Category: Chart of the Week

It’s Getting Hot in Here

If global temperatures rise more than 1.5° Celsius the planet and its inhabitants could face severe consequences as a result of climate change. In 2022 — using temperatures from 1951–1980 as a baseline — the average global temperature rise was 1.4° Celsius, pushing the planet close to its tipping point. We are already experiencing more frequent and severe heatwaves, droughts, floods, and storms as well as rising sea levels and melting ice sheets. In fact, 2015–2022 were eight of the warmest years on record. The effects of rising temperatures are impacting people, ecosystems, and economies around the world and will only intensify in the coming decades unless we can bend the emissions curve and stabilize global temperatures.

To do so, the Intergovernmental Panel on Climate Change — a scientific body established by the United Nations and comprised of hundreds of climate scientists — has urged immediate, rapid, and large-scale reductions in greenhouse gas emissions. This would require systemic changes and large investments across all sectors of the economy, especially within energy, agriculture, transportation, heavy industry, and buildings.

For investors who are so inclined, there are a variety of methods to assist the cause, particularly for reducing portfolio-level climate risks as well as leveraging assets to foster society wide-decarbonization that aligns with a net zero future. Approaches can include engaging high-emitting companies to set science-based emissions reduction targets and create climate transition plans, increasing investments in “climate solutions” such as renewable energy infrastructure, assessing portfolios and assets for exposures to physical and transition-related climate risks, and subjecting a portfolio to climate-related stress tests and scenario analysis. Of course, all of these approaches involve trade-offs between risk, return, and impact; investors will ultimately have to decide the appropriate balance among these principles based upon overall portfolio and organizational goals.

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Source: See IMF data on annual surface temperature changes

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 Eagle Has Fallen

When First Republic Bank’s 84 branches opened Monday morning, they belonged to the since-failed bank in signage alone after a tumultuous several weeks marked by depositor flight and a portfolio of loans that had dropped substantially in value amid rising interest rates. Three of the four largest U.S. bank failures have occurred in the past two months, with First Republic, now the second-largest bank to fail in U.S. history, behind only the 2008 collapse of Washington Mutual, the latest.

Despite an initial $30 billion lifeline from the U.S.’s largest banks in the wake of the Silicon Valley Bank (SVB) collapse, First Republic went on to lose more than $100 billion in deposits during March. Regulators took control of First Republic and oversaw a sale to JPMorgan Chase on Monday morning. JPMorgan, already the nation’s largest bank, will take on all $92 billion of deposits remaining at First Republic and “substantially all” of its assets, including $173 billion of loans and approximately $30 billion of securities. As part of the agreement, the FDIC will cover some of First Republic’s loan losses and provide JPMorgan with $50 billion in financing, with the deal estimated to cost the FDIC roughly $13 billion. JPMorgan will also return the $25 billion in uninsured deposits its large peers deposited into First Republic as part of the Treasury’s March plan to prop up the bank.

While the U.S. banking system is not yet out of the woods, the demise of First Republic, another regional lender with a concentrated depositor base and an investment portfolio that was overly exposed to rising rates, does not come as a surprise and does not change the contagion narrative. Markets have remained calm with generally solid earnings reports from other regional banks and ongoing support from the FDIC. While overall macro uncertainty remains, the risk of a broader breakdown in the U.S. banking system does not seem to be an imminent threat.

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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.

Unleashing the Power of AI

The launch of ChatGPT — a chatbot technology that can mimic human-like understanding and generate well-crafted, conversational responses — marks a pivotal moment for artificial intelligence (AI). Similar to the mainframe era of the 1950s, the rise of PCs in the 1980s and 1990s, and more recently the mobile and cloud era, AI could become the next technology platform that drives significant productivity gains and transforms our world.

The advancement of AI systems has resulted in increased adoption of the technology by various organizations, including businesses and governments. While the integration of AI within the economy brings excitement, it also raises questions about its impact on productivity, the potential displacement of human workers, and whether it will be used ethically. While limited adoption prevents us from being able to fully measure the effects AI could have on the workplace, the chart above summarizes the cost savings and revenue benefits noted by firms that have implemented AI within their organizations. On the cost side, the functions most widely benefiting from AI adoption were supply chain management (52%), service operations (45%), strategy and corporate finance (43%), and risk (43%). On the revenue side, respondents broadly saw increases in marketing and sales (70%), product and/or service development (70%), and strategy and corporate finance (65%). While there are fair criticisms of AI, the potential benefits are clear. As we continue to navigate the rapidly evolving landscape of AI, we must work to ensure that this powerful technology is harnessed in a way that benefits both individuals and society as a whole. By doing so, we can unlock the full potential of AI as the next transformative technology platform.

GICS Reclassifies Away From Tech, Again

The Global Industry Classification Standards (GICS) were established in 1999 by MSCI and S&P Dow Jones Indices to categorize publicly-traded equities. Broadly accepted across the industry, the GICS classification system undergoes an annual review, which has resulted in only 12 updates to the classification system since inception. These updates can have significant impacts on the underlying performance drivers of sectors as well as the concentration of sector-specific indices. The Technology sector has been meaningfully impacted by the two most recent updates. In 2018, GICS broke the Technology sector up to create the Communication Services sector, which includes FAANG stocks Meta, Netflix, and Alphabet. While the update was less consequential this year, it again relocated some of the Tech sector’s largest constituents, increasing its concentration to new highs.

Effective after the close on March 17, 2023, 14 firms were reclassified, impacting five GICS sectors. Notably, Visa and Mastercard, previously two of the five largest Technology companies, along with PayPal, Fiserv, and others, were reclassified as Financials. As a result, the Financials sector is now more exposed to growth factors, including, on the margin, valuation risk from rising rates. The Technology sector, conversely, has become even more concentrated in two mega-cap stocks — Apple and Microsoft. The resultant weighting and concentration changes will impact active manager attribution metrics as well as the exposures achieved via sector-specific ETFs and are important for investors to be aware of. Lastly, while not implemented this year, another key proposal discussed concerned renewable energy companies. These stocks are generally categorized within the Energy and Utilities sectors, and future changes could represent another meaningful shift in GICS classifications.

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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.

Power Concentrated in the Hands of a Few

2022, marred by macro uncertainty and aggressive rate hikes, marked the worst year for the S&P 500 since the Global Financial Crisis. Given the sensitivity of growth stocks to increasing rates, technology-related equities underperformed and significantly detracted from the S&P 500 given the group’s large index weighting. In the first quarter, however, technology rebounded strongly — with the Information Technology sector up almost 22% and Communication Services up 20.5%, relative to the broad index +7.5%.

FAANG, comprised of Meta (formerly Facebook), Apple, Amazon, Netflix, and Alphabet (Google), is a well-known group of five large tech stocks. Although only five companies, the group contributes significantly to the performance of the S&P 500, positively or negatively, given the aggregate market capitalization of the stocks. The group reached its largest combined weighting in the index — 19.9% — at the height of COVID in August 2020, before retreating to a still-outsized 13.4% in early January 2023. Amid tech’s first quarter rally, FAANG alone drove almost half of the S&P’s 7.5% return and ended the quarter at 15.9% of the index. While there are many different macro and micro factors at play, the path of these mega-cap tech stocks will continue to be a key determinant of index returns.

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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.

Direct Lending is Eating the World

In 2011, Marc Andreessen famously proclaimed that software is eating the world, meaning more and more industries and businesses are relying on software for their operations. This statement has since proved incredibly accurate, as evidenced by our daily dependence on software applications. What was said about software over a decade ago can be said about direct lending today, supported by the growing percentage of companies that rely on direct lenders or private credit managers to finance their operations. Direct lending is a form of financing where borrowers receive loans directly from lenders, without intermediaries such as banks or financial institutions. In this type of lending, borrowers can access funds more quickly and with more flexibility than via traditional lending channels. The terms and conditions of the loans are typically negotiated directly between the borrower and lender, allowing for greater customization and potentially more favorable rates for borrowers.

A number of different supply and demand tailwinds have contributed to the growth of direct lending, including a shift in banking practices post-GFC, including Dodd-Frank legislation and Basel III, the growth of private equity and its preference for direct lending financing, and the investment premiums inherent to the asset class. From here, Marquette expects direct lending to continue to grow, providing attractive investment opportunities for clients. The fallout from the failure of Silicon Valley Bank and the issues facing regional banks may continue to force small and mid-sized borrowers into the arms of private credit lenders. Private equity managers, who tend to prefer financing provided by non-bank institutions over those influenced by the mercurial nature of traditional capital markets as well as the certainty of execution offered by direct lenders, are armed with a record nearly $2 trillion in dry powder.¹ And lastly, we believe institutional investors will continue to allocate to direct lenders and private credit given the attractive risk-adjusted returns and portfolio diversification benefits the asset class provides, particularly in today’s challenging market environment.

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¹Thomas, Dylan. “Global Private Equity Dry Powder Approaches $2 Trillion.” S&P Global, December 21, 2022.

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 Link Between MiGs and Treasury Curves

In the movie Top Gun, Charlie asks Maverick, “Well if you were directly above him, how could you see him?” Maverick’s response left Charlie in a state of shock: “I was inverted.” That same sense of shock hit bond investors as the Treasury curve inversion breached 100bps on March 7. Treasury curves are normally upward sloping with shorter maturity notes having lower interest rates than longer maturity bonds. The spread between 2-year Treasuries and 10-year Treasuries is a commonly cited statistic to describe the shape of the Treasury curve, with the 2-year note sensitive to Fed policy and the 10-year note driven by economic growth and inflation.

Treasury curves generally flatten when the fed funds rate rises, via a rise in the 2-year yield, and steepen when the fed funds rate falls, via a lower 2-year yield. A flattened Treasury curve typically steepens as higher rates drive up unemployment and push the economy toward recession, leading the Fed to cut rates. Though less likely, a flat curve could also steepen via rising back-end rates, which would require strong global growth forecasts with natural levels of inflation and unemployment.

The Fed first started to raise rates in 2016 after holding near zero following the Global Financial Crisis. The curve started to flatten and the spread between twos and tens approached zero. The Fed eased off its slow hiking cycle in 2019 and the curve started steepening. In 2020 as COVID hit, the Fed quickly took the fed funds rate to zero and pushed the curve to 50bps. The curve further steepened as back-end rates moved higher with inflation, to a peak of 158bps in 2021. With heightened inflation proving to be more sustainable than initially expected, the curve started to flatten as the market anticipated rate hikes. As the Fed continued to raise rates throughout 2022, the curve moved from flat to inverted, hitting -56bps by year-end.

While 2023 has seen the magnitude of rate hikes slow, the Fed has reiterated that it would maintain its restrictive policy stance until inflation was tamed. After a hot jobs number and an unexpected pickup in PCE inflation, the curve hit its most inverted — -109bps on March 8. Days later, two regional U.S. bank failures (Silicon Valley Bank and Signature Bank), the collapse of Credit Suisse, and the subsequent change in tone from Fed Chairman Powell at the FOMC’s March meeting led to expectations that the hiking cycle is near its end, causing the Treasury curve to steepen. The curve hit -40bps before returning to -60bps to end the first quarter. So far, the curve steepening has followed typical patterns — the 2-year fell by 68bps in March, while the 10-year was down 38bps.

The shape of the Treasury curve varies over time. Market forces are more impactful further out on the curve, but short-term rates are heavily impacted by Fed policy. The curve flattened and then inverted as the Fed raised rates. While no one has a crystal ball, the most likely outcome from here is that the curve will steepen once the Fed starts cutting rates, causing the 2-year to follow.

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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.

Central Bankers Unite

Over the weekend it was announced that UBS will buy beleaguered Credit Suisse for $3.2 billion after a drastic plunge in Credit Suisse’s share price. The terms of the deal will see Credit Suisse shareholders receive 1 UBS share for every 22.48 Credit Suisse shares held. The Swiss National Bank has pledged a loan of up to 100 billion Swiss francs ($108 billion) to support the takeover and shore up any liquidity and the Swiss government announced that it would provide more than 9 billion francs to backstop some of the losses that UBS may incur as a result of the merger. Until the completion of the deal, expected by the end of 2023, Credit Suisse and UBS will operate as separate businesses and are conducting business as usual.

The shotgun deal, which follows turmoil in the U.S. banking system over the last few weeks, was brokered by Swiss authorities to prevent serious damage to the Swiss and international financial markets. Banking concerns have pushed global central bank authorities to coordinate a response to maintain sufficient liquidity in the global financial system. The U.S. Federal Reserve, Bank of Canada, Bank of England, European Central Bank, and Swiss National Bank have agreed to use standing U.S. dollar swap line arrangements to enhance liquidity. Separately, on March 22, the U.S. central bank will announce its next policy decision. Markets will be closely watching not only the action taken but Chairman Powell’s comments on the strength of the U.S. economy and global financial system given the recent banking turmoil.

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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.

Bank Failures: Past and Present

Recent developments within the banking industry have revived difficult memories of the Global Financial Crisis (GFC). As many will recall, hundreds of financial institutions failed during that period, including Washington Mutual (WaMu), a savings and loan organization with approximately $307 billion in assets at the time of its collapse. The Federal Deposit Insurance Corporation (FDIC) ultimately sold the banking subsidiaries of WaMu to JP Morgan for $1.9 billion, marking the largest U.S. bank failure in history. In total, 25 banks with combined assets of more than $373 billion closed their doors in 2008, with additional failures in 2009 (140 banks) and 2010 (157 banks). In response to the widespread impact of the GFC, the federal government enacted many new laws and regulations pertaining to the financial sector, which resulted in greater industry oversight and more robust stress tests of bank operations. While additional failures have occurred since the GFC, most banks have been healthy and resilient in the last decade, including during the COVID-19 pandemic. All told, a total of just eight banks with a combined $678 million in assets failed from 2018–2022.

Needless to say, dynamics within the domestic banking industry have shifted in the last several days. After a run on its deposits, Silicon Valley Bank, which had once been the 16th largest bank in the United States, failed and was placed into receivership of the FDIC on March 10. Silicon Valley Bank is now the second-largest bank to fail in American history, with approximately $209 billion in total assets and $175 billion in deposits at the time of its collapse. Signature Bank was the next domino to fall over the weekend, again due in part to a run on its deposits, and now stands as the third-largest U.S. bank failure ever ($110 billion in assets and $88.6 billion in deposits). While these two cases represent the only bank failures thus far in 2023, many regional banks have seen their share prices drop significantly amid fears of contagion.

It is important to remember that while GFC-inspired regulations were designed specifically to mitigate the fallout from these types of events, the situation related to recent bank failures is fluid and could have ongoing impacts on global markets and central bank interest rate policy. Marquette will continue to monitor dynamics within the banking industry and provide updates and counsel to clients accordingly.

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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.

Emerging Markets Take the Reins

Following a year of heightened volatility, stubborn inflation, and intense monetary tightening, global economic growth is expected to slow in 2023 and remain below trend in 2024. Based on the IMF’s forecast, global growth during that period is expected to be driven by emerging markets and developing economies.

The two countries projected to see the strongest economic growth are China and India, with China forecasted to grow 5.2% in 2023 and 4.5% in 2024, and India 6.1% and 6.8%, respectively. China is one of the world’s largest economies and is rebounding following three years of strict COVID policies. However, a number of risks plague investors, including regulatory and governance issues as well as geopolitical concerns. Additionally, China, a leader in lower-cost labor and manufacturing, is facing an aging population and declining workforce, with the country experiencing a net population decline in 2022 for the first time in decades. India, with a population that is expected to surpass China’s this year, is projected to become the world’s third-largest economy and stock market in the coming decade. Optimism surrounding the Indian economy can be attributed to its ongoing structural reforms, tariff negotiations with the West, young and growing population, and robust domestic demand. These factors have helped India weather the storm of recent economic uncertainty better than other emerging markets. As the world is projected to enter a period of slower economic growth, investors will benefit from remaining well-diversified as inevitable bright spots emerge with the ever-changing composition of the global economy.

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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.