Category: Chart of the Week

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.

Mounting Bankruptcies Reflect New Consumption Patterns

COVID-19 has caused a slew of bankruptcies across multiple industries as companies struggle to meet their cash needs. Re-openings might have come too little, too late, as large and small companies alike are filing for restructurings or bankruptcy protection. In this week’s chart, we dive into which industries have been hit the hardest and the potential lasting impact of these bankruptcies.

As shown in the charts above, nearly 140 companies with over $166 billion of assets have been forced to liquidate or restructure to meet the new environment created by COVID-19. Most recently, Ascena Retail Group, parent company of Ann Taylor and Lane Bryant, has been forced to close 1,100 stores and lay off many employees as a result. Overall, retail and restaurants have seen the largest number of companies file for bankruptcy, with 49. However, the amount of assets defaulted on in retail/restaurants were less than energy and travel. Small retail shops and restaurants have been adversely affected as these tight margin businesses are unable to be closed for very long. The shutdowns across the country have forced this exact scenario, and a wave of defaults followed. In energy and travel, large names like Chesapeake Energy ($16.2 B) and Hertz ($25.8 B) have driven the disparity between the number of companies declaring bankruptcy and total assets. Smaller companies are being adversely affected, and additional stimulus may be needed to tide these businesses over. If a second wave of coronavirus hits with an impact similar to the outbreaks in the southern and western parts of the nation, then additional shutdowns will undoubtedly force many more of these businesses to close. The concern is that many mom and pop shops could shut down permanently, forcing consumers to shop at large big-box stores. The long-lasting effects of COVID-19 have yet to be determined, but travel, retail/restaurants, and energy businesses specifically are bearing the brunt of the shutdowns as they are largely unable to be conducted online. These mounting bankruptcies are likely to continue until consumers are able to resume their normal consumption patterns, which includes in-person shopping, dining, and a return to leisure travel.

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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.

 

Coastal COVID: Diverging State Responses

Nearly a month into summer, the tragedy of COVID-19 rages on globally and in the U.S. As of July 13th, America’s death toll sat at over 135,000 with total cases approaching 3.4 million. The good news is that a number of virus hot spots have largely been tamed, most notably New York. To maintain this progress, Governor Cuomo implemented a mandatory quarantine period for travelers arriving from a number of other states. Elected officials in other once hard-hit locations, including Chicago Mayor Lori Lightfoot, have followed suit. Yet, despite the progress in some parts of the country, others are going in the opposite direction.

Two of the most populous states, California and Florida, have made headlines recently for their surging cases but differing responses. As of July 13th, California had 336,508 positive COVID-19 cases. Accelerating this grim total was a notable increase in the infection rate during June, which has continued into July. In response, Governor Newsom announced renewed restrictions this past Monday, and although not as wide-ranging as the initial spring lockdown, they are effectively a statewide ban on indoor activity with 80% of California residents affected. Also newsworthy was the announcement by both the Los Angeles and San Diego school districts that the school year will begin fully online.

Facing just as significant a problem, Florida’s case count sat at 291,629 on July 13th. Despite the rising cases and recently deemed “epicenter”¹ of Miami, Florida’s Commissioner of the Department of Education issued an order on July 7th that all of the state’s schools open for full-time in-person learning next month. After another week of surging cases, support for this directive was offered by Senator Marco Rubio on Monday, noting that “additional measures” be taken in hot spot locations. And, in the Sunshine State, it’s not just schools that are heading towards a return to normalcy. Disney World opened its doors for the first time since March last weekend.

The divergence in responses between these two coastal states highlights the differences in opinion witnessed since the start of the pandemic and helps explain the inconsistent success rates across states in controlling the outbreak. Though progress has been notable in the U.S., this most recent pattern suggests that a more uniform approach to battling the pandemic could help reduce the spread of COVID-19. The coming months will be telling for financial markets: the longer that the pandemic surges, the more volatility and headwinds will dominate the headlines and investor returns. On the other hand, if a more uniform and consistent approach can be embraced, the curve is sure to be shortened and a return to normalcy should be expected sooner rather than later.

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¹Dr. Lillian Abbo, University of Miami, via NPR

 

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.

Best Historical Performing Asset Class Is on Sale!

It is critical for institutional investors to understand the importance of both relative and absolute value when considering investment allocations. From a relative value perspective, private equity ­— which has been one of the most desired and consistently best performing asset classes over the last 20 years — is now on sale.

Following global investment volatility and panic from the COVID-19 crisis in March, the combination of government intervention along with public equity enthusiasm has driven public valuation multiples to near-record levels over the last three months with the Russell 3000 trading at 15x EV/EBITDA (S&P 500 at 23x EV/EBITDA), making the relative value trade even more compelling for private equity investments. Meanwhile, private equity multiples have been more stable, with May transactions occurring at 10x for middle market buyouts and 7.5x for small buyouts less than $100 million in enterprise value, providing investors a 35% or 50% relative discount respectively as compared to the Russell 3000. The current valuation spread provides the widest spread these markets have offered.

Private equity managers have mostly shown investment discipline, thinking longer-term and focused on absolute returns over a multi-year basis, which has resulted in a tighter range of valuations paid as compared to rising public equity multiples over the last decade. However, given the current market dynamics with the valuation spread growing, it is likely private market investors will benefit from the relative outperformance of private equity capital deployed in 2020.

This may be an opportune time for institutional investors to consider stepping back from elevated public market valuations and find ways to allocate more capital and raise their targeted allocations to private equity in order to maximize the absolute returns of their portfolios. We have seen clients increasing their annual deployment and focusing on more opportunistic strategies, including co-investment funds and secondary funds which have shorter investment periods thus allowing more capital to be deployed in 2020 and 2021.

Furthermore, private equity managers should increasingly be thinking about the relative value of the capital that has been committed to them. The last few years have provided for record-breaking fundraising for the private equity industry. This committed capital is currently sitting in dry powder and in most cases remains uncalled from investors sitting in public equity markets. Due to the current valuation spread, the relative value these private equity managers provide by finding opportunities present in the private market is great. Most importantly, more capital being put to work in private markets can expand the number of private equity-owned businesses and does not have to drive up the valuations paid, unlike in public markets where there are a fixed number of opportunities and where more capital being deployed in public equities pushes valuations higher.

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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.

Russell Rebalance: What Happened?

Summer has arrived and with it comes the annual “Russell Rebalance,” or as FTSE Russell — the index administrator — officially calls it, the Russell Reconstitution. The last Friday in June brings a unique set of challenges for investors managing to one of Russell’s many indices. More than half of U.S. equity investment managers benchmark to a FTSE Russell Index and the Russell rebalance affects an estimated $9 trillion across these products.¹ The entire family of Russell U.S. indices is recast to reflect changes in the U.S. equity markets over the preceding year. Essentially, the rebalance resets market cap weightings and style designations, which ultimately drive shifts in the underlying sector distributions. This creates one of the highest trade-volume days of the year.

The market’s appreciation over the longest bull market in history pushed the market cap breakpoint between the asset classes to a peak in 2018 of $3.7 billion. As a result, the market cap threshold for constituents to be placed into either the large- and mid-cap focused Russell 1000 Index or the small-cap focused Russell 2000 Index has grown 150% since the Great Financial Crisis.

This past Friday, June 26th, marked the official reconstitution day. Notable movements in this year’s rebalance revolved around a few key sectors: Financials, Health Care, Industrials, and Information Technology. The Russell 1000 saw little movement in sector allocation, while the respective style indices, the Russell 1000 Growth and Value benchmarks, experienced the brunt of change. Technology now comprises a record 43% of the Russell 1000 Growth Index, a 2.3% rise, while the Industrials allocation fell to 4.6%, from 7.3%. The Russell 1000 Value Index was the recipient of those Industrials companies, rising from 9.6% to 12.4%.

From a market cap perspective, many banks within the Russell 1000 Financials sector moved to the small-cap index as investors sold economically sensitive stocks in the first quarter of the year. The Russell 2000 Index saw a 1.6% increase to the sector, bringing the total weight in Financials to 16.2%. As expected, many of these banks qualified for the Russell 2000 Value Index, which now has a nearly 29% weight to the sector. Likely the largest hurdle for active managers navigating the rebalance is the increased allocation to Biotechnology, an industry within the Health Care sector. These securities, many of which do not make money and have no established products, go against the investment philosophies of many fundamentally driven active managers. The Russell 2000 Growth Index now has a more than an 18% allocation to the industry. As managers settle into their new benchmarks, it will be pertinent to discuss these sectoral and capitalization changes in the context of future performance expectations.

Print PDF > Russell Rebalance: What Happened?

¹ FTSE Russell

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Private Equity in Times of Crisis

While there is still much uncertainty around the long-term economic ramifications of COVID-19, financial markets have been undergoing frequent massive swings as both investment managers and allocators evaluate the situation and what it might mean for their current and future investments. Given the illiquid and slow-moving nature of private equity investments, an outstanding question is: What will this mean for private market investors?

One principle which people took serious note of in the last crisis was something called the “denominator effect.” A decline in the value of one asset should result in other assets being sold to properly rebalance a portfolio, but many assets like venture capital (“VC”), private equity (“PE”), and others can be quite hard to sell in the short-to-medium term, leaving LPs overallocated to private markets. When the stock market falls dramatically, public market investments fall in value immediately; however, private market investments do not reflect the changing environment right away because they require a manual valuation process that is one to two quarters behind public markets.

In addition, LPs allocating to PE and VC can expect net cash flows to turn negative, a break from the norm of recent years when distributions outpaced contributions, which led to positive net cash flows. During a time of crisis, GPs dislike realizing investments at diminished valuations. Instead, they tend to further invest into existing portfolio companies, or at least hold those companies longer, which leads to reduced distributions. Furthermore, GPs also tend to call down capital more slowly during times of market crisis because deal-making slows substantially. It is forecasted that it will take months, possibly even until the end of the year for transaction volumes to rebound.

The exact repercussions the crisis will have on PE fund performance will remain unknown until we know how deeply the virus will affect global economies. However, we do believe private markets will fare well in the current market environment. Research indicates that while PE exhibits high correlation with public market performance over longer periods of time, in times of volatility it tends to drop less and subsequently outperform. Funds deploying cash through the crisis are in a favorable position to deliver elevated returns given the higher likelihood of finding a bargain in a crisis. Previous crisis funds, such as 2001 or 2009 vintages, posted top-tier metrics; the hope is that this pandemic is consistent with these previous patterns for private equity returns.

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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 Stock Market vs. Trump

Though it has so far taken somewhat of a backseat to the COVID-19 pandemic and global protests for racial justice, 2020 is a U.S. presidential election year. As can be seen in the chart, over the last year and the last several months in particular, the S&P 500 has generally moved in line with expectations for Trump’s reelection this November.¹ As the complicated debate over whether the stock market performs better under a Republican or Democratic president continues, the historical numbers show that the market does notably better in an election year when a Republican wins the seat. While there are always many moving pieces, this makes sense, as Republicans are often considered more pro-business and pro-market than Democrats.

Now into June, that correlation has completely reversed. The S&P 500 has continued its recovery, getting back to flat on the year before last Thursday’s correction, while chances of a 2020 Republican victory have hit new lows. Though based on only two weeks of data — and with another almost five months until the election — it is an interesting departure from historical trends. Voters certainly have a lot to grapple with over the next several months and we will continue to follow all developments closely as history is made.

Print PDF > The Stock Market vs. Trump

¹As measured by data from political betting site PredictIt: “Which party will win the 2020 U.S. presidential election?”

 

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.