Category: Chart of the Week

Active Managers: The Mid-Year Report Card

Domestic equity indices suffered significant pullbacks in the first half of 2022 amid increasing investor concerns of a prolonged economic slowdown. Growth benchmarks were hit hardest given the recent focus on rising rates, although core and value indices across the market capitalization spectrum also notched negative returns during the period. These types of broad-based pullbacks are often conducive to active manager outperformance because, in theory, one of the main benefits of active strategies is protection during down markets. Fund managers are usually able to deliver on this proposition by avoiding speculative stocks with uncertain future cash flows that tend to drop precipitously amid corrections, instead gearing toward high-quality business with pricing power and robust earnings that are able to withstand market swoons. That said, the extent to which managers have been successful in notching returns in excess of their respective benchmarks this year has largely depended on investment style.

In the first six months of 2022, most value-oriented active strategies have done a good job protecting capital. Roughly 67% of managers in the large-cap value space have outperformed their relevant benchmarks, while 90% and 78% have done the same in the mid- and small-cap value spaces, respectively. Core strategies have had similar success. Just over half of large-cap core managers have recorded positive relative returns for the year, while 68% of mid-cap core and 78% of small-cap core managers have outperformed their respective benchmarks. The story is different on the growth side, however, where just 26% of active large-cap, 45% of mid-cap, and 36% of small-cap managers have been able to keep pace with or exceed relevant benchmarks. At a high level, performance of growth indices in 2022 has largely been driven by multiple compression rather than changes in earnings growth or company fundamentals, and active managers are more likely to lag in periods when valuation is the primary driver of market returns.

Marquette recommends allocating between active and passive management based on the efficiency of the underlying market. At the top of the market capitalization spectrum, outperformance has been notoriously difficult in recent history, with roughly two-thirds of all active U.S. large-cap managers trailing the S&P 500 on a trailing 10-year basis regardless of investment style. Mid- and small-cap strategies have had more success generating alpha over longer periods of time given the less efficient nature of those segments of the market, with the majority of managers outperforming their respective indices over the last decade. While even the most capable managers experience periods of underperformance, the case for active management within the U.S. equity space is certainly stronger further down the cap spectrum. Marquette will continue to source best-in-class strategies across all asset classes and recommend these strategies for inclusion in client portfolios where appropriate.

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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.

Fair or Free?

While developed economies across the globe are struggling with historical levels of inflation, the European Union and its 27 constituent nations are facing extraordinary economic challenges related to energy costs and security amid the ongoing Russia–Ukraine conflict. Against this backdrop, Germany posted its first monthly trade deficit in more than 30 years. Following the adoption of the euro in 2002, Germany built its economy around the cheap common currency, using its relative cost advantage to grow via exports. The country’s trade surplus expanded over the next several years, hitting a peak of more than 7% of GDP in 2017. Today, in the face of higher prices for vital imports like food and energy, and with supply chain disruptions impacting trade, that trade surplus has collapsed to a deficit. The Russia–Ukraine war has changed longstanding dynamics in the region and will likely have far-reaching implications, with one in four jobs in Germany reliant on the export market. With central banks around the world focused on controlling inflation, the risk of recession has continued to rise, with the outlook in Germany and broader Europe even more challenged following this latest data point.

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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.

Global Equities Still Well Above COVID Lows

Just over two years ago, on March 23rd, 2020, global equities hit their COVID-19-induced bottom. At their lows, the S&P 500, MSCI Emerging Markets Index, and MSCI EAFE Index were down 30%, 32%, and 33%, respectively, year-to-date. Over the next seven quarters, global equities produced mostly positive returns, with the S&P 500 leading the way. From the 2020 trough, the large-cap U.S. index was up an astounding 119% through the end of 2021.

This year, markets have faced several geopolitical and macroeconomic concerns that have squashed that positive momentum. Russia’s invasion of Ukraine in February and China’s rise in COVID-19 cases combined with its zero-COVID policy have worsened supply chain issues, exacerbated global inflation, and added to mounting economic pressures. To combat inflation, central banks have aggressively raised interest rates, which will likely further dampen economic activity. As a result of these headwinds, the S&P 500, MSCI EM, and MSCI EAFE benchmarks are all down roughly 17–19% year-to-date.¹ Despite these losses, global equities remain well above the COVID-19 trough, with non-U.S. equities still roughly 40+% higher and the S&P 500 77% higher. Looking forward, we expect global equities — particularly in developed countries — to face continued volatility in the second half of the year as central banks continue their fight against inflation, likely at the expense of economic growth.

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¹As of June 29, 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.

Private Equity — Living in the 21st Century

In 2011, venture capitalist Marc Andreessen wrote “software is eating the world,” and added that disruptors were “invading and overturning established industry structures.” Private equity firms were taking notes. Over the past decade, technology investments have steadily grown as a percentage of the global buyout market. In 2021, $284 billion in technology deals were closed, accounting for 25% of total buyout deal value and 31% of total buyout deal count — the largest share of any sector. Of that $284 billion, software deals comprised $256 billion. And while capital has flooded the sector, increasing competition for these businesses and driving up multiples, superior performance has continued, both in terms of lower loss rates and higher upside of outperforming deals.

Additionally, the value creation levers being pulled by private equity firms in the technology space appear sustainable. According to DealEdge, in fully realized global buyout deals between 2010 and 2021 with more than $50 million in invested capital, 71% of the value created in technology deals (excluding software) and 55% in software deals was driven by EBITDA growth, relative to 44% for all other sectors. These compelling return characteristics are due in large part to the operating models of these businesses — asset light, scalable, with high margins, and, in most cases, sticky, recurring revenue.

Despite the sector’s broad appeal, technology has proven to be a domain for specialists within the buyout market. The complexity of these business models, constant evolution in the technology landscape, and the need for expertise to lead these businesses at scale lends itself to investors who focus exclusively on the sector. LPs appear to share this sentiment, with more than $270 billion raised by technology-focused private equity firms in the past five years, equivalent to 13% of total global buyout capital raised during that time.

While technology and software stocks in the public arena have suffered over the last year-plus amid rising rates, private companies have not been subject to the same mark-to-market risk. The sector remains a driving force in innovation and economic value creation, and we expect exciting opportunities for private equity firms to persist.

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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 Apple Becomes the Forbidden Fruit

For much of the last two years, big name tech stocks had been tantalizing fruit for investors willing to pay up for growth. Enter 2022. After peaking on January 4th, the S&P 500 has taken a nosedive, led by those same tech stocks. Since 2018, the Information Technology sector has grown from a 20.1% weight in the S&P 500 to 26.8%, setting it up to now have an outsized impact as equities correct. The largest detractors year-to-date, regardless of GICS sector classification, have business models and value propositions rooted in technological advancement and innovation. The top eight detractors this year are Apple, Microsoft, Amazon, Alphabet, Meta, Tesla, NVIDIA, and Netflix. These eight stocks have cost the index more than 800 basis points year-to-date, almost half of the S&P 500’s -17.6% return.¹

Behind the outsized correction in technology stocks are macro headwinds and rising rates. The instability caused by the Russia/Ukraine war, COVID-related shutdowns in China, ongoing supply chain disruptions, and heightened inflation has led to shifts out of longer-duration growth stocks towards the perceived safety of assets like gold and value stocks. Rising rates are weighing on growth stock multiples and increasing recessionary concerns are reducing confidence in outyear earnings projections. Uncertainty is high and sentiment is weak, and while risks certainly remain, that may eventually help support a market bottom. Up or down, large tech stocks will continue to have a meaningful impact on broader market returns.

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¹As of June 10, 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.

High on Lithium

Electric vehicle (EV) sales have seen significant growth over the past several years. Recently, elevated demand has contributed to a rampant increase in lithium prices, a primary input to the batteries that power EVs. As the global transition to a clean energy economy continues, the demand for lithium is expected to rise exponentially, to the point of creating a supply shortage in the coming years. While the metal itself is not in short supply, there are limitations to the extraction process and investment in the space has yet to catch up with the rise in demand.

In the last two years, lithium prices have soared more than 700% as sales of EVs have hit record-breaking numbers. Demand for lithium, according to McKinsey & Co., is expected to increase more than sixfold to 3.3 million metric tons in 2030 from 0.54 million metric tons in 2021. Supply is currently projected to reach 2.7 million metric tons by 2030, leaving 0.64 million in demand unaccounted for. The lithium mining industry today resembles an oligopoly, with only a handful of companies responsible for the majority of global supply. Going forward, this could change as further investment is made into the space, which could in turn help normalize price levels. While mining is often thought of as the polar opposite of sustainability, lithium mining actually helps further green energy initiatives, and lithium-related investments may serve ESG-focused investors well over time.

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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.

Consumer Sentiment: Harbinger for Recession or a Reflection of Pain at the Pump?

U.S. consumer sentiment has become increasingly pessimistic in 2022 as a plethora of macro headwinds have created uncertainty. The University of Michigan Consumer Sentiment Index, a key proxy for consumer confidence, fell to 58.4 in May, the lowest reading since August 2011. The survey aggregates consumer views across a range of questions including personal finances, general business conditions, housing market conditions, spending expectations, and outlook. The overall level of the index and the relative change from prior readings provide an indication as to how consumers feel about the current and future U.S. economy. Since its inception in 1978, the survey has posted a reading below 60 in only three other distinct periods: the late stages of the stagflationary environment in 1980, the Global Financial Crisis in 2008–2009, and a brief period in 2011 when S&P Global Ratings downgraded U.S. Treasury debt.

Despite consumer spending comprising the majority of GDP, extremely bearish consumer sentiment has historically been a poor predictor of recession. Survey readings below 60 have coincided with a recession only 33% of the time (two out of six recessions) since 1978. Consumer sentiment surveys seem to be far more indicative of the current consumer experience than the longer-term economic outlook. As seen in this week’s chart, the University of Michigan Consumer Sentiment Index has shown a strong correlation to gasoline prices — a very visible component of inflation for most consumers — especially during periods of rising gas prices. While current sentiment can have a very real impact on economic growth via consumer spending, it is important to consider this metric alongside other economic measures, many of which still show consumer strength. With the market laser-focused on the health of the U.S. consumer and the risk of recession, we will continue to monitor various economic indicators and advise our 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.

Our Growing Stake in the Stock Market

Equity markets have experienced heightened levels of volatility throughout 2022 with the S&P 500 down nearly 20% from its high in January. A host of macroeconomic factors — 40-year high inflation, supply chain disruptions, the war in Ukraine, and hawkish central bank policy — are stoking uncertainty in the markets and driving stocks lower. With the consumer at the center of the biggest unknown — whether the U.S. will dip into recession — the growing connection between individuals and the equity market is an increasingly important dynamic.

It’s generally accepted that the stock market is not the economy, though today the lines are more blurred. The portion of household financial assets held in equities has been steadily increasing, reaching an all-time high of 41.2% at the end of 2021. Individuals have an increasing stake in equity performance, with fluctuations in the stock market directly impacting consumer balance sheets and spending potential, and thus economic growth. This dynamic further complicates the job of the Federal Reserve as it looks to raise rates enough to combat heightened inflation without extinguishing growth. While no one has a crystal ball, continued market volatility seems likely. That said, for long-term investors, history has shown that markets are resilient and staying invested leads to the best outcomes; we encourage investors to remain disciplined.

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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.

Money for Nothing?

Uncertainty remains at the forefront for the U.S. consumer, with decades-high inflation exacerbated by supply chain bottlenecks and geopolitical conflicts triggering a sharp change in monetary policy. April CPI rose 8.3% year-over-year, down slightly from March’s 8.5% but still well above the Fed’s 2% target and the second highest print since 1982. Supply side dynamics, with consumers facing shortages from baby formula to custom kitchen deliveries, complicate the job of the Fed, whose tools only impact the demand side.

Despite increases in nominal earnings in line with long-term trends, inflation has outpaced wage growth, resulting in a downtrend in real weekly earnings since early 2021. With job openings still far exceeding the number of unemployed workers, many sectors across the economy are looking to fill vacancies. While higher wages are one way to attract workers, the decline in real wages is unlikely to abate until inflationary pressures can be contained. Wage growth can be a double-edged sword, with higher wages helping the consumer but contributing to sustained inflation. As the Fed looks to engineer a soft landing, reining in inflation without tipping the economy into recession, health of the U.S. consumer will be key. So far, the U.S. consumer and the labor market remain strong, but there are many moving pieces and there is much more to be done to stabilize prices.

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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.