Author: cvernon

It’s All About the Bitcoin: Dollars or Cryptocurrency?


Flash talk by Greg Leonberger, FSA, EA, MAAA, at Marquette’s 2017 Investment Symposium

What is cryptocurrency? We examine how cryptocurrency is transacted, including how blockchains function, then dive into Bitcoin’s uses, acquisition, mining, and circulation. As an investment, the last few years have shown impressive (and frightening) growth, but we caution investors to be aware of the volatility within Bitcoin and look back at tulips for some insight. There are many challenges and unknowns cryptocurrencies face, and it is still early in the game to determine whether Bitcoin will (or can) become a conventional medium of exchange.

The Emerging Sector in EM Equity

This week’s Chart of the Week examines how investment opportunities in emerging markets have changed over the last seven years. Historically investors have associated emerging markets with commodities but this view is becoming outdated. In 2011, Financials, Energy and Materials were the three largest sectors within the MSCI Emerging Markets (EM) Index. The Information Technology (IT) sector constituted 12% of the benchmark. Fast forward to present day and IT has now more than doubled to 27% while Energy and Materials have both halved.

This evolution speaks to the economic developments several emerging countries have experienced over the last two decades, with increases in population and income. This can be especially seen in China where companies like Alibaba, Tencent, and Baidu have capitalized on the expanding middle class. Investors have taken notice of the growth potential and the IT sector within EM has led the way in 2017 returning just over 50% through September. Investors can debate whether these stocks have gotten ahead of themselves but the shift in investment opportunity over the last decade is unquestionable.

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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.

Where’s the VIX?

In a time when there is a lot of fear and uncertainty surrounding political turmoil, geopolitical issues, and tension with North Korea, the market appears remarkably calm. For this week’s chart of the week we take a look at the widely followed CBOE Volatility Index (VIX) which is considered to be the best gauge for expected fear in the markets over the next 30 days. On October 5th, the VIX dropped to a 23-year low closing at 9.19, a number not seen in almost two decades. Leading up to this record close was an impressive eight-day stretch of closes below 10, the longest streak of its history.

Why do the markets seem to be resilient to the ever-concerning news cycle? While impossible to know for certain, speculation includes positive macroeconomic signs, stronger earnings growth, gaining popularity of passive index investing, and complacency of the markets. Although the VIX is well below its historical average of 19, it is worth noting that fear can quickly resurface. In the meantime, it will be interesting to see if further VIX index levels can be achieved which would likely be paired with the markets reaching additional record highs.

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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.

Info Tech Surpasses Dot-Com Peak – Is This Time Different?

With U.S. equities enjoying the second longest bull market run on record, it has become a frequent occurrence to see equity indices hit new closing highs.  The S&P 500 has recorded 39 new closing highs during the first three quarters of 2017 alone.  A noteworthy milestone recently occurred for the S&P 500 Information Technology (“IT”) sector.  This sector now trades at levels above its prior March 2000 dot-com peak.  IT is the best performing sector of the S&P 500 thus far in 2017 with a year-to-date return of +27.4% through September and is now the largest weighted sector in the S&P 500 with a weight of 23.2%.  Like most sectors of U.S. equities, the information technology sector trades near the high end of its historical valuation range.  Strong performance from this sector in recent years has led to comparisons with the prior dot-com bubble, but is this time different?

While few would disagree that we are nearing the later stages of the current market cycle, the typical excess and euphoria seen in prior market peaks do not appear to be present.  Compared to the prior dot-com peak, the information technology sector today is on noticeably better footing.  Companies in this sector today tend to have healthier balance sheets and hold greater cash levels.  Valuations, while elevated, are not nearly as overvalued as the prior peak.  On a 12-month forward P/E basis, the IT sector trades at 19.5x versus a level of 56x seen in March 2000.  There are certainly individual cases of overvalued securities, but in aggregate the sector is valued much more reasonably than during 2000.  Additionally, the main driver of long-term stock returns has historically been growth in corporate earnings.  Today, the IT sector generates healthy levels of earnings growth and cash flows; many companies during the dot-com era did not have actual earnings to justify their lofty valuations.  While market bubbles are only identified on a post-mortem basis, investors today can at least take comfort in knowing that the IT sector possesses healthier fundamentals and less euphoric valuations than seen in the past.

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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.

Healthcare Organizations’ Top 3 Investment Concerns for Balance Sheet Assets

Historically, healthcare organizations have covered their cost of debt by investing in a conservative mix of fixed income securities. However, for most of the recovery since the Great Recession, the yield on their debt payments exceeded the Bloomberg Barclays Aggregate (Agg) bond index yield. Therefore, many organizations were forced to consider riskier assets to cover their debt payments as a result of this adverse spread. Now that the Federal Reserve rate hikes are underway, Agg yields are once again approaching parity with healthcare issuer debt yields and thereby reducing the pressure to invest in riskier assets to make up for the spread disparity.

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The Market’s Bad Breadth

While many are familiar with technical analysis and its claimed prophetic approach to the markets using historical performance, this week we look at a derivative of the 50-day moving average through the lens of breadth.

Crossing below the 50-day moving average is considered a point of weakness whereas crossing above this trendline is viewed as a sign of future strength and bullish activity for the market or index in question.  While the broad market, as proxied by the Russell 3000, had a strong May and June and remained above this moving average, it found weakness in August and has been below this trendline for the past few weeks. Instead of just analyzing the index as whole, we examine the behavior at a component level through market breadth which is a ratio of stocks with increasing prices to those with falling prices. A derivative of this metric is charted below as a ratio of stocks above their 50-day moving averages over those below; a ratio above 1 is a positive indicator for the market as this means more stocks are above their short-term average than below and indicates substantial market breadth. This is a good sign for the market as it means the majority of index constituents are exhibiting strength as opposed to only a few mega-caps lifting up the market.

Recently, however, this ratio fell below 1 which means stocks falling in price outnumber those increasing in price.  Less than 42% of stocks in the Russell 3000 universe are trading above their short-term moving average whereas back in July more than 70% were trading above their short-term averages. That the market is trading flat during this new trend means that the upward movement of only a few stocks relative to the universe is keeping the market flat; this does not make for a stable market.  While these are only technical indicators and are not cause for extreme alarm, the general indication of these data points is that market stress in the near future would not be completely surprising.

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The State of Real Estate: An Era of Normalization?

Core real estate investments have flourished since the financial crisis. Since delivering six consecutive double-digit annual returns through 2015, the NCREIF Open-end Diversified Core Equity Index (NFI-ODCE) returned a positive 8.8% in 2016 and a positive 3.5% YTD through June 2017. While overall returns are moderating, the relatively lower high single-digit returns remain consistent with our longer term expectations for the asset class and real estate remains an attractive investment relative to other assets classes. Investors may be wondering how much longer the real estate cycle can continue and if it is time to pull back on their allocations. In this newsletter, we address these questions by examining critical drivers of the real estate market, including performance, valuation, leverage, income, and capital flows.

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Don’t You Know, We’re Talking About An Evolution? Addressing The New Challenges Facing The Diverse Manager Community

In recent years, some proactive and thoughtful pieces have spurred constructive dialogue within the investment consulting and plan sponsor communities on the measurable benefits of incorporating “diverse” investment firms within their various investment programs. In short, a diverse investment manager can be defined as a firm that is women owned, minority owned, or a combination of the two.

This newsletter strives to enhance the ongoing series of constructive discussions and solutions featuring Marquette, the diverse investment manager community, and the plan sponsors who wish to advance diverse manager initiatives. It is Marquette’s view that broader conversations about the diverse manager community should deliberately acknowledge the existence of newer structural headwinds that diverse managers face in today’s market. By focusing on these material hurdles – some of which are highlighted in this newsletter – the plan sponsor, diverse manager and consultant communities will be in a stronger position to formulate practical solutions to these challenges.

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The Re-Price is Right

Bank loans provide investors with many advantages, chief among them a floating rate feature that resets on a quarterly basis, benefiting the investor as interest rates rise. They also offer a senior secured top-of-an-issuer’s-capital-structure positioning, meaning that the bank loan investor has first-in-line access to the issuer’s assets should something go wrong. However, recent market dynamics have produced a phenomenon that cuts into bank loans’ attractiveness: re-pricings. A re-pricing is a renegotiation performed by the bank loan issuer with its bank loan investors. Typically occurring in rising rate periods, the re-pricing lets the bank loan issuer reduce the spread that makes up the total coupon it has to pay under its bank loan agreement. An example representative of several recent re-pricings is shown in this week’s chart.

The chart shows two time periods: one year ago (before re-pricing), on the left, and today (after re-pricing), on the right. One year ago, LIBOR, the base rate, was at 1.0%. The spread was 4.0%, making the total coupon, or yield, 5.0%. After the re-pricing on the right, as LIBOR increased from 1.0% to 1.5%–a direct result of the Federal Reserve’s recent rate hikes–the issuer has successfully renegotiated the spread from 4.0% to 3.5%. The total yield then remains at 5.0%. Bank loan issuers get to re-price only if the price of their bank loan exceeds par value, typically 101, and they can initiate re-pricings only after the non-call period ends, which typically lasts six to twelve months after issuance. High yield bonds, on the other hand, have much longer non-call periods, typically five years.

Currently, we are seeing large amounts of bank loan re-pricings. This is because of strong demand for bank loans, including re-priced bank loans, and a lack of supply in the form of new issuance due to low mergers and acquisitions activity, as the issuance of new bank loans is typically how an acquirer finances a take-over. Investors currently have an appetite for re-priced bank loans that is keeping the total yield after the re-pricing approximately equal to the total yield before the re-pricing. This phenomenon explains why bank loan spreads have remained close to their long term averages, as investors have not completely rushed into bank loans, which would have made spreads much tighter. We continue to recommend bank loans as a short-term and long-term allocation due to their moderate spread level, relatively strong yield (currently averaging 5.0%), and the aforementioned floating rate and senior secured features. As M&A activity picks up, we expect more new bank loan issuance, which would reduce the proportion of re-priced loans in the market, thereby raising overall yields on bank loan investment portfolios.

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EM and Max Draw Down

Through the end of May, the MSCI Emerging Markets Index has returned 17.3% year-to-date and 27.4% over the trailing 12-months.  This asset class has benefitted from improvements in the macro-economic environment that took place in 2016: stronger commodity prices, more stable currencies, and a better global economic growth outlook. With this change in backdrop, broad company fundamentals have improved including earnings growth and corporate profitability (as measured by ROE). Markets have taken notice and investor sentiment has shifted, resulting in positive fund flows into the asset class.

With all these good vibes in mind, this week’s chart looks at the annual max drawdown of the MSCI Emerging Markets Index. For every calendar year, even those with very strong returns, the index has experienced a double digit max drawdown. For example, in 2006, the max drawdown was 24%, but the calendar year ended with a 32% gain. Thus far, the max drawdown in 2017 is just 3%. Based on history, investors should not be surprised to see a double digit pullback in EM this year. Even if that occurs, a strong 2017 return is possible, as these types of swings have been par for the course in this asset class.

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