Category: Chart of the Week

Fed Cuts Rates 50bp to Fight Coronavirus Effects

This morning, the Federal Reserve cut short term interest rates by 50bp to defend against the global economic effects of the coronavirus outbreak. The previous three cuts occurred throughout 2019 as a result of combatting the global slowdown due to the U.S.-China tariff negotiations. This latest cut was a surprise for the markets as going into the day Fed Funds futures showed a strong probability of one rate cut in each of the Fed’s March, June, and September Federal Open Market Committee meetings this year.

This week’s chart shows that the rate cut brings the Fed Funds target range upper limit now to 1.25% (not shown is the lower limit now at 1.00%), juxtaposed against the VIX, which is a measure of the S&P 500’s expected volatility that spiked over the last few days.

It is unclear what the ramifications of this central bank action might be on the markets in the short-term, as the Fed’s signal of apparent concern may cause a fear-induced sell-off in the markets. This is what we are seeing so far, as the S&P 500 is off 2.8% for the day while the 10-year U.S. Treasury fell from yesterday’s close of 1.10% to 1.02% at today’s close. However, the longer-term effects should be stimulative as lower rates will make it easier for businesses and consumers to borrow and refinance their debts as well as ease their interest expense burdens.

The hope is that this cut will reduce short-term economic headwinds to the global economy and combat the onset of a recession. While it is impossible to predict when the outbreak will be contained, the number of new cases in source country China is declining and the coronavirus fatality rate remains low at 3%.

The global fatality rate is especially low for individuals not of elderly age. The latest data provided by global insurer Natixis and the Chinese Center for Disease Control & Prevention show that the fatality rate for individuals under 60 years of age is less than 1.3%, with those under age 50 seeing a fatality rate less than 0.4%.

As such, the U.S. Treasury yield curve is still upward sloping in both the 2-year vs. the 10-year and the 2-year vs. the 30-year, showing no signal of an impending recession. In contrast, both these measures were downward sloping going into the tech crisis in 2000 and housing crisis in 2008.

However, we may expect persistent short-term volatility as China recently released its Purchasing Managers’ Index (PMI). A PMI below 50 signals a contraction, and China’s latest PMI is at 30, the lowest it has ever been. To preemptively combat this potential economic slowdown, the Fed’s 50bp rate cut should provide a boost to the U.S. and global economy and we would expect central banks around the world to likely follow suit.

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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.

Coronavirus Roils the Equity Markets

U.S. equities recently experienced a sharp three-day sell-off as the market digested the potential for short-term disruptions to economic growth and company earnings due to the Coronavirus (COVID-19). With new health figures coming out daily, it is easy to become alarmed. However, as our Chart of the Week from February 13th highlighted, prior health crises have been proven to be non-events longer-term for equity markets. Similar outbreaks in the past caused short-term sell-offs in equity markets but longer-term saw positive market performance.

This week’s chart shows calendar year returns for the S&P 500 along with the max drawdown that occurred in each respective year. As of February 25, 2020, the S&P 500 has recorded a year-to-date drawdown of 7.6%. The current pullback is undeniably sharp in nature, but it is important to maintain perspective during turbulent times. Over the past 15 years, the average annual max drawdown was 14%. Many years experienced drawdowns near this level, yet still yielded a positive return for the year. On average, equities see a 5% pullback four times per year, a 10% pullback once per year, and a 20% correction once every five years.

While no one knows the full impact that the current outbreak will have to supply chains, trade, or travel, we recommend taking a long-term view to investing. The market had been looking past this current health crisis until the last few days, so a repricing of risk was inevitable. As this is an evolving situation, there is risk that the economic impact could increase and add further pressure to equities. However, the current pullback remains in-line with historical trends.

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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.

Coronavirus and the U.S. Economy: Assessing the Impact

Over the last month, the world has been gripped by fears of the coronavirus and its eventual toll on the global economy. Most economists expect global economic growth to reaccelerate in the second half of the year after the virus peaks. We agree that most of the negative effects will most likely be felt in the first half of 2020.

Since January and February Chinese economic data will not be released for a few weeks, we thought it would make sense to review the current state of the economy in the United States. The table above shows leading indicators for the U.S. economy. Green denotes a healthy measure and red denotes a deteriorating measure. Some of the more stable measures over the past few years have been the 50-year low unemployment rate and inflation, which has been stable at 2%. The more volatile measures have been stock market valuations, the purchasing manufacturer’s index (“PMI”; a gauge of domestic manufacturing activity), and corporate earnings growth. Let’s start with PMI first since stock market valuation and earnings growth are more intertwined. PMIs have been under pressure since the start of the U.S.-China trade war in 2018. In January 2020, PMIs traced their way back into expansionary territory (i.e., above 50), but the coronavirus fallout may cast a cloud over manufacturing in the coming months.

What about the U.S. equity market? Last year, corporate earnings growth was virtually flat in an expensive stock market. Since then, stock market valuations¹ have come off their 2019 high but are still above the 10-year historical average of 16 times forward earnings. We believe meaningfully positive corporate earnings growth will be needed to support such an above-average market valuation. The most obvious way to ensure that is to have a strong U.S. consumer. Consumer confidence has steadily increased throughout this business cycle and right now consumers are as confident as they have ever been. Since the U.S. consumer drives two-thirds of the economy, we will be closely monitoring the consumer for weakening sentiment through measures like retail sales, revolving debt defaults, overall debt level, and other telling data. While we expect some metrics to potentially soften due to the coronavirus, we expect most to be positive by year-end. Ultimately, much like SARS and MERS, the virus’s bark will be much worse than its bite on the U.S. economy and equity market.

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¹ As measured by forward P/E
² FactSet Expected Earnings Growth for 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.

Much Ado About Corona?

By now, you have all read the headlines and watched various news commentators detail the perils of the latest pneumonia outbreak, 2019 Novel Coronavirus (“nCov”), impacting China, nearby countries, and a few of their western trade partners. As of February 13th, confirmed cases in mainland China had reached over 60,000 patients, and as was broadcast on February 11th, the death total has surpassed 1,000. Even though these health figures are alarming, we have experienced similar outbreaks in the past and can take some comfort in knowing that eventual containment — and a vaccine — are in the works.

From a financial market’s standpoint, one common theme we are hearing from economists and portfolio managers is that, similar to the SARS outbreak of 2002–2003, the recent sharp, nCoV-driven market sell-off is temporary and the overall market impact will be minimal over the long-term. This chart of the week shows the short-term returns of the broader market — using the MSCI All Country World Index as the guidepost — during the SARS outbreak, as well as the current coronavirus. As shown in the chart, during the first three months of the SARS outbreak the MSCI ACWI posted a -2.9% return. However, six months after the initial SARS patient, the MSCI ACWI return was back in positive territory, up 2.8%.

While comparing SARS and nCoV makes sense from a regional and virus strain commonality, one must also consider the economic circumstances surrounding each outbreak. The supply chain connectivity between China and the broader world has advanced in leaps and bounds since 2003. The potential knock-on effects of an extended drop in Chinese factory productivity could slow, for instance, the technology supply chains for Apple, LG, Google, and more. Hence, economists are probably spot on that the market will rebound, but the details of the true impact on global growth are yet to be defined.

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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.

Is Manufacturing on the Rebound?

The ISM PMI index is a survey of manufacturers and measures the overall strength of the manufacturing sector. A measure over 50 indicates the sector is growing while over 43 suggests the economy overall is expanding. Over the last five months of 2019 this measure fell below 50, leading analysts and investors to wonder if we were in a manufacturing recession, driven by the U.S.-China trade dispute and slowing global growth. However, January’s reading came in at 50.9, beating expectations of 48.5 and recovering from an almost four year low. January’s surprise gain was met positively by stocks, bond yields, and dollar gains. The PMI had recently been held back by weak export markets and the trade war and it seems that news of the Phase One trade agreement between the U.S. and China supported manufacturing health; however, effects of the coronavirus nearly freezing parts of China’s economy and Boeing’s halted production straining producers will likely impact February’s number. So, while January’s reading was certainly a welcomed surprise, economists are now in “wait and see” mode to see how these risks play out in February.

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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.

Another Way to Look at Spreads

Bond spreads¹ now appear tight based on the traditional method of calculating spreads² as positive momentum with the U.S.-China trade deal over the fourth quarter of 2019 culminated in the recent signing of the Phase One agreement.³ This week we examine another way of viewing spreads for an additional perspective on how tight spreads really are and, therefore, how rich bond valuations might truly be at the moment. The left chart shows investment grade bond spreads while the right chart shows high yield bond spreads. Both charts display the traditional way of calculating spreads — yield minus U.S. Treasury yield — in purple, with the dotted purple line representing the average spread. As we can see, today spreads for both investment grade and high yield are tighter than their respective averages using the traditional approach to calculating spreads.

The rationale for examining an alternative way of measuring spreads comes from the fact that the 10-year U.S. Treasury yield has fallen dramatically over time. In 1987 it was 9.1% whereas today it is 1.7%. A corporate bond yielding 10.1% in 1987 had a spread of 100bp (10.1% minus 9.1%), while a corporate bond yielding 2.7% today also has a 100bp spread (2.7% minus 1.7%). Since they both have the same spread, the traditional method of calculating spreads using subtraction would deem both to have the same value. Even though the 10.1% yield from 1987 produced a lot more yield than the current 2.7% value, a relative value comparison suggests a different conclusion.  In 1987, the ratio of high yield to the 10-yr Treasury was only 1.1x (10.1/9.1), whereas today it is 1.6x (2.7/1.7).

The teal lines in both charts show this alternate view of spreads, by taking the bond’s yield as a multiple of the U.S. Treasury yield. The teal dotted lines show the averages of the spreads using this alternate method. The results are surprising as they show that both investment grade and high yield spreads, using this approach, are actually wider today than their averages, which one might interpret as indicating that both investment grade and high yield are actually attractively priced at the moment and there is still room for further spread tightening.

While there may be some justification behind this novel view of spreads, one key rebuttal is that the broader market does not view spreads using this approach. We would recommend that investors take into consideration both methods when assessing bond valuations as well as where we are in the broader market cycle to inform asset allocation decisions.

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¹ Bond spreads are used as an industry standard for assessing bond valuations.
² The traditional method of calculating bond spreads is the yield of the bond, for example, an investment grade corporate bond or a high yield corporate bond, minus the U.S. Treasury yield. If the spread is tight then the bond is richly priced, if the spread is wide then the bond is cheaply priced.
³ Concern over this past week’s global spread of the coronavirus widened spreads slightly but spreads still remain tight overall based on traditional calculations.

 

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.

Despite Political Tensions, 2020 off to a Great Start

This week’s chart shows the cumulative S&P 500 return and 10-year Treasury yields through January 21st. The S&P 500 is up over 3% year-to-date despite impeachment proceedings and geopolitical tensions with Iran. We investigate why equity markets have remained strong through a seemingly difficult start to an election year.

Impeachment proceedings allege that Trump interfered in the coming 2020 election by holding back millions of dollars of military aid to Ukraine in exchange for them launching an investigation into Joe Biden. The market seems relatively unphased, however, as Republicans control a majority in the Senate of 53 to 47. A two-thirds majority (67 senators) is required to convict Trump and remove him from office. This seems unlikely as evidence remains thin and he retains backing from the Republican party.

Iran has been another point of conflict early this year as the U.S. killed Qassem Soleimani as a result of his alleged targeting of U.S. embassies. Iran then responded by firing missiles at U.S. targets in Iraq. It is widely viewed that Iran is looking to avoid a head-on conflict with the U.S. as economic sanctions are harming the Iranian economy. As the direct conflict seems to have abated and Iran’s economy is struggling, the market seems to view this as a non-event.

Rates have remained low and the economy is growing. Though there seems to have been a few bumps in the road, the S&P 500 continues to march higher. Uncertainties remain, however, as a surprise verdict from the impeachment trials or newly discovered coronavirus could upset the markets moving forward. Going forward, investors will look for positive earnings and economic growth — both domestically and abroad — to support further equity market gains in 2020.

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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.

Will 2020 Earnings Expectations Hold Up?

Despite poor earnings growth in 2019, global equities had a strong year, generating double-digit returns. The MSCI World Index, a developed global equity benchmark, and the MSCI Emerging Markets (EM) Index returned 28.4% and 18.4%, respectively. Paradoxically, however, earnings growth was negative for both indices in 2019. Why were equity returns so strong while earnings growth was so weak? One key reason was investor reaction to central bank activity.

Throughout most of the world, central banks took accommodative actions in response to slowed economic growth. The developed markets central bank policy rate dropped from 1.96% to 1.39% between 2018 and 2019. Emerging countries also acted as China, Brazil, Indonesia, Mexico, Russia, Turkey, and the Philippines all deployed interest rate cuts. This central bank activity boosted investor optimism leading to strong returns in anticipation of better economic and earnings data in the year ahead.

Looking forward, 2020 earnings growth estimates range from 8% to 14%. In a typical year, estimates are revised downward as analysts begin the year with a more optimistic view. In fact, at this time last year, 2019 estimates ranged between 5% and 8%. Will the 2020 expectations hold up as we move through the year? We think markets are betting that they will and that a significant miss, similar to 2019, is likely to lead to disappointing returns in the year ahead.

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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 Does the Next Decade Look Like for Private Equity Investors?

For U.S. private equity investors, it has been a spectacular decade. Through September 2019, EV/ EBITDA¹ multiples, a standard for measuring private equity investment value, stood at 12.8x, just below the 2014 high of 12.9x. This figure marks an 82% increase from 2009, during which the U.S. economy was emerging from the Global Financial Crisis. In addition to revenue growth and EBITDA margin expansion, increasing multiples is a driver of private equity value creation and the most publicized metric on the state of the market.

A decade of increasing multiples has benefited private equity investors and managers. As investors saw the value of their private equity allocations grow, they rewarded managers with increasing amounts of capital. In 2019, global private equity raised $595 billion,² the second-largest sum ever.  A decades’ worth of prolific fundraising, like 2017’s record total of $628 billion, has created substantial amounts of dry powder, or uninvested capital. Today, private equity managers are sitting on $1.43 trillion of dry powder, waiting for investment opportunities to emerge.

These record-setting figures beg investors to ask very important questions regarding the next decade of private equity. Regardless of the past decade, we continue to see a tremendous amount of value in the private equity asset class as a return enhancer and diversifier for portfolios. Undoubtedly, investor scrutiny will increase as the asset class becomes more competitive, and manager differentiation will be paramount.

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¹ Enterprise value / earnings before interest, taxes, depreciation, and amortization
² Cummings, C. “Fundraising Stumbled in 2019 From Decade’s Record Pace,”  9 Jan. 2020. The Wall Street Journal.

 

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.K. Domestic Banks Spike After Tory Triumph

In what has been called a landmark victory, Prime Minister Boris Johnson and the Conservatives handily defeated their Labour party opposition in the Thursday, December 12th U.K. general election, winning 364 of the 650 Parliament seats. This landslide gain locks in a Tory government majority, which should enable Johnson to fulfill his campaign pledge to “Get Brexit Done.” The win also provides the broader market with greater certainty about the direction of Brexit, as Johnson will now have the votes necessary to complete the steps needed to make the existing divorce deal law and to take Britain out of the European Union by the end of 2020.

Brexit has been a major overhang on U.K. stocks, as evidenced by the FTSE 100 being the worst performing European Index year-to-date. In this chart of the week, we show the London stock market response to the election results. The FTSE 100 Index rallied on both the Friday and Monday after last week’s election, up 1.1% and 2.3% respectively based on closing price. In intraday trading on Monday, December 16th, the U.K. blue-chip index surged to its highest level in four months, up nearly 2.7%. Of note, those businesses acutely impacted by the domestic U.K. economy saw a meaningful boost. British financial service firms were among the major climbers during the rally, with Hargreaves Lansdown, Barclays, and Lloyds Banking Group (shown in the chart) up over 4%.

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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.