be educated in order to make a decision that is best for their participant pools.

This paper serves as an educational tool for plan sponsors to aid in the selection and continuing evaluation of target date funds. Topics including purpose, construction, goals, and benchmarking will be discussed.

Download PDF >

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.

Rebalancing Position Paper

Regularly rebalancing portfolios is one of the key duties of trustees and other fiduciaries responsible for managing an institutional portfolio. Asset allocations are set to provide a predetermined risk/reward profile that fits a fund’s objectives and constraints. Portfolios are rebalanced when they drift away from policy target in order to maintain the risk/reward profiles implicit in the original asset allocations. But how often should clients rebalance their portfolios? What guidelines should clients use to determine when to rebalance? And what are the costs and benefits associated with rebalancing? This paper takes a rigorous look at rebalancing and provides some guidelines for implementing a rebalancing policy.

Download PDF >

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.

 

What Do Higher Rates Mean for Asset Class Returns?

Higher interest rates coupled with signs of a global slowdown and roughly two months of market volatility — including several periods of a selloff — have clouded an otherwise positive picture of the U.S. economy. Despite this, many investors are still worried future increases in interest rates will hinder the economy, given growth in the U.S. and other regions is likely to slow down next year.

An analysis of the performance of different asset classes during U.S. rate hike cycles since the 1990’s suggests the opposite — these cycles were largely positive for investors. In fact, during the most recent hike cycle (Jan-16 to Nov-18), annualized returns for both private and public markets (excluding real estate) were well above their 1-year annualized rates of return before the initial hike began. The orange bars, which illustrate the various asset classes’ 1-year returns before the hike cycle, are well below their annualized returns during the cycle, as depicted by the colored columns. U.S. equities (S&P 500) outperformed other asset classes, gaining almost 12% during this period. U.S. buyout, non-U.S. equities and fixed income gained roughly 6%, 4%, and 1%, respectively. Real estate appears as the outlier with this most recent cycle, but comes on the heels of a considerable run for real estate after the Great Recession.

When looking at 1-year annualized returns after a hike cycle occurred for the prior three rising-rate regimes in 1994, 1999 and 2004, the data paints a similar picture. As illustrated in the graph, annualized returns 1-year after the hike cycle ended (when the effect of an increase/decrease in interest rates will be felt on a wide scale) were on average higher than returns during the cycle. This is depicted by the gray bars (1-year returns after the hike) being on average well above the returns during the hike cycles.

The volatility we have seen thus far in the market is typical for the later stages of an expansion and should not be solely attributed to the Federal Reserve’s tightening policy. It is important to note that interest rate hikes alone will not adversely affect asset class performance, but rather, the economic backdrop of each rate hike cycle will determine the market outcome. Given the uncertainty surrounding the current cycle’s path moving forward, investors should expect continued volatility and watch closely for upward-trending inflation.

Print PDF

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.

Should Investors Be Concerned About Yield Curve Inversion?

After eight post-recession Fed rate hikes since 2015, the U.S. Treasury yield curve continues to flatten. On Monday, December 3, the yield curve inverted by one basis point between the three-year yield at 2.84% and the five-year yield at 2.83%. The next day, that inversion intensified to two basis points, with the three-year yield at 2.81% and the five-year yield at 2.79%, causing an 800-point correction in the Dow. The bellwether steepness indicator — the difference between the two-year yield and 10-year yield — remains upward sloping, however, but narrowed from 15bp on Monday with the two-year at 2.83% and 10-year at 2.98% to 11bp on Tuesday with the two-year at 2.80% and 10-year at 2.91%.

Based on previous market cycles, an inverted yield curve has predicted a recession six months to two years after inversion. Prior to the 2008 crisis, the first sign of inversion occurred in the 4th quarter of 2005, when the three-year and five-year inverted first, followed by the two- and ten-year inverting in the same quarter, roughly two years before the crisis that began in early 2008. This week’s chart shows the actual yield curve at the end of the day on December 4, along with the predicted yield curve at the end of this year and the next three years based on Treasury forwards. We can see that the market expects the curve to be generally upward sloping for the rest of this year, but to further invert in the front of the curve to the belly, and remain inverted in that region, for the next three years. However, the market still shows the 10s minus 2s to be upward sloping, even in the outer years.

Over the last few quarters, the expectations for the Fed’s hikes declined from one this December plus four more in 2019 to one this December plus only one more in June 2019. With this first sign of inversion, the Fed may pause on a hike for December, but it has communicated the hike so much that it may have to move forward with it or risk a loss of credibility. As 2018 heads to a close, this recent inversion bears watching and will no doubt have an impact on this month’s as well as next year’s capital markets.

Print PDF

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.

America’s Infrastructure Report Card

Pending a final vote count in Florida, the U.S. midterm election results are in with the Democrats regaining control of the House and Republicans maintaining majority control of the Senate. While a split Congress may lead to gridlock on various policies, one thing both parties should be able to agree on is the need for infrastructure investments in the U.S.

The historical under-investment, coupled with the lack of available public-sector funding, has impaired the government’s ability to deliver public services at adequate levels. The American Society of Civil Engineers (ASCE) estimated that $4.5 trillion needs to be invested through 2025 to upgrade the nation’s infrastructure. In its annual report, the ASCE in 2017 gave an overall “D+” grade for the condition and capacity of infrastructure in the U.S., further highlighting the need for additional investment.

Consequently, governments and public agencies have begun looking beyond the traditional funding methods to private investment in infrastructure via privatizations and public-private partnerships (“PPPs”). As a result, ownership and operation of infrastructure assets has been gradually moving from the public to the private sector on a global level. With this trend, the role of government has shifted from the provider of services to that of a regulator. This has provided a stream of investment opportunities and fueled development of a distinct alternative asset class for institutional investors that complements fixed income, public equities, real estate, and traditional private equity investments, and whose popularity is likely to increase as more investments and hence products come to fruition.

Print PDF

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.

Will U.S. Equities Rally to Finish the Year?

U.S. equities experienced a sharp correction last month with broad market indices erasing virtually all their year-to-date returns. The October pullback was especially jarring for investors since it followed an unusually quiet third quarter and had seemingly few changes in the economy or corporate earnings to warrant such a sell-off. Unlike the volatility seen in the first quarter of 2018, the S&P 500 didn’t record a single daily move of more than ±1% in the third quarter. During October, the S&P 500 saw a total of ten daily moves greater than ±1%, surpassing the total number seen in all of calendar year 2017. The recent resurgence of equity volatility coupled with the anticipation of midterm election results has created uncertainty in the outlook for risk assets in the near-term.

While stock prices are ultimately affected by a variety of factors, the fourth quarter has historically yielded the highest percentage of positive market returns compared to other quarters. In addition, market returns following midterm elections tend to be quite strong. Examining S&P 500 returns during midterm election years dating back to 1946, we see that the S&P 500 has never ended the year below its October closing low. The average return over these last 18 midterm elections is +10.6%. Although the sample size for post midterm elections is small, it is reassuring to know that we are in a historically strong period for equity markets.

Print PDF

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.

Market Impact of Evolving U.S. Policies

2018 Investment Symposium flash talk by Greg Leonberger, FSA, EA, MAAA

In this session, Greg explores the effects of various policy changes in the U.S. and how they could impact investor portfolios. In particular, we examine the effects of tax reform, U.S.-China tariff escalation and finally, the upcoming mid-term elections. While the ultimate impact of each is not yet known, we highlight trends and sensitivities that can help guide prudent portfolio decisions in the coming months.

A summary of this flash talk can be downloaded here.