Category: Chart of the Week

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.

A Tale of Two CPIs

With headline inflation hitting a 41-year high, the market has become increasingly skeptical of the Federal Reserve’s ability to combat rising price levels for consumers and producers alike. As market participants await additional action from the Fed, core inflation numbers have broken away from historical trends with core CPI exceeding core services since March last year. Core CPI, which includes all items except food and energy, has historically stayed near 2% and below core services. As the U.S. began to reopen in early 2021, the increased demand for goods amidst supply chain stresses was quickly followed by a rapid rise in core CPI. Recent geopolitical conflicts such as Russia’s invasion of Ukraine and lasting pandemic mitigation measures taken by China have only exacerbated supply chain disruptions as global trade remains stifled. While policymakers were initially confident in the transitory nature of inflation, it has proved more persistent, with the U.S. now entering a period of a wage-price spiral as higher prices and higher wages threaten a prolonged period of elevated price levels. In addition to supply chain matters, employment dynamics within the U.S. have left many sectors of the economy seeking workers, with many companies resorting to wage increases to maintain or expand their workforce. While wage growth has continued to lag inflation, it has contributed to core services significantly, with year-over-year increases reaching levels not seen in over 20 years. While it remains to be seen whether overall inflation has peaked, it is likely that core services inflation will remain for the time being as persistent labor shortages keep upward pressure on wages.

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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.

Buy Land, They’re Not Making It Anymore

Individuals commonly allocate 20–30% of their net worth into a primary residence, which oftentimes accounts for the single largest investment in their portfolio. The market value of one’s home is impacted by variables that include, but are not limited to, supply and demand relationships, property location, borrowing rates, and tax policies. Since early 2020, median home prices have increased over 25%, benefitting homeowners and their portfolios significantly.¹ The appreciation in home prices can partially be attributed to the shortage of homes built over the past decade. Not since the 1930s, when the country’s population was roughly 40% what it is today, have so few homes been built in the United States. The problem is further exacerbated by the average age of a home in the U.S. — 40 years,² well beyond its useful life — and current labor and material shortages that have been lengthening project timelines and delaying starts.

The sudden rise in housing valuations has homeowners and investors wondering if this could be another bubble, akin to the 2008–2009 mortgage crisis. While new home starts will likely remain low in the near and medium-term, rising interest rates may serve to stymie demand. Since the end of 2021, interest rates on a 30-year fixed mortgage have risen nearly 200 basis points to almost 5.0%,³ adding meaningfully to the cost of buying a home and potentially pushing ownership outside the reach of prospective millennial and generation Z buyers. However, opportunity exists in any inefficiently priced market, which is why more and more institutional investors are allocating “dry powder” to the residential real estate market. Ultimately, buyers, sellers, and lenders are justified in asking whether we are on the precipice of another housing crisis or if this is the start of a new normal with additional runway for growth.

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NOTES
¹ Lambert, Lance. “Homeowners struck gold during the pandemic—here’s the breakdown in every state.” Fortune. 23 Dec 2021.
² Jones, David. “Ages of Houses in the US.” BuyersAsk. Last updated 4 May 2021.
³ 4.96% as of April 4, 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 Evolving Secondary Market

The private equity secondary market has matured and become more efficient over the last decade, with annual secondary transaction volume scaling from approximately $25 billion in 2012 to roughly $130 billion in 2021. Investors are increasingly turning to the secondary market for liquidity as they look to exit their private equity investments to better manage their overall portfolio allocations. Single asset transactions have been a more recent contributor to the growth of the secondary market, growing from 3% of total secondary transaction volume in 2018 to 25% in 2021, with a large part of this volume driven by the creation of continuation vehicles. These vehicles are quickly gaining in popularity, primarily by managers within the middle and upper end of the private equity market.

Continuation vehicles have become a hotly debated topic within the private equity community. The ability for private equity managers to recapitalize what is often their top portfolio company into a new single fund structure helps raise additional AUM and allows the manager to continue to own the company. However, it can be challenging for Limited Partners (LPs), who often lack the ability to underwrite a single company or are not given enough time to do so. Many institutional LPs are also simply unable to take the concentration risk of investing in a single asset.

As the secondary market evolves, single asset continuation vehicles are expected to become more common. LPs in private equity funds will need to evolve as well to take advantage of these opportunities and remain invested in the best assets over a longer period. This may require LPs to increase their allowable concentration limits, expand underwriting capabilities, or adjust policies in order to roll top investments into continuation funds.

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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.

Could Conflict Spur an Energy Revolution?

Now one month into the Ukrainian crisis, investor concerns about the knock-on effects of war, higher energy costs, and generally prolonged, heightened inflation have hit a crescendo. Europe’s natural gas benchmark, the Dutch TTF, has been extremely volatile, at one point spiking to more than ten times last spring’s levels. The European Union relies heavily on Russian natural gas. According to the International Energy Agency, in 2021, the EU imported 155 billion cubic meters of natural gas from Russia, comprising roughly 45% of European Union gas imports and close to 40% of total gas consumption. Russia’s invasion of Ukraine has underscored the risks of Europe’s dependence on Russian gas imports and prompted the European Commission to take action.

Beyond halting approval of Nord Stream 2, a set of offshore natural gas pipelines from Russia to Germany, at the outset of the conflict, the European Commission has now vowed to curtail the EU’s usage of Russian natural gas, with a target of reducing imports by two thirds by the end of the year. To make up the difference, the Commission will increase gas and liquefied natural gas (LNG) imports from other countries and phase in alternative gases like hydrogen and biomethane. The U.S. has answered this call, with the Biden administration authorizing additional exports of LNG from two major facilities on the U.S. Gulf Coast. The Commission is also looking to accelerate the transition to renewable energy. In particular, the EU will accelerate its “Fit for 55” rule, deploying a massive campaign of electrification, expansion of renewables and electricity storage, development of green hydrogen tech, and investment in energy efficiency measures. While these longer-term initiatives will take several years to come to pass, the composition of energy sources, at least in Europe, should have a stronger, greener future as a result.

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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 Impact of Russia’s Invasion on Bond Indices

Russia’s invasion of Ukraine has meaningfully altered the emerging market landscape. At the start of the year, Russia and Ukraine combined had comprised almost 5% of the hard-dollar index, JPMorgan EMBI Global, and the hard-dollar emerging market corporate index, JPMorgan CEMBI, with 3–4% in Russia and roughly 1% in Ukraine. In local markets, represented by the JPMorgan GBI-EM, Russia was approximately 7% of the index, while Ukrainian local bonds were scheduled for index inclusion at the end of March.

Since the invasion in February, Ukrainian debt, already stressed, has fallen further, and now represents less than 0.5% of the hard-dollar indices. Its inclusion in the local index is on hold until further review due to market disruptions. Foreign sanctions and self-imposed capital restrictions have pushed Russian dollar debt to distressed levels, with Russia unlikely to pay external debts in hard dollars. Local bonds are still trading near par, though a weakening currency has reduced the value to international investors. At present, Russia represents no more than 1% in the hard-dollar or local indices and will be removed by JPMorgan entirely at month-end as sanctions have made the debt illiquid and uninvestable. Belarus is also facing removal from JPMorgan’s ESG indices for its role in the conflict.

Managers face a tough decision regarding holdings in Russia. The local bond market is frozen for international trading. Although local bonds are trading near par in the domestic market, many managers are pricing holdings at zero. External debt is distressed but the market continues to function and there have been bright spots, with Russian energy giant Gazprom redeeming a bond, priced down to 50 cents on the dollar, at par on March 7th. With the write-down already taken and the removal from indices, Russian debt could be a source of upside in a recovery scenario, though uncertainties and risks certainly remain. Prudent risk management and process consistency remain key factors for Marquette as we analyze and recommend funds to clients.

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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.