Author: mgyurcsik

Profits and Employment: A Balancing Act

Following last week’s preliminary annual benchmark review from the Bureau of Labor Statistics that suggested U.S. job growth has been weaker than initially estimated, investors have been closely monitoring the labor market for signs of strain. Corporate profit margins may be particularly important to watch as they directly impact the labor market and have historically served as a leading indicator of layoffs and economic frailty.

Using the quarter-over-quarter percentage increase in average initial jobless claims as a proxy for changes in employment, this week’s chart highlights the relationship between the labor market and pre-tax corporate profit margins. Over the past three decades, corporate profit margins have generally trended higher and sit at approximately 12.2% today. While current margins are down slightly from recent cycle peaks, they remain elevated compared to historical levels. This signals that corporate profitability remains relatively robust. Despite challenges caused by higher rates and inflationary pressures, these higher margins have allowed companies to avoid significant layoffs by tapping into other cost-control measures as needed. Given that workforce reductions are often seen as a last resort for companies due to the high costs associated with obtaining, training, and retaining employees, significant layoffs typically do not occur until corporate profit margins have declined precipitously from cycle peaks. The orange line illustrates this point by showing sharp increases in initial jobless claims during economic downturns, including the Dot-Com Bubble, the Global Financial Crisis, and the COVID-19 pandemic, during which quarter-over-quarter jobless claims spiked by an astonishing 165%.

While there were certainly other dynamics at play during each of these recessionary periods, significant increases in layoffs generally coincided with slower growth and material declines in corporate profitability. These trends underscore the importance of monitoring these indicators in tandem.

2 vs. 2000

A key metric that many investors use to measure the size of a company is market capitalization, which represents the total number of a company’s outstanding shares multiplied by the current market price per share. U.S. Steel became the first company to cross the $1 billion market capitalization threshold when it went public in the early 1900s. The first company to reach $10 billion in market capitalization was General Motors in 1945, and General Electric passed the $100 billion mark roughly 50 years later. More recently, two mega-cap technology companies crossed the $1 trillion milestone. Apple was the first to accomplish this feat in 2018, having come a very long way from its market capitalization of around $2 billion at the time of its initial public offering during the 1980s. The second company to gain membership into the exclusive $1 trillion club was Microsoft in 2019. These two behemoths have continued to achieve new market capitalization milestones in recent time, with both surpassing the $3 trillion mark within the last year.

One notable fact related to these dynamics is that in 2023 both Apple and Microsoft became larger than the entire Russell 2000 Index, a market capitalization-weighted benchmark that tracks the U.S. small-cap universe. While this is in large part due to robust growth of these technology giants, poor performance from smaller companies in recent years has also given rise to the trends depicted in this week’s chart. All of this being said, recent pressure on Apple shares, in conjunction with a small-cap rally to close out last year, has led to Apple falling back below the $3 trillion mark and the Russell 2000 Index, which now sits at roughly $2.95 trillion in total market capitalization. It is possible that Microsoft will soon follow suit given concerns related to its potentially lofty valuation, as well as the relatively attractive multiples of small-cap equities in general.

Chinese Equities Down 17% in October

2022 has been a difficult year for Chinese equities, which are now down 43% year-to-date through October. In comparison, the MSCI Emerging Markets (EM) ex China Index is down 23% over the same period, while the MSCI World Index, a developed markets benchmark, is down 20%. It has been a seesaw year so far as Chinese equities underperformed in the first quarter, down 14% while the EM ex China index lost 3%. In the second quarter, China was one of the few countries to generate a positive return (+3%) as the EM ex China benchmark declined 18%. In the third quarter, the China index was down sharply again – -22% – with the sell-off carrying into October as other markets globally rebounded. China was down 17% in October – the worst month for the country benchmark in 11 years.

Over the course of the year there have been three key challenges to Chinese equities: 1) continuation of the zero-COVID policy, 2) property sector troubles, and 3) geopolitical issues. For most of the year, markets have reacted to various news and events centered on these three topics. More recently, markets turned sharply negative following the country’s Party Congress where President Xi Jinping was elected to an unprecedented third term and further consolidated power within the newly elected governing body. While there were hopes that the focus would shift to the economy following the Party Congress, President Xi went on to reaffirm China’s zero-COVID policy, casting a shadow over future economic growth. Chinese equities fell 8% the day after the Party Congress concluded, ending the month down 17%. Trailing and forward price-to-earnings multiples now sit close to twenty-year lows. From here, markets are likely to remain choppy, presenting both risks and opportunities to investors, until there is additional clarity regarding China’s zero-COVID policy and property sector, as well as broader geopolitical issues and China’s intentions.

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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.

Picking up the Pieces: Assessing the Economic Impact of Hurricane Ian

The 2022 hurricane season is the latest headwind in a challenging year for investors. Last week, Hurricane Ian made landfall in Florida as a powerful Category 4 hurricane, unleashing heavy rains, high sustained winds, and extensive flooding along the coast. While the full extent of damages and the ultimate impact on the U.S. economy will not be known for several months, preliminary estimates indicate that Hurricane Ian will rank among the top 10 costliest storms in U.S. history. Current estimates of Hurricane Ian’s total cost — including damages and lost economic activity — range widely from $65 billion to as much as $120 billion. While several industries across the southeastern United States have been negatively impacted, Hurricane Ian’s overall impact on U.S. GDP is expected to be limited. Recent analysis by EY Parthenon, Ernst and Young’s global consulting arm, projects GDP to be reduced by 30 basis points in Q3 and 10 basis points in Q4 as a result of the hurricane. Natural disasters tend to have short-term economic consequences, with lost economic output recovered over time as federal assistance and insurance payouts allow communities to rebuild. Reconstruction efforts can also provide a temporary boost to GDP. As with other sources of uncertainty, Marquette encourages investors to maintain discipline and stick to long-term strategic allocations to best weather the market’s storms.

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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.

Digital Assets as an Inflation Hedge?

With inflation a top concern for investors, digital assets and cryptocurrencies have reemerged in several narratives as a potential inflation hedge. Crypto proponents have long purported bitcoin as deflationary, citing the crypto’s finite supply and diminishing mining rewards. This week’s chart looks at daily market values of the S&P 500, CPI, bitcoin, and the Cryptocurrencies Index 30 (CCi30), supplemented with correlations. The CCi30 is an index of the top 30 free-floating digital assets by market capitalization, designed to objectively measure the performance of blockchain-based assets, excluding pegged assets known as stablecoins.

Typically, an inflation hedge should correlate and increase in value as inflation increases. The data suggest digital asset performance relative to inflation is intermittent with negligible correlations ranging between -0.02 and 0.03 over the trailing 1-, 3-, 5- and 10-year periods. Although there have been several periods – April 2020 and May 2021 – where digital assets moved in step with inflation, there are just as many divergent periods – May 2017 or January 2022. With U.S. adoption of crypto prior to 2020 largely driven by retail investors and opportunistic hedge funds, it is possible that the observed crypto-inflation correlations were the result of short-term momentum and investor sentiment. Looking ahead, advances in institutional adoption could change the crypto-inflation dynamic, with implications for market behavior, volatility, and portfolio application. At this point, however, there is little evidence that cryptocurrencies offer a hedge against inflation, but given the limited data available, this is worth monitoring over the coming years.

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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 More the Merrier?

A driving force for most investors seeking to add a private equity allocation to their portfolios is the strong performance that the asset class has consistently generated over time. Since 2009, the total number of global private equity investors has more than tripled, growing to nearly 10,000 global investors at the end of 2020.  The asset class has historically experienced a 5%-15% increase in the number of new investors on an annual basis, however the growth of new private equity investors has been 10%-15% in recent years. We believe these growth figures will remain elevated due to continued strong demand, which is largely driven by return targets, strong equity markets, and portfolios that have become larger and better able to accept illiquid private market allocations.

As more investors enter into the private equity space, it will likely become more difficult to access top performing managers due to fund size capacity constraints and the deeply established relationships that formed between early investors and these managers as they grew their platforms. Investors who are unable to gain exposure to the funds of established managers will need to seek out emerging managers for allocations.  While these emerging managers have historically provided a higher median return due to strong incentive alignments and smaller fund sizes, they have come with a much wider range of performance outcomes.  New and existing investors are likely to require guidance as difficult choices will need to be made when it comes to either constructing a new private equity program or refining an established program. To that point, difficult selections must be made as many managers are both returning to the market more quickly than they have in the past and raising larger funds with capital deployment outside their historical focus.

All of this being said, investors should not be deterred from exploring the value of an allocation to the private equity space given the benefits the asset class provides, including diversification and the potential for strong absolute returns. While the private equity investor universe is mostly comprised of larger, institutional investors like pension plans, endowments, and foundations, high-net-worth individuals and families have increasingly made allocations to private equity investments in recent years. We would encourage clients with sizeable asset levels, the ability to build diversified programs, and appropriate tolerances for the illiquidity associated with these types of investments to consider adding an allocation to private equity within their portfolios in a prudent and thoughtful manner.

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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.

Multifamily Matters

Amid ongoing vaccination progress and an improving U.S. economy, we are seeing a recovery across property sectors – those that were most impacted by the pandemic as well as those that proved relatively resilient, like the multifamily sector. Apartment landlords have greater flexibility to adjust rents at a faster pace than other core sectors, allowing the group to better adjust to landscape changes accelerated by the COVID pandemic and near-term inflationary trends. This, in turn, gives investors the opportunity to position their portfolios to capitalize on these relative advantages.

Already, overall apartment occupied stock has increased to a level 20% above the prior 2000 peak. This demand has driven up effective multifamily rent growth, as seen in the chart above. While expected to moderate from here, national apartment rent growth is forecasted to stay above recent levels, increasing an average of 4.7% and 4.5% in 2021 and 2022, respectively1, driven by ongoing economic expansion and an expected hiring boom. The U.S. economy is expected to add an estimated 12 million new jobs between 2021 and 2023, particularly impacting demand across sunbelt regions and tech hubs, where suburban rentals have outperformed and urban core sub-sectors have rebounded. ² On an ongoing basis, flexible work from home policies will impact where people prefer to live, likely pushing the demand for additional living space and driving effective rents across unit types.

From here, with the added uncertainty brought on by COVID-19 variants, we may see multifamily demand and rent continue upward, or we may see the sector lose momentum from increasing supply or the downstream effects of the recent end to the eviction moratorium. Ultimately, we will continue to look for the best risk/reward opportunities in the evolving real estate space, helping our clients maneuver through the changing dynamics.

1 Real Page, CBRE-EA, Clarion Partners Investment Research, Q2 2021. Note: U.S. apartment rent growth forecast is provided by RealPage as of July 2021

² Moody’s Analytics, CBRE-EA, S&P CoreLogic Case-Shiller National Home Price Index, Clarion Partners Investment Research, August 2021

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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.

Private Credit: Consistency is Key

We are all familiar with adages like “consistency is the key to success” and “excellence is mundane”. For private credit, consistent returns achieved in a straightforward way bring these statements to life. Recent data1 has shown that from 2004 to 2021, U.S. private credit has generated positive or flat performance throughout the economic cycle – from expansion, to late cycle cooling, through a recession and into a turnaround. The same cannot be said for U.S. high yield and leveraged loans, which have historically contracted during recessionary periods. Private credit has outperformed both high yield and leveraged loans during expansionary and late cycle stages, only underperforming in the turnaround phase when the ISM Manufacturing Index is less than 50 and rising. The straightforward, perhaps ordinary nature of these loans, loans to businesses from non-bank lenders, makes the asset class even more interesting in our opinion. Marquette advocates allocating to private credit in order to capture two premiums – yield premium and structure premium – which are especially compelling in today’s low interest rate environment. Moreover, the data shown in the chart above gives quantifiable evidence that the asset class is also a solid diversifier to a traditional fixed income allocation. We continue to find attractive managers and strategies in the market for investors who already have a dedicated private credit allocation and would be happy to further discuss with others interested in the space.

1https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/guide-to-alternatives/mi-guide-to-alternatives.pdf

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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.

Welcome Back…to the Grind

Uncertainty lingers in the office sector against a backdrop of extended office closures across the U.S. Average occupancy rates have dropped over the past year and net absorption further declined in the first quarter of 2021. The national average vacancy rate for the office sector rose to 16% in Q1 2021, up 100 basis points quarter-over-quarter and 370 basis points year-over-year.¹ The ongoing rate of deterioration in office fundamentals has been somewhat surprising given the rebound in the labor market as the economy has reopened. Although office rents have been sticky so far, questions remain about the longer-term demand for office space, with some property owners offering leasing concessions in primary markets hit hardest by vacancies.

The second half of the year should provide some clarity with the COVID-19 vaccine rollout in full swing and more and more employees expected to return to work. The long-term extent of remote working on office demand is the biggest outstanding question. Average days in the office has fallen from 4.6 days a week to 3.6 days a week.² Employers are re-evaluating office space needs, looking to balance a flexible work environment with the benefits of workplace collaboration and productivity. Rising new supply combined with more than a year of minimal leasing activity will also continue to put downward pressure on office rents and occupancies in the near term. From here, we may see office demand stabilize, setting the stage for an uptick in leasing activity, or we may realize we are facing a new normal. We will continue to look for and recommend to our clients real estate managers that we believe are best positioned to navigate this evolving dynamic.

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¹ Cushman & Wakefield, KPMG, The 2021 KPMG CEO Outlook Pulse Survey, Clarion Partners Investment Research, June 2021.
² TA Realty, Defining Themes of 2021

 

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 Recovery: A Closer Look at Sector Performance

The S&P 500 hit its Covid-induced trough on March 23rd, closing at 2237 points. Since then, it’s more than made up its losses, setting new records in the process. As detailed in a May Chart of the Week, “There’s FAAMG and Everyone Else”, technology companies have driven this recovery, spurred by a variety of increased demand attributable to remote work and schooling, online shopping, and virtual socialization, among others.

Despite technology companies grabbing the headlines, not all are classified as Information Technology by the GICS® sector classification system used by Standard & Poor’s, as one might assume. For example, the top five constituents within the S&P 500 in order are Microsoft, Apple, Amazon, Facebook, and Google parent Alphabet (FAAMG stocks), only two of which are classified as Information Technology (Microsoft & Apple). Amazon is Consumer Discretionary because of its retail focus, while Alphabet and Facebook are Communication Services. Amazon as a Consumer Discretionary stock helps explain the sector’s on par performance with Information Technology since the market bottom. Its stock price increased by 81% from March 23rd through August 31st, while Apple’s recovery over this same timespan was +131% with Facebook (+98%) not far behind.

Financials has been one of the weaker performing sectors in the recovery, as banks and other financial services companies have seen their bottom line potential shrink with Fed rate cuts. This only added to the struggle that these traditionally value-oriented firms have had keeping up with their new economy, growth-oriented counterparts. Berkshire Hathaway is the only Financials company in the top ten of the S&P, and the conglomerate’s lackluster recovery (+34% through this time period) resembles the sector as a whole. Visa is also a top ten index constituent; however, it’s classified as Information Technology. It has seen a moderate recovery of +56% over the noted timeframe.

As shown in the chart, the S&P 500 sits near the middle in recovery performance when compared to individual sectors. The S&P 500 ex-Information Technology isn’t far behind, which is surprising at face value but more understandable after considering that some tech behemoths fall into other sector classifications. As technology continues its ever expanding importance in the economy and daily life, it’s safe to assume that products and services based on technology, but outside the realm of traditional IT, will continue to grow in size and relevance.

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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.