Category: Chart of the Week

The Dynamic Duo vs. the Russell 2000

Apple and Microsoft are the two largest companies (by market value) in the United States and the only two U.S. listed firms with a market capitalization over $1 trillion. Both companies have been standout performers in 2019, with Apple’s market value increasing 58.6% this year through the end of November, while Microsoft’s market value has increased 47.1% over the same period. The combined market value of the two companies now stands at $2.3 trillion dollars and together they represent roughly 9% of the total value of the S&P 500 Index. To put the size of these two businesses in perspective, this week’s chart of the week shows the combined market value of Apple and Microsoft compared to the entire Russell 2000 index of U.S.-based small cap stocks. At the end of November the combined value of the two companies was essentially equal ($2.342 trillion vs. $2.367 trillion for the Russell 2000) to the market value of the entire small cap index. The stellar performance of Apple and Microsoft has a been a large driver of the outperformance of large cap stocks in the US over the last decade. But with the 2020’s approaching, maybe small caps are poised for a better decade 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.

Will the Good News Continue for U.S. Equities?

Domestic equity returns have surprised investors to the upside this year. The S&P 500 is up ~24% and the S&P has posted 26 new highs in 2019. Over the past 10 years, the S&P has recorded 233 new highs and a 481% cumulative return. The chart shows that many of the market highs were backloaded into the second half of the current recovery as economic growth and investor confidence increased. The S&P 500 did not reach its post-recession peak until 2013: four years after the financial crisis. During those four years, market volatility was elevated, but steadily decreasing.

2019’s market environment has been very different from 2009. The first contrast is valuations. In March 2009, the S&P 500 traded at 11.2 times forward earnings and today it trades at 19.2 times forward earnings, higher than its 10-year average of 16 times. Second, while market volatility on average has decreased by 50% since 2009, volatility (measured by the VIX index) ­— as shown by the orange diamond — remains elevated since 2017’s lows. Lastly, geopolitical risk has predominantly shifted from Europe and its sovereign debt crisis to the U.S.-China trade war, the latter of which is still not resolved. Luckily, U.S. businesses and especially U.S. consumers have proved resilient through these stressors. If the status quo continues into 2020, we can only hope for more of the same: positive equity returns albeit with higher market volatility and geopolitical risks.

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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 an Election Year Mean for Equity Investors?

Prior to each presidential election, there is inevitable talk about market reactions to candidates and how policy changes could impact investors. As shown in the table, election years tend to exhibit more muted returns (as measured by the S&P 500 index) and greater volatility compared to the years leading into the presidential election. Year-to-date, 2019 has continued the Year 3 trend of strong performance, but if history is any indication, the 2020 outlook is less optimistic.

When it comes to Republicans vs. Democrats, political pundits often try to show one is better than the other for equity market returns. The reality, however, is that there isn’t enough of a sample size to draw any meaningful conclusions about parties, given the number of combinations of who controls the Presidency, Senate, and House of Representatives. Even in the case of 2016 with Trump’s unexpected win, markets initially sold off but quickly rebounded to their previous levels. No matter the candidate or the policy, markets care most about clarity and dislike uncertainty. As a result, we are expecting greater volatility over the next 12 months as we head into the 2020 presidential election. While the election will certainly not be the sole driver of market volatility, it will undoubtedly contribute to further uncertainty over the coming months.

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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.

Should Investors Worry About the Growing Deficit?

Americans have seen tax cuts and strong historical returns across asset classes since the Global Financial Crisis. However, though the general populace has been flourishing, the decrease in revenue flowing to the government and an increase in defense spending have contributed to the deficit increasing each year since 2016. Is the increased deficit a systemic risk or simply a side effect of a low rate environment?

This week’s chart of the week shows the United States’ deficit since 2007 in absolute terms as well as a percentage of GDP. The deficit spiked during the financial crisis at $1.4 trillion dollars as the administration took action to provide stimulus to the nation while in a recession. Shortly after, the deficit began decreasing as the economy moved towards recovery. More recently, the deficit has been increasing and is projected to reach $1.1 trillion dollars in 2020, an amount not seen since 2012. On an absolute basis, the deficit has been moving upward, but has this been offset by an increase in GDP? The blue line on the graph shows the deficit as a percentage of GDP. This metric has also been steadily increasing since 2016, though it is still much lower than during the Great Recession.

One area of potential concern is that during past expansions the deficit was decreasing or low, while now the deficit is moving in the opposite direction. If a recession were to occur, the government would have to borrow even more to stimulate the economy, pushing the debt level even higher and possibly raising concerns about the U.S. financial system. On the other hand, a theory of economic thought called Modern Monetary Theory (“MMT”) has gained traction due to the proposal of large increases in government spending by left-wing presidential candidates. MMT states that a country that prints its own currency does not have to worry much about debt as it can pay it off simply by adding to the monetary supply. Thus, the thought is that the only target for central banks should be inflation.

In all, deficit spending is a crucial means of financing public programs and stimulating the economy, no matter which economic viewpoint is applied. The U.S. deficit has ebbed and flowed over time and will continue to be a point of political contention for years to come.

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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 Argentina’s New President Drive Losses for Hedge Funds?

When Argentina President Mauricio Macri was elected in 2015, he brought along a pro-business agenda, which reopened the country’s financial markets bringing investors ­— including hedge funds — back into the country. As hedge funds returned, their investments in both debt and equity were on the presumption that Argentina would not default on its debt, and economic growth would strengthen. Unfortunately, those bets were hit hard following a disappointing showing for Macri in August’s primary election. Bonds across the Argentina complex sold off to distressed levels as investors expressed concerns that Alberto Fernández, the Peronist candidate, would return the Peronist movement back to power. Investors feared market overhauls made by Macri would be undone by Fernández and the Peronist party.

On October 27th, the Peronist movement was voted back into power when Fernández received 48% of the vote. Despite the election result, hedge funds remain invested across the Argentina debt complex with the view that Fernández will not allow Argentina’s bonds to default. It remains to be seen if that will happen, but hedge funds remain long on this distressed credit despite taking a large haircut to their positions in August. These managers have quite the hole to climb out of and only time will tell if they are on the right side of this trade; for those with exposure, all eyes will be on Fernandez and any new policies that arise from his regime that could impact these investments.

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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 Hidden Risk Within Passive Small-Cap

The rise of passive investing has been a multi-year trend among investors and currently accounts for nearly half of all assets within U.S. mutual funds and ETFs. The popularity of passive investing is not surprising given that the majority of actively managed funds charge higher fees and struggle to consistently beat their target benchmarks. However, the small-cap segment of the market bears watching, particularly among those investors that are passively invested.

This week’s Chart of the Week shows the percentage of companies over time within the Russell 2000 index that have no earnings. As of September 30, 2019, the percentage of companies within the Russell 2000 index with no earnings stands at 38%. This is one of the highest readings observed in nearly 25 years and is at levels typically not seen outside of recessionary periods.

Consistently strong passive inflows, a low interest rate environment, and general investor preference towards longer duration assets perceived to have recession-resistant, long-term secular growth drivers have helped to support companies with little to no earnings. This trend may eventually reverse and could bode well for active strategies that are structurally underweight this segment of small-cap. Regardless, it is important to acknowledge the growing trend and potential risk within the small-cap space.

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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 New “FronTier” in Retirement

Historically, few plan sponsors have emphasized the retention of retirees in plans, but over recent years, plan sponsors have been dedicating more conversations and efforts into doing just that. We’ve seen this trend prove out as progressively more assets over the past three years from participants 65+ are kept in plans, as shown in this week’s chart. Plan sponsors began prioritizing retiree retainment due to a few developments, but most importantly because the large asset balances of retirees can provide better pricing leverage for the plan as a whole. This benefit is mutual in that retirees will likely get better pricing within the plans than they would as individuals.

To better serve retirees, plans are increasingly discussing the “retirement tier” of the DC plan which would consist of products only available to those nearing or at retirement. Products aiming to provide better retirement solutions have expanded notably over the past few years, largely focused on addressing the issue of retirees taking a large lump sum withdrawal at retirement age. Instead, new products allow retirees to receive regular payments ­— similar to paychecks — while the underlying principal (i.e., their “nest egg”) remains invested and grows with the market. Many of these are labeled “retirement income” products and offer retirees better liquidity options that are easy to understand. Typically, the funds target a certain amount of risk in order to distribute a specified percentage of assets — usually 2–5% — to the retiree at regular intervals throughout the year.

While the concept seems simple enough, these products initially faced slow adoption due to several factors including cost, recordkeeping constraints, lack of portability between plans, and lack of regulatory guidance. However, as the industry continues to leverage technology to address these challenges and expand its capabilities, the tool kit is expanding for plan sponsors to provide participants flexibility in their retirement planning; this is particularly important for those near or in retirement which brings an increased dispersion of personal situations, savings, and spending goals. As the DC industry grows in size and in complexity, Marquette will remain abreast of retirement income innovation to better guide plan sponsors as they provide retirement solutions for their participants.

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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.

 

Central Banks Fight the Threat of Recession

On September 12th, the European Central Bank (“ECB”) — headed by departing President Mario Draghi — passed a major stimulus package fueled by a key interest rate cut and a large bond repurchase program. The ECB deposit facility rate, which is used by banks to make overnight deposits, was lowered 10 basis points to -0.5%, a new record low. The newly approved quantitative easing program is set to begin on November 1st. It will involve the ECB buying over 20 billion euros worth of Eurozone government bonds on a monthly basis with the intention of increasing the money supply, thereby lowering interest rates and encouraging growth.

Though this move by the ECB did not receive unanimous approval by voting members, it was implemented with the hopes of stemming an increased slowdown in Europe and fighting against the threat of recession. One indicator of the Eurozone slowdown has been PMI numbers, which dropped again in September, remaining in contraction territory. This trend began at the start of 2018 with the crossover into negative growth occurring early this year.

Similar though slightly better numbers have been seen in the United States over the past few months, and it is widely expected that the Fed will continue monetary easing by cutting rates one more time in 2019, either at the end of this month or the end of the year. As trade tensions and market uncertainties persist, the ECB, Federal Reserve, and central banks across the world are fighting to maintain growth and avoid a global recession.

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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 Root Cause of Negative Rates

At our annual investment symposium last Friday, we worked through a thought-experiment with keynote speaker Mohamed El-Erian on two points central to the state of our global economy today. The first is that with the furtherance of negative rates in Germany and Japan driven by the global growth slowdown, foreign investors’ continued buying of U.S. Treasuries may eventually cause U.S. rates to go negative. In turn, this could lead to a shift from bonds to stocks and thereby drive up P/E ratios to higher and higher norms. The second is that the global slowdown appears to be very much driven by an aging of the overall population, which includes mounting retirements out of the workforce.

This week’s chart is actually two charts; the first on the left shows the number of people aged 65+ per 100 people of working age, which has grown in leaps and bounds for all developed countries between 1980 and 2015. Japan is especially notable, with 13 people aged 65+ per 100 people of working age in 1980, skyrocketing to 43 people aged 65+ per 100 people of working age in 2015. While data from China and emerging economies are not readily available, we can expect them to follow a similar trend. The second chart on the right shows the share of the U.S. population aged 65+ growing from only 5% in 1910 to 15% today and expected — based on actual birth rates — to reach 20% and 25% in the next few decades.

Certainly, this evolution of workforces will be a focus point going forward, and as more baby boomers exit the workforce, their productivity will need to be replaced to maintain current economic growth rates. Whether that comes from technological innovation or simply an influx of workers bears watching and will no doubt help shape the economic growth narrative in the 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.

The Growing Appeal of Co-Investment Funds

Co-investment funds are becoming an increasingly attractive area of deployment within private equity programs. The number of dedicated co-investment vehicles has risen dramatically over the past decade as many fund-of-funds managers have looked for product expansion and have responded to investor demand.

Co-investment vehicles provide investors the ability to provide additional capital — alongside and aligned with private equity managers ­— at a significantly reduced fee (less than traditional private equity investing) and with quicker deployment (mitigating much of the j-curve). These factors have contributed to the higher net returns recorded by dedicated co-investment funds over this past decade.

As seen in the charts above, these dedicated co-investment funds have outperformed the broader private equity fund performance with a higher median net IRR of 18.9% (430 bps of outperformance over Preqin’s direct private equity median net IRR) and with 80% outperforming their median PE performance within their respective vintage years (2009–2016). We believe this past decade has really proven out many of these teams and strategies and that proven managers with strong and repeatable selection processes should continue to outperform private equity benchmarks in nearly all vintages throughout a full economic cycle.

We encourage investors to continue to allocate to these dedicated co-investment funds as an important allocation within their private equity programs. However, we caution investors must be selective as there is a very wide range of skill, sourcing, alignment, and access differential between managers within this area of the market.

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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.