Category: Chart of the Week

Keeping the Lights On

While overall fundamentals for U.S. equity benchmarks have remained mostly resilient this year amid a painful repricing of risk assets, earnings growth has actually been concentrated in just a few areas of the market. The blended year-over-year earnings growth rate for the S&P 500 index during the third quarter of 2022 is 2.2% (with roughly half of companies reporting at the time of this writing), though only four sectors of the index have reported growth in earnings for the period. The Energy space stands out especially among these sectors, with its earnings up a massive 134% year-over-year amid strong demand for natural resources and continued commodity price inflation. Were the sector to be excluded from the S&P 500 index, earnings for the benchmark would be down 5.1% on a year-over-year basis, despite the fact that Energy accounts for less than 6.0% of the index. This trend is expected to continue into the fourth quarter, during which total earnings growth for the index is expected to be roughly 0.5%, with a decline of 3.5% excluding the Energy sector. For the full calendar year, S&P 500 index earnings are expected to grow 6.1% and decline 0.6% without Energy stocks.

Examining data below the index level is always important when assessing the health of equity markets and company fundamentals. To that point, simply looking at earnings figures for the S&P 500 index in aggregate obscures the fact that growth-oriented spaces of the benchmark like Communication Services and Information Technology, which are expected to post year-over-year earnings declines of 22.2% and 2.1% in the third quarter, respectively, are experiencing significant headwinds amid ongoing interest rate and inflationary pressures. These trends, however, are expected to reverse beginning in the second quarter of next year when, against tough compares, the Energy space is projected to become a detractor to overall earnings growth for the S&P 500 index while the rest of the benchmark grows earnings at a positive rate. With all of this in mind, investors should continue to employ a prudent approach to diversification across asset classes, geographies, and economic sectors, which will help position portfolios for success as market leadership rotates.

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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.

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.

When Not to Quit

One of the oft-touted advantages of investing in private equity is the opportunity to buy in at a discount to public markets. This valuation discount, as measured by EV/EBITDA multiples, has persisted since 2012, widening to nearly 60% in 2020.¹ Since that peak, the discount has narrowed significantly as public market equities have sold off. While this may give some cause to pause, it is interesting to consider what transpired for investors between 2009 and 2012, on the heels of a near-meltdown of the financial system. With equities down sharply into 2009, the denominator effect boosted percentage allocations to private equity within investor portfolios. The instinctive reaction (and in some cases, forced action) may have been to abstain from new private equity investments beginning in 2009 so as not to exacerbate the over-allocation. This may sound familiar to private equity investors in 2022.

With hindsight being 20/20, these corrections to annual capital commitments ultimately resulted in an under-allocation to private equity, and thus underperforming portfolios over the next decade, as public markets and public market allocations snapped back. Furthermore, while private equity will likely not see the type of drawdown that public markets have seen, we do expect valuations to pull back, creating attractive entry points for managers with dry powder to deploy capital. While investors should be mindful of any liquidity constraints and maximum allocations to private markets, those that are able to remain steadfast in their annual commitment pacing schedules may find themselves in a better position once the public markets settle. Marquette believes that a successful private equity program is one that is consistently diversified by vintage year over time and highly selective in terms of manager partnerships.

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¹Pitchbook, as of June 30, 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 Forgotten Man

While there has been no shortage of recent headlines dissecting the sorry state of the economy and markets, the average U.S. consumer is occasionally overlooked in that narrative. Year-to-date, the Federal Reserve has increased the federal funds rate by 300bps. As the Fed raises rates, the prime rate, or rate set by commercial banks, increases in tandem. For the average Joe, this means any interest rates that are not fixed increase as well, including credit card rates and adjustable mortgage rates. Consumers in the market for a home or vehicle also face higher fixed rates on new loans. This year, rates have reached highs not seen in years: mortgage rates — currently at 6.9% for a 30-year fixed loan — have not been this high since 2002, auto rates at 5.5% are the highest in more than 10 years, and credit card rates — at 16.3% — have never been this high in a data series dating back to 1994.

In an environment where the average consumer is already paying higher prices for fuel, food, and other staples due to soaring inflation, increasing credit card and auto loan rates add to the burden. While consumer spending has so far been fairly resilient to rising prices, the underlying dynamics are not sustainable. According to a Forbes survey from June 2022,¹ 67% of Americans have dipped into their savings for spending, with 31% either depleting their savings or using a significant portion of it. With all eyes on U.S. GDP, it is important to remember that consumer spending makes up 70% of the economy, and the health of the average Joe is what will determine our path from here.

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¹Forbes Advisor OnePoll survey, June 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.

Fighting Fire with Oil

Lower oil prices, primarily via lower gasoline prices, were a key contributor to headline CPI moving off peak in July and August. Since late September, however, oil and gasoline prices have started to rise again. In early October, OPEC+ — comprised of the 13 OPEC members and 10 additional major oil-exporting countries, including Russia — agreed to steep oil production cuts, decreasing supply in an already stressed market. The total production cut is estimated to be around 2 million barrels per day (bpd), approximately 2% of global supply and the biggest production cut since the start of the COVID pandemic.

The move is expected to prop oil prices back up — as similar production cuts have done historically — after the commodity had fallen considerably over the last three months amid fears of a global recession, the stronger dollar, and higher interest rates. Higher energy prices would weigh on European countries, which are more heavily reliant on Russian oil and already facing recession, as well as the U.S. consumer, with oil accounting for roughly half of the retail price of gasoline. Earlier this year Federal Reserve Chair Jerome Powell quantified the impact of higher oil prices, noting every $10 per barrel increase in the price of crude raises inflation by 0.2% and sets back economic growth by 0.1%. The decision also adds to already heightened geopolitical tensions, with President Biden pursuing consequences for Saudi Arabia, the de facto leader of OPEC, following the announcement. This evolving situation is one more unknown variable to monitor as we look for macroeconomic clarity.

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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.

Inflation: Expectations Matter

The announcement of another 75 basis point rate hike at last week’s FOMC meeting reaffirmed the Federal Reserve’s unwavering commitment to reducing inflation. One of the key variables the Fed watches to help it determine the path of rates is expected inflation. Inflation can become a self-fulfilling prophecy if consumers start pricing future inflation into their decision-making and businesses start making anticipatory adjustments to their prices and behavior. To combat this, the Fed strives to anchor expectations around a 2% target inflation rate. When long-term inflation forecasts deviate from that 2% target it means inflation expectations are not well-anchored, i.e., people believe that a short-term rise in inflation could lead to higher price levels longer-term.

Inflation expectations have moved further away from the 2% target over the course of 2022, something the Fed recognizes as a potential roadblock in navigating the current inflationary environment. Indeed, Fed Chair Jerome Powell stressed the importance of “expeditiously continuing to raise rates” to “ensure that longer-term inflation expectations remain well-anchored” at the June FOMC press conference.¹ With higher-than-anticipated August CPI figures, however — headline inflation of 8.3% and core inflation that reaccelerated to 6.3% — inflation expectations may remain higher for longer. Headline inflation is moving in the right direction, but core inflation, which remains well above Fed targets, tends to be stickier and may further complicate the Fed’s task. While there are no crystal balls, longer-term inflation expectations will continue to bear monitoring as investors search for potential indicators of a market bottom.

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¹ Lee, J., Powell, T., & Wessel, D. (2022, June 27). What are inflation expectations? Why do they matter? The Brookings Institute. Retrieved September 28, 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.

Midterm Madness

If inflation, rising rates, and a war in Europe were not enough to keep markets interesting this year, 2022 is also a midterm election year. Based on data over the last nine decades, midterm election years — while only marginally more volatile than non-election years overall — tend to exhibit a distinct performance pattern throughout the year. On average, returns during midterm years tend to be flat to slightly negative through the first three quarters as investor confidence is dampened by uncertainty around the outcome of the election. Historically, returns start to pick up as November draws near and tend to finish strongly, with fourth quarter returns in midterm years significantly stronger than non-midterm years. This holds true regardless of which party wins the House and Senate and whether or not there is a change of control, suggesting investors value predictability more so than a specific party controlling Congress. While each year is unique, and this analysis does not consider the deluge of other macroeconomics issues plaguing 2022, it is interesting historical context. Come November 6, there may be one less source of uncertainty in markets.

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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.

Go Green or Go Home

Accelerating energy innovation is proving to be a key driver of decarbonizing the economy and mitigating climate change and may also expand the opportunity set for infrastructure-focused investors. President Biden signed the Inflation Reduction Act of 2022 (“IRA”) into law on August 16th, 2022. The legislation is projected to raise $737 billion in revenue, require total investments of $437 billion, and reduce the deficit by more than $300 billion.¹ The IRA bill aims to help offset long-term inflationary pressure via targeted spending in clean-energy renewables and decarbonization initiatives over the next decade-plus. In addition, the bill will utilize tax credits and government subsidies to encourage household and commercial renewable energy purchases, clean-energy manufacturing, and decarbonization of domestic industries. As private equity and infrastructure investors digest the impact of the new legislation, we expect electric utilities and clean hydrogen production to be key beneficiaries of an increase in capital deployment. Infrastructure-focused strategies can provide exposure to these tailwinds while being ESG-friendly and more broadly helping to diversify a portfolio, provide a hedge against inflation, and generate attractive long-term risk-adjusted returns.

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¹ Inflation Reduction Act of 2022, Investopedia

This Exit Closed

Amid public market turbulence, venture capital exit activity and total exit value so far in 2022 are down significantly from peak 2021 levels. The venture-backed exit value in the U.S. came in just under $50 billion in the first half of the year. If this pace continues, 2022 is on track to come in at less than 15% of 2021 levels, returning to an exit value range last seen in 2017.

The number of acquisitions and buyouts as forms of exit are tracking close to 2021 numbers. Firms at the lower end of the market commonly use acquisitions and buyouts as exit strategies. This area of the market has also been more resilient against public market compares. Weakness in the IPO market — potentially on track for its worst year since Dealogic began tracking it in 1995 — is having the greatest impact on the decline in exit value. The IPO market has essentially shut down for venture capital-backed businesses. The familiar macroeconomic headwinds — high inflation, rising interest rates, and the risk of recession — have weighed on venture capital valuations alongside public market equities. Startups that were planning on an IPO are now forced to reevaluate their options. In the meantime, these companies have to rely on the strength of their balance sheets and the financial backing of sponsors. For companies still early in their life cycle and burning cash, liquidity may be a growing concern. Since valuations are down, VC managers are predicting 2022 could in theory be an attractive vintage year and entry point into the VC market. Partnering with VC managers who have experience investing through business cycles and periods of high and low valuations will prove to be important. Overall, with the outlook for the IPO market still uncertain, we are carefully monitoring the impact to the VC landscape and the potential impact to investors.

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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.