Category: Chart of the Week

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.

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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 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.

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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 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.

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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.

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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.

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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.

And the Beat Goes On…

This week, the S&P 500 index closed at 3,389.78, setting its first record high since previously peaking on February 19th, 2020; it is up 4.9% year to date. This post-bear market recovery is officially the fastest ever. For the sake of comparison, it took more than three years for the S&P 500 to reclaim its peak after the Global Financial Crisis. However, the S&P 500 was not the first broad market index to reclaim its high in 2020. The NASDAQ 100 index surpassed its previous peak more than two months ago on June 5th and is up 30.5% year to date. On the other hand, the Dow Jones Industrials Average (DJIA) is still more than 5% off its record high and negative for the year.

How is it that each of these indices is considered to represent the broad domestic equity market, but they have such wide performance differences? The main reason is the calculation and composition of the indices. Let us begin with the Dow, the oldest index out of the three indices. Founded in 1896, the Dow is comprised of 30 stocks that are selected by their size and influence on American business (with the latter clearly being subjective). In addition, the DJIA is a price-weighted index which means that the companies with the highest share price have the highest weighting in the index. For instance, Apple, which trades at $462 a share¹ is the largest constituent in the DJIA with an 11.4% weight. The next largest constituent is UnitedHealth Group, which trades at $316 a share² and has a 7.8% weight in the DJIA. As a result, large price increases or declines in these stocks will have an outsized effect on the returns of the index. Consequently, the price decline in Boeing, a top 10 Dow constituent, due to delays in the Max 8 and lower demand from the COVID-19 pandemic has had a large impact on the Dow’s year-to-date return.

The S&P 500 and NASDAQ 100 indices are market capitalization-weighted indices. This means that the weightings of their constituents are based on the product of the stock price and the outstanding shares. As a result, stocks with high prices and the largest number of shares outstanding will have the greatest impact on the index’s return. In the case of the S&P 500, which tracks the largest 500 companies in America, this means that Apple, Microsoft, Amazon, Google, and Facebook are the largest constituents in the index. As discussed in my previous post, “There’s FAAMG and Everyone Else,” investor enthusiasm has propelled these stocks to new highs even though most of the companies in the S&P 500 are still negative for the year.

Technology companies have been the biggest beneficiaries of the COVID-19 pandemic and the NASDAQ 100, a proxy for the Technology sector, is more concentrated than the S&P 500 and more tech-centric than the DJIA. The NASDAQ 100, which was created in 1985, tracks the largest non-financial companies listed on the NASDAQ exchange. The FAAMG stocks are still the largest constituents in the NASDAQ 100, but Technology makes up over 55% of the NASDAQ 100 relative to 27.5% for the S&P 500 and 26.9% for the DJIA. It is also important to note that the Dow does not include Amazon, Google, or Facebook.

Over the short term, index calculation methods and composition differences can cause wide performance divergences. However, these divergences come and go based on the performance of the underlying sectors and companies. This year’s divergence has been exacerbated by the COVID-19 pandemic and the outperformance of Technology. As other non-Technology sectors rise in economic importance, we would expect the S&P 500 and DJIA to post more attractive relative returns.

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¹ Apple’s closing price as of August 18, 2020. Apple has also announced a 4-for-1 split effective August 31, 2020, which will reduce its price to ~$115 a share. Thus, Apple’s weight in the DJIA will decline accordingly.
² UnitedHealth Group’s closing price as of August 18, 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.

U.S. Treasury Borrowings, Receipts, Outlays and Deficit

The U.S. government — including the U.S. Treasury, Federal Reserve, Congress, and executive branch — has stepped up to emergency action in rapid fashion during this coronavirus pandemic. This, along with the heroic efforts of healthcare workers, first responders, and vaccine researchers, is one of the key reasons why our financial markets have enjoyed such a quick recovery, with the S&P 500 currently back to the all-time peaks that it previously reached in February and investment grade and high yield bond spreads now having tightened back to tighter than long-term averages.

Our chart this week looks at how rapidly the U.S. Treasury raised capital by borrowing from the public and deployed that capital via the large-scale Congressional relief packages as well as Fed quantitative easing asset purchases and financial market backstops in the face of declining tax receipts. The green line represents the U.S. Treasury’s monthly borrowings from the public, which skyrocketed in March, peaked in April, and have gradually declined since. Shown in the tan are monthly U.S. Treasury receipts, which as expected gradually declined with the retrenchment in tax revenue due to the recession in which so many ill-fated businesses have shut down and millions of workers have lost their jobs. The darkest slate line shows monthly U.S. Treasury outlays, which rose steeply in March and remain high as these funds continue to be deployed for both fiscal and monetary stimulus measures. Lastly, the blue line shows a rising monthly U.S. Treasury deficit which is not surprising as U.S. Treasury outlays continue to exceed receipts.

While the financial markets have dipped and rebounded to previous highs several quarters quicker than the full circle throughout the 2008 housing crisis, there are still several challenges that lie ahead: the efficacy of the vaccine candidates currently in human trials and the ability to distribute and encourage the adoption of a final approved vaccine in a timely manner; the prospects of the Republican-led Senate and Democrat-led House to agree on a next relief package to help mitigate renter evictions and homeowner foreclosures; the risk of seasonal second or third waves of infections in various regions across the world; and the implementation of re-openings with social distancing that can successfully prevent resurgences until a vaccine is approved and distributed. We continue to expect these challenges to heighten market volatility, which will be further exacerbated by a contentious U.S. presidential election looming less than three months away. Marquette will continue to monitor these issues and provide our perspectives as further developments unfold throughout this pandemic.

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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.

Gold or Glitter?

Gold prices are hitting new highs, closing above the $2,000 per ounce threshold for the first time yesterday, August 4th. It is a familiar scene amid the confluence of economic concern and uncertainty brought on by the spread of COVID-19, negative real interest rates with 10-year Treasury yields just above 0.5%, a weaker U.S. dollar, and the potential for increased inflation following unprecedented monetary stimulus. But with an asset class that only makes headlines at extreme levels, it is important that investors know what they are really getting.

Over time, gold has produced real returns about in line with Treasury Bills (before any storage costs or impact from rolling futures contracts in contango), but with volatility that more closely resembles the S&P 500. And despite being widely considered to hold its value over time, gold is a physical asset whose price is determined by supply and demand, including ongoing mining operations and a large gold jewelry market in China and India. But what is perhaps most surprising is that gold is actually a poor inflation hedge. Over the last 50 years, the correlation between gold and core inflation has ranged from -0.55 to +0.75, with an average of 0.05.¹ Over time, equities have been the best option for outperforming inflation.¹ Dating back to World War II, gold has only outperformed equities in the short windows when inflation has been categorically greater than 6% (the last of which ended in 1982), and even then only half the time.¹ Thus despite the headlines that gold receives when its price is notably rising, it is not a particularly attractive allocation for long-term investment portfolios.

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¹ Goldman Sachs Investment Strategy Group

 

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.

Bond Downgrades Subsiding

As a key indicator that we have come a long way from the late-March panic and that both the economy and financial markets are steadily recovering from the COVID-19 pandemic, downgrades of bonds by the bond ratings agencies such as S&P and Moody’s have been experiencing a sharp decline. Our chart this week profiles the weekly downgrade volume of U.S. investment grade corporate bonds — excluding financials — showing a precipitous drop in weekly downgrade volume from the March peaks. The reduction in downgrades for investment grade financials, as well as for both high yield bonds and bank loans, are following a similar trend, though are not shown in the chart.

Bond agencies have become more comfortable with bond issuers’ abilities to cover their debt expenses due in large part to (1) vaccine progress, (2) the commitment to stimulus by global governments, and (3) re-openings. The vaccine remains the ideal solution to this pandemic and progress has improved since March. Today, a number of vaccine candidates are in Phase II human trials, with one that began Phase III yesterday. Moderna’s vaccine started Phase III on Monday, overseen by the University of Illinois at Chicago. Pfizer/BioNTech’s candidate has been shown to produce more antibodies than those produced by people who have recovered, and last week they received from the Department of Health and Human Services and the Defense Department an order of 100 million doses for $2 billion. Oxford/AstraZeneca’s candidate has been shown to produce antibodies that may fade but it helps produce killer T-cells that may stay in circulation for years and may kill cells infected with the virus. With regard to stimulus, Senate Republicans and the White House announced a stimulus package yesterday to follow the handful of COVID-19 stimulus packages that have preceded it this year. Congress is currently working on closing the gap between this $1 trillion CARES 2.0/Safe to Work Act put forth by Senate Republicans and the $3 trillion HEROES Act put forth by House Democrats. Marquette will provide a detailed assessment of this latest package and its implications as soon as it is signed by Trump. Moreover, the Treasury continues to have the ability to issue debt at current debt-to-GDP levels in order to fund further stimulus.

All this progress is balanced by several challenges, however, with the markets having priced in the last few weeks’ rise in cases, especially from Texas and Florida — the new epicenters — and the re-closings of restaurants and bars by several states including Illinois and California, along with recent resurgences in certain countries abroad. Hospitalizations and mortality have not risen as much as cases, however, so this resurgence may be attributed to the rise in testing detecting less-serious cases, which is potentially a positive in curtailing super spreaders. As the pandemic and its recovery gradually unfold, the markets are starting to price in more non-COVID developments, such as the Biden vs. Trump campaign and recent U.S.-China tensions. The U.S. ordered China to close its consulate in Houston last Tuesday, and China took over the premises of the U.S. consulate in Chengdu, a southwestern city. Marquette will continue to assess and issue guidance on further developments related to the pandemic, the recovery, and other geopolitical events.

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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.