Category: Chart of the Week

Record Growth During Third Quarter, but Will It Continue?

In this week’s chart of the week, we look at the estimated growth of Gross Domestic Product (GDP) — the value of all goods and services produced across the economy — for the third quarter of 2020. GDP increased at a seasonally adjusted annual rate of 33.1% according to the “advance“ estimate released by the Bureau of Economic Analysis. This increase is the largest on record, following a record decline (-31.4%) in the second quarter as COVID-19 severely disrupted business activity across the country. The increase was driven by increases in personal consumption expenditures, private inventory investment, exports, nonresidential fixed investment, and residential fixed investment; detractors were decreases in federal, state, and local government spending. The actual quarter-on-quarter rate of expansion, without annualization, was 7.4%.

Economists expect the economy to expand throughout the fourth quarter though much more slowly compared to the third quarter. Rising COVID-19 cases across certain parts of the country could plunge the economy into turmoil again if states are forced to put tighter restrictions back in place, likely slowing consumption and ultimately, GDP growth. Mitigating factors to these trends are potential vaccine approval and distribution, as well as additional stimulus from the U.S. government. Fourth quarter GDP will undoubtedly hinge on how these themes play out and bear watching over the coming months.

Print PDF > Record Growth During Third Quarter, but Will It Continue?

 

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.

Will a Vaccine Be the End of COVID-19?

Simmering in the background of the presidential race and stimulus talks remains a crucial step towards fully re-opening the country: vaccine progress. Many experts view the development of a vaccine as the key to finally ending the battle against COVID-19. With a commercially available vaccine anticipated as early as April of 2021, it seemed that we were drawing nearer to the end of restrictions on large gatherings. People would be able to attend sporting events, weddings, and graduations again in a return to more normal life. However, in a startling recent poll of over 34,000 people regarding their interest in receiving a government-approved vaccine, over half said that they would not or are not sure that they would want to receive the vaccine.

The stark difference in responses seems to correlate with education level, as shown in the charts above. There is a significant increase in wanting to receive the vaccine on behalf of people whose education includes a college degree. For education levels below college, the results were much more mixed about receptivity to a vaccine. The most commonly cited reservations were accessibility (cost, wait time, proximity of distribution center/medical office) and effectiveness. Although this was just one poll, it appears that the release of a vaccine may not completely stem the pandemic unless there is a dramatic reversal in vaccine sentiment over the coming months.

Print PDF > Will a Vaccine Be the End of COVID-19?

 

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.

ESG AUM Continues to Grow

Over the past five years, there has been a substantial increase in assets under management (“AUM”) for ESG (environmental, social, and corporate governance) mandated funds, as investors are placing greater emphasis on environmental and social issues while realizing that performance is not a tradeoff for sustainable investments. Since 2015, there has been a 147.5% increase in AUM for ESG-mandated funds, specifically looking at U.S. Equity, U.S. Fixed Income, Global Equity, and Global Fixed Income.

Going forward, we expect to see a larger increase in ESG investing as the COVID crisis further unfolds against the backdrop of other significant environmental and social issues. The recent inflows into ESG funds are a combination of new funds and the restructuring of old non-ESG funds. During the first half of 2020, over 20 new ESG funds have been launched in the U.S., making it the sixth consecutive year of 20+ new launches, and the U.S. is expected to set a new record by the end of the year. Clearly this is a trend that is gaining momentum across the investment universe and bears watching in future years. For more information on sustainable investing, reference our Sustainable Investing Video Series.

Print PDF > ESG AUM Continues to Grow

 

 

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 Real Assets Help Protect Portfolios from Inflation?

Against the current backdrop of unprecedented monetary stimulus, investors have become increasingly wary of future inflation and its potential degenerative effect on portfolio returns. While deflationary pressures appear more likely in the near term, the COVID-driven stimulus packages have created the potential for inflation once the pandemic has subsided. Predictably, investors are contemplating which asset classes can help hedge inflationary risk and real assets are a natural asset class to offset this risk.

During periods of upward price pressure, both real estate and infrastructure funds have at least some degree of pricing power, meaning they can boost rental income and revenue streams from their underlying holdings. In some cases, the embedded lease and contractual agreements of these holdings are linked to an inflation index, particularly for infrastructure. Therefore, the incomes of such holdings will rise as inflation rises and thus unlike fixed rate bonds, the real rate of return will not be eroded.

In order to examine this hypothesis, we compared traditional asset classes — stocks and bonds — to the real assets mentioned above: real estate and infrastructure. We compared cumulative returns during periods of above average inflation and during positive inflation surprises.¹ Although data is limited for real assets (particularly infrastructure), we analyzed cumulative returns for these four asset classes back to the earliest common date of index inception. Since the 2006 inception of the FTSE core infrastructure index, both real estate and infrastructure assets significantly outperformed U.S. equities and bonds during all periods when U.S. CPI rose above the period’s historical YOY average (1.9%). And during all quarters over the same period when developed world inflation experienced a material positive shock (“positive inflation surprises” defined previously), real assets also significantly outperformed both bonds and equities. Thus, while we have only experienced marginal inflationary pressure over the past 15 years, the data indicates that the inflation hedging mechanisms of real estate and infrastructure assets have been effective in protecting the purchasing power of portfolios. While it is difficult to forecast the ultimate timing, duration, and magnitude of inflation from this point forward, it is clear that real assets should offer a degree of insulation from the adverse effects of inflation.

Print PDF > Can Real Assets Help Protect Portfolios from Inflation?

¹ Surprises to developed world inflation are defined as periods where the expectations to the GDP weighted CPIs of the U.S., UK, and EU were below the actual CPI level by more than 10 bps.

 

 

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.

EM: Less About “ME” and More About “IT”

In 2010, the emerging markets equity benchmark was all about “ME” as materials and energy constituted 28% of MSCI’s Emerging Markets Equity Index. Today, however, they account for half of that, and IT and Consumer Discretionary have nearly doubled, growing from 19% in 2010 to 34% in 2020.

In September of 2018, MSCI adjusted its sector classification standards, partially in response to the increasing integration of the internet into all aspects of our communication and business transactions. This change specifically reclassified e-commerce to include companies providing online marketplaces for consumer products and services in the Consumer Discretionary sector rather than their previous IT classification. Alibaba — the largest stock in the index and one of the largest internet-based companies in the world — serves as one example of a company reclassified under the 2018 standards.

Emerging Markets have become less reliant on commodity prices over the past decade and we see this as a positive. Investors can benefit from the larger investment opportunity set which includes companies that are capitalizing on technology trends that played out in the U.S. throughout the 2010s and continue today, including e-commerce, online payment processing, and social platform businesses.

For more coverage on the Emerging Markets Index, reference our recent newsletter, The Changing Landscape in EM Equity.

Print PDF > EM: Less About “ME” and More About “IT”

 

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 Year of SPACs

If there is one corner of the financial market that has benefited from the pandemic, it is special purpose acquisition companies (SPACs). This atypical pathway to the public markets was once a niche strategy for small investment firms. Now, the strategy has become one of the hottest financial topics of 2020 after a massive uptick in the volume of these vehicles.

A record 82 special purpose acquisition corporations went public this year to raise a record $39 billion, far exceeding the $9.5 billion in gross proceeds for SPACs in 2019 or the $8.5 billion in 2018.

SPACs are vehicles that raise money in an IPO, and then place the funds in a trust while the sponsor searches for a business or multiple businesses to acquire. The companies then complete a merger and the target becomes a listed stock.

A private company going public via SPAC has a few advantages over a traditional IPO. Private companies can go public on a faster timeline and there is more certainty around a company’s valuation. Furthermore, the listing of a SPAC requires a much lower level of diligence than a similarly sized IPO since there are no financial statements to analyze. For a sponsor, raising a SPAC is similar to raising a closed-end fund, allowing for a shorter and more comfortable timeline during the fundraise. In addition, the reputation of SPACs has improved over the past decades as governance practices have been refined and made more shareholder-friendly.

The volatility and price declines earlier in 2020 made IPOs and direct listings impractical options for many private companies, which is where SPACs have stepped in. There has been a lot of talk particularly in the venture community not being satisfied with the IPO process. That has led to conversations about going the direct listing route, and now the SPAC route. There have been several companies that have gone the IPO route and set a price underwriters deemed reasonable, only to see the stock surge on the first day of trading, which ultimately results in money being left on the table. And with IPOs being inherently riskier, there was less incentive to take on more risk by going public during an election year and pandemic.

It is clear SPACs are here to stay, but it is uncertain whether they will continue at the same rapid pace as this year. While the population of companies that might combine with a SPAC is growing, it still represents a small subset of private companies, limiting the potential disruption of the traditional IPO process. While the momentum driving innovation around public listings is encouraging, SPACs will not provide a solution for every private business. That said, there is a two-year time period for a SPAC to acquire a business, guaranteeing they will remain around for at least the foreseeable future.

Print PDF > The Year of SPACs

 

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 Key Rebalancing Consideration: Drawdowns

In times of market turbulence, investments may sustain peak-to-trough declines known as drawdowns. The COVID-induced drawdown in March was no exception. Our chart this week illustrates the drawdown history for core bonds, bank loans, high yield bonds, and hard currency sovereign emerging markets debt (“EMD”) compared with the S&P 500. While past performance is not indicative of future returns, historical drawdown risk associated with past market volatility is a helpful metric to consider in the recovery from the current global health pandemic. As evident in the chart, each of the fixed income plus sectors¹ is correlated with the S&P 500, but the magnitude of plus sector drawdown risk is much less than the magnitude of equity drawdown risk — with one notable exception. In the 1990s EMD exhibited larger drawdowns than equity. At that time, EMD was very thinly traded, less mature, and more susceptible to dramatic swings.

While rebalancing from equity to fixed income plus sectors increases credit risk and introduces some drawdown risk, the magnitude of that drawdown risk from plus sectors is expected to be less than the expected drawdown risk from equity. As such, in this low Treasury yield environment, we recommend that investors consider both fixed income plus sectors and equity as ways to achieve greater total return potential and yield in portfolios. A diversified portfolio that takes advantage of the lower correlations between bank loans, high yield, EMD, and equities may benefit from greater efficiency and a higher Sharpe ratio in addition to the lower-magnitude drawdown risk from plus sectors.

Print PDF > A Key Rebalancing Consideration: Drawdowns

¹Bank loans, high yield bonds, and emerging markets debt.

 

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.

Do Presidents Play a Role in Equity Performance?

With market volatility already heightened due to the COVID-19 pandemic, the U.S. presidential election this year poses another layer of uncertainty that investors may view as added risk to their portfolios. In particular, there is inevitable speculation about how the market will react upon which candidate or political party wins the election. This week’s chart illustrates equity performance over the last nine presidents since 1969.

The question most asked is how the stock market will perform under Republican or Democratic leadership in the White House. Based on the data above,¹ the equity markets have averaged 14% annualized total returns when the president has been a Democrat and 8% when a Republican has been president. However, we caution that equity markets are subject to many market forces and most importantly, the sample size from this data set is not large enough to support these trends in a statistically significant manner. The good news is that regardless of political party, the stock market has averaged 10% a year over the time period shown in the chart.

As we look towards the November election, it is critical to understand the platforms of each candidate and how they can broadly impact the economy and by extension, equity markets. Understanding each candidate’s position on a variety of economic and social issues will inform the market’s likely reaction to the election results and help formulate expectations for investors. In the coming weeks, we will release a paper that examines these very topics in greater depth to establish baseline expectations of each candidate’s policies, market impact, and historical market performance of political party leadership in Washington across the White House, Senate, and House of Representatives. If nothing else, we know the election will be contentious and scrutinized, with market participants closely watching the ultimate result.

Print PDF > Do Presidents Play a Role in Equity Performance?

¹ For measuring equity performance, a total return index was used to account for shares that pay dividends and represent more accurate performance by reinvesting dividends back into the index.

 

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.

Market Recovery: A Closer Look at Sector Performance

The S&P 500 hit its Covid-induced trough on March 23rd, closing at 2237 points. Since then, it’s more than made up its losses, setting new records in the process. As detailed in a May Chart of the Week, “There’s FAAMG and Everyone Else”, technology companies have driven this recovery, spurred by a variety of increased demand attributable to remote work and schooling, online shopping, and virtual socialization, among others.

Despite technology companies grabbing the headlines, not all are classified as Information Technology by the GICS® sector classification system used by Standard & Poor’s, as one might assume. For example, the top five constituents within the S&P 500 in order are Microsoft, Apple, Amazon, Facebook, and Google parent Alphabet (FAAMG stocks), only two of which are classified as Information Technology (Microsoft & Apple). Amazon is Consumer Discretionary because of its retail focus, while Alphabet and Facebook are Communication Services. Amazon as a Consumer Discretionary stock helps explain the sector’s on par performance with Information Technology since the market bottom. Its stock price increased by 81% from March 23rd through August 31st, while Apple’s recovery over this same timespan was +131% with Facebook (+98%) not far behind.

Financials has been one of the weaker performing sectors in the recovery, as banks and other financial services companies have seen their bottom line potential shrink with Fed rate cuts. This only added to the struggle that these traditionally value-oriented firms have had keeping up with their new economy, growth-oriented counterparts. Berkshire Hathaway is the only Financials company in the top ten of the S&P, and the conglomerate’s lackluster recovery (+34% through this time period) resembles the sector as a whole. Visa is also a top ten index constituent; however, it’s classified as Information Technology. It has seen a moderate recovery of +56% over the noted timeframe.

As shown in the chart, the S&P 500 sits near the middle in recovery performance when compared to individual sectors. The S&P 500 ex-Information Technology isn’t far behind, which is surprising at face value but more understandable after considering that some tech behemoths fall into other sector classifications. As technology continues its ever expanding importance in the economy and daily life, it’s safe to assume that products and services based on technology, but outside the realm of traditional IT, will continue to grow in size and relevance.

Print PDF > Market Recovery A Closer Look at Sector Performance

 

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 Quality of Index Construction

Index choice plays a pivotal role in investment management. Passive investors utilize indices to gain exposure to a specific segment of the market or asset class, while active managers look to them as a benchmark of success or failure. For small-cap investors, the choice rests between two options: the S&P 600 Index and the Russell 2000 Index. While 93% of the eVestment Small Cap Core strategies utilize the Russell 2000 as a benchmark, the S&P 600 has been a superior investment over the long-term. The S&P has outperformed its more heavily-utilized peer by more than 1.8% on average across rolling three-year periods. On a cumulative basis, the S&P has generated more than 140% outperformance to the Russell since the turn of the century. This week’s chart seeks to understand the nuances of each index and share insights on why the “quality”-focused S&P index has begun to lag the Russell 2000 in the current market environment.

Launched in 1984, the Russell 2000 measures the performance of the smallest stocks in the United States. FTSE Russell ranks the entirety of the U.S. equities market by market capitalization in descending order. Stocks with a rank of 1,001st to 3,000th are included in the Russell 2000 Index. This approach effectively captures the breadth of the small cap market in its totality with objective, predictable, and transparent construction. On the other hand, the S&P 600 Index takes a committee-determined more concentrated approach, investing in just 600 stocks in the small cap universe. In addition, S&P utilizes an earnings screen for new constituents. For a company to be included, the sum of the most recent four consecutive quarters of GAAP earnings must be positive, as should the most recent quarter. We view this requirement as a proxy for quality. Without this screen, non-earning stocks have risen to more than 40% of the Russell 2000 Index.¹ Relative to large-cap peers, small-cap companies tend to be rife with debt, unproven business models, and inexperienced management teams. While this lends itself to market inefficiencies and opportunities for active management, it is important to view the asset class through a quality lens.

These indices utilize vastly different construction processes and yet both are tasked with measuring the performance of U.S. small-cap equities. The driving force behind the S&P 600’s outperformance lies in the earnings screen. Over the long-term, small-cap companies with higher return on equity (ROE) have historically outperformed their low or negative ROE peers.² In other words, companies that make profits have outperformed those that do not. However, history shows us that markets are cyclical. In the latter stages of a bull market, earnings tend to take a back seat to momentum and speculation. At such a point, investors are risk seeking – as shown in the lead up to the early 2000’s Dot.com bubble – crowding into popular “high-tech” offerings despite deteriorating fundamentals. This echoes today’s environment and while every economic downturn is unique, themes tend to persist. Today we have an abundance of capital injected into the economy by the Federal Reserve, allowing small-cap companies to fund operations in the face of falling demand and narrowing margins. Market dynamics have been dictated by winners and losers of the pandemic, allowing the S&P 500 to reach new daily highs as the top-heavy index continues to soar regardless of record high unemployment and cratering corporate earnings. Eventually, investing in quality will reign supreme as it has – on average – over the last two decades. As the cycle continues its course, remaining invested in companies with positive earnings will pay off in the long run.

Print PDF > The Quality of Index Construction

¹ Strategas
² Factset; The top quintile of the IWM ETF outperforms the bottom quintile of cumulative return by ROE by 7.4% over a 7 year period ending July 31, 2020.

 

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.