Category: Chart of the Week

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.

Can the Fed Thread the Needle?

All eyes are on rates this week as the Federal Open Market Committee (FOMC) convenes for the third time this year. In the seven weeks since the March meeting when the Committee raised rates an initial 25 basis points, continued inflationary pressures and an increasingly hawkish tone from Chairman Powell and other FOMC members have driven up market expectations for future hikes. The futures market has gone from pricing in a total of six 25 basis point increases and a year-end federal funds rate of 1.94% to ten hikes, including three consecutive 50 basis point increases, and a year-end rate of 2.81%. If market expectations prove correct, it would be the steepest pace of increases since the 1980s.

For a central bank that never quite normalized policy after the GFC, cooling decades-high inflation without tipping the economy into recession amid strained supply chains, a war in Europe, and COVID lockdowns in the world’s second-largest economy will be no easy task. Recent market volatility and sentiment reflect this uncertainty, with both equities and bonds down sharply year to date. While first quarter U.S. GDP “growth” of -1.4% missed expectations, the contraction was driven by trade and inventories as opposed to a consumer slowdown. The U.S. consumer is still strong, but the path forward is uncertain, with the yield on the 10-year Treasury — a key reference point for borrowing costs — briefly surpassing 3% yesterday for the first time since 2018. The Fed has to consider many moving pieces as it plans its path from here, and we look forward to hearing more about that process at Chairman Powell’s press conference tomorrow.

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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.

Lockdowns Lead to Slowdown

COVID cases have been on the rise in China over the last ten weeks, surpassing February 2020 highs by 800%. The seven-day rolling average has moved from 110 new cases at the end of January 2022 to a high of 30,500 on April 21st. Since the beginning of the pandemic, China has operated with a zero-COVID policy, combining testing and tracing with the use of lockdowns to prevent the spread of the virus. These measures have resulted in an extremely low case count compared to the rest of the world. The country’s recent high near 30,000 is still well below the U.S. seven-day average peak of 800,000 in January 2022.

China’s aggressive use of lockdowns to control the spread of the virus has impacted the country’s economic activity. March’s Purchasing Managers Index (PMI) reading was 48.8, below the neutral 50 mark, indicating a contraction in economic activity. Several Chinese cities are feeling the pressures of the recent lockdown, including Shanghai, a key finance and manufacturing hub. Many investors expect Chinese authorities to step in with supportive policies to help the country navigate the current downturn. Ultimately, however, China may need to choose between two of its seemingly opposing agenda items — its zero-COVID policy and its 5.5% target growth rate — with the choice likely to have material implications for equity markets for the rest of 2022.

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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.

What Do the Internet and Cryptocurrencies Have in Common?

Discussions surrounding cryptocurrencies and digital assets have become more common in recent months as investors seek opportunities for future growth amidst high headline inflation and mounting recession concerns. While the narratives regarding digital assets vary widely, one of the more intriguing dialogues to emerge is the broad adoption comparison between the internet and crypto.

Illustrated in green on the left is global internet adoption in its first 10 years; measured as the total number of internet users, global internet users as a percent of world population, and U.S. internet users as a percent of the U.S. population. Similarly, illustrated in blue on the right is global crypto adoption in its first 10 years; measured as total crypto owners, global crypto owners as a percent of world population, and an estimate of U.S. crypto owners as a percent of the U.S. population. At first glance, the commonality between the trends is hard to miss. However, there are some notable nuances.

First, as the U.S. led the digital revolution through the 1990s and into the 2000s, internet users and users as % of the U.S. population grew in tandem. Certainly, U.S. crypto adoption is increasing. However, the fluctuations in U.S. crypto adoption — notably from 2016 through 2020 — seems to imply that U.S. adoption has been less influential in crypto than it was with the internet. Global adoption appears to be a more consistent and prominent growth driver for crypto.

Second, the scale of internet adoption in its first decade was almost ten times greater than that realized by crypto. Although there are numerous explanations for this difference that extend beyond the scope of this causal analysis, the difference itself indicates that crypto has not realized the same breadth of adoption in its first decade as that experienced by the internet.

Naturally, no internet-crypto comparison would be complete without referencing the Dot-Com Bubble and the volatility in crypto markets. The third and final observation is the pattern of both internet and crypto adoption during market drawdowns. Despite the Dot-Com Bubble bursting in 2000, global internet adoption appears to have proceeded unphased. Similarly, when the crypto ICO (initial coin offering) bubble burst in 2018, global adoption seems to have steadily increased. In the context of adoption, this may suggest that both the excesses in secondary markets creating a bubble and the ramifications of a bubble bursting may be overplayed or overstated.

Much remains to be seen and there are many variables at play beyond the scope of this comparison. While the first 10 years of crypto adoption appears more modest than that of the internet, it can be said that crypto has steadily advanced on a trajectory comparable to the internet. History may not repeat itself, but it could rhyme. Past performance does not guarantee future results, but nonetheless, we are fascinated to watch this dynamic play out in 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.