Category: Chart of the Week

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.

The Yield Curve Inverted a Month Ago… Now What?

The U.S. Treasury yield curve briefly inverted a month ago, when the 10-year Treasury yield fell 4 basis points below the 2-year Treasury yield on August 27th. An inverted yield curve has historically signaled a recession to come, as was the case prior to the 2000 tech bubble and 2008 housing crisis. However, the stock markets in the U.S. have been resilient since this latest inversion. The S&P 500 is up 4.2% and the Russell 1000 is up 6.6% since August 27th. This is not surprising as historically there is roughly a 20-month lag between yield curve inversion and the start of a recession.

It should be noted, however, in this most recent case of inversion there is the additional ­— and unprecedented — phenomenon of yield-seeking from investors whose domestic yields are currently negative. Foreign countries currently own approximately $6.6 trillion of U.S. Treasuries. In fact, countries with negative interest rates such as Japan and Germany increased their U.S. Treasury holdings by 9.2% and 21%, respectively, over the last twelve months. Foreign holdings of U.S. Treasuries amount to roughly 30% of the total amount of U.S. Treasuries outstanding and as a result, the shape of the yield curve has been warped and therefore may be a less-reliable indicator for recessions. It is true that yield curve inversion typically signals a market’s pessimistic view of the economy. However, given the current demand dynamics from foreign investors, yield curve inversion may be less reliable of a recession prediction signal given the overall state of economic growth and consumer health.

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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 Rise of Co-Investing

Much like the overall private equity ecosystem, the private equity co-investment landscape is undeniably growing and has yet to show any signs of slowing down. Historically, co-investing was implemented for one-off decisions to fill the gap in financing that GPs were unable to obtain. Now, GPs have come to embrace co-investment capital with a more recent phenomenon pushing its way to the forefront. We are now seeing GPs form dedicated co-investment vehicles, which eliminate the need for GPs and LPs to negotiate terms for each transaction. This structure gives co-investors access to a stream of co-investment opportunities with preferential economics.

Co-investing is beneficial to not only the GP, but also to the co-investors (LPs) who benefit from high-quality investment opportunities at favorable economics. Co-investing allows LPs to commit capital alongside preferred GPs and create tactical allocations to a pool of high-quality investments for their portfolios. Additionally, the more appealing fee structure of co-investments, which often have no management fee or carried interest, is fueling demand from institutional investors.

The value of co-investment deals has more than doubled since 2012 (totaling $104 billion in 2017) with the number of LPs making co-investments in PE rising from 42% to 55% over the past five years. In 2017, roughly 20% of the private equity market accounted for this volume. The volume of co-investment deal value in recent years has increased rapidly, illustrating the growing appetite investors have for this space.

Given the competitiveness of the co-investment market, having the right GP relationship is of utmost importance and a major determinant in the success of a program; however, given the size of the maturing private equity co-investment marketplace, we encourage investors to — at the very least — retain the option to pursue co-investments as even a modest allocation to the space can improve the return profile of a private investment program.

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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 Infamous September

When it comes to timing the stock market, one oft-heard saying is “Sell in May and go away,” which “warns” investors to try to avoid the underperforming summer months and re-enter the market sometime in October. While this might be little more than an anomaly, it is true that over the last 40 years these months do tend to have weaker performance. Most notable in underperformance is September, the only month to average a loss in the S&P 500.

Given the volatility and global growth trends we’ve seen recently, a disappointing September would hardly be surprising. Pairing this historical weakness with the results of last year’s fourth quarter — when equities were down 13.5% — it is understandable that many investors are nervous about the remainder of the year. Fortunately, performance has been positive with equities up 2.6% month-to-date at the time of writing. But what’s far more important is that despite some concerning headlines, the S&P 500 is still up over 21% year-to-date. Even if we do see some losses this month and 4Q disappoints, investors are still on track for a profitable year in their domestic stock portfolio.

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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.

Plummeting Pound Rebounds as PM Johnson is Thwarted

There has been a flurry of updates on the Brexit saga over the last three weeks, starting with the leak of the Yellowhammer doomsday report on August 18th to Wednesday’s stunning news of British Members of Parliament (MPs) successfully pressing forward on a measure to foil a no-deal Brexit. Throughout that time ­— and since the Referendum — the pound sterling has taken varying degrees of “pounding” based on these Brexit updates, and this week was no different.

In today’s chart, we show the intraday moves of the USD/GBP spot rate over the last three days. On Tuesday, September 3rd, MPs exerted their legislative muscle and debated the merits of a bill designed to prevent a no-deal Brexit on October 31st. In a sharp early sell-off that morning, the pound nosedived below the October 2016 “Flash Crash” dip and hit a 34-year low. The slump came amid growing fears that Britain could crash out of the European Union sans divorce agreement and the possibility of a snap general election. By that evening, however, MPs had voted 328 to 301 to seize control and presented a formal debate on the proposed legislation, delivering Prime Minister Johnson’s first legislative defeat in the House of Commons and causing the pound to rebound from the intraday low. And we saw the pound continue to rise in conjunction with PM Johnson’s second loss on the following day — MPs voted 329 to 300 in favor of the proposed legislative block on a no-deal Brexit. While it is unknown whether the pound will continue to climb, the MPs’ steps towards ensuring that the worst-case Brexit scenario would be avoided appeared to placate currency traders and 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.

Low Volatility Takes a Bite out of FAANG

FAANG stocks have underperformed the broad market over the past year, a stark change from their previous multi-year run of outperformance. More recently, this high-flying group has been negatively affected by a slowing global economy, the U.S.-China trade war, and antitrust investigations. On the other hand, low volatility equity strategies — heavily allocated to defensive sectors of the market such as utilities, REITs, and consumer staples — are benefiting from concern that we are late cycle, slowing global economic conditions, and falling interest rates. As investors seek to mitigate downside risk within equities, low volatility investments have been the recent winner.

This week’s Chart of the Week shows the growth of $100 for the S&P 500 Low Volatility index, the S&P 500 index, and the NYSE FANG+ index over the past year. As of August 23rd, the S&P 500 Low Volatility index had a trailing one-year return of +15.3%. Over this same time frame, the S&P 500 index returned a meager +1.7% while the NYSE FANG+ index fell by -12.4%.

The basic premise of low volatility investing is winning by not losing. A focus on lower beta, lower volatility stocks provides downside protection and helps with the power of compounding over time. The low volatility trade isn’t entirely a free lunch since popularity in this investment style has driven up valuations. Across defensive sectors, valuations are well above their long-term historical averages and trade at a premium to the broad market. As of July month-end, the S&P 500 Low Volatility index had a trailing P/E ratio of 23x compared to 21x for the S&P 500 index. While valuation levels for low volatility indices are certainly elevated and may have an impact on future price appreciation, their lower beta nature should act to mitigate downside risk relative to the broad 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.

The Good Old Days

It may be tempting for some investors to “time” the market in order to enhance returns in times of market volatility or to avoid exposure on days of anticipated losses in the equity market. However, this strategy can prove detrimental to a portfolio that compounds over time.

This week’s Chart of the Week shows the cumulative effect of missing out on the 5 best days and 10 best days of return for the S&P 500. If $1 were invested in October of 1988 and simply left alone, the investor would have $20.88 as of August 22nd, 2019. However, if out of a sample of 7,771 days, solely the 5 and 10 best days of return were missed as a result of not being invested in the S&P 500, the investor would have $13.95 and $10.50, respectively. Investors may be tempted to time the market in the short-term but making a wrong timing decision can drastically impact returns as shown in the chart above. It is nearly impossible to predict how the market will react on any given day and attempting to move in and out of the market incurs trading costs as well as the risk of losing out on a few crucial days of return. Compounding returns also widen the gap between the lines over time and exponentially affects the dollar value of a portfolio. This illustrates the importance of staying invested, especially through periods of high volatility when large swings in returns are more common.

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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.

All is Not Lost for 2019

Given this week’s volatility driven by (brief) yield curve inversion, the ongoing U.S.-China trade dispute, disappointing economic data from Germany, and overall growing pessimism about future growth, investors’ growing concerns about portfolio returns are entirely justified. However, despite this week’s volatility and mostly negative news, almost all asset classes have delivered positive returns for the year, with the great majority of U.S. equity strategies up double digits. Furthermore, most fixed income strategies have profited from falling interest rates, as shown by positive returns from investment grade as well as below investment grade sectors. And for all the negative news out of the Eurozone and China, international equities — as represented by the ACWI ex-US index — are still up more than 6% through August 15th. While the rest of the year is likely to feature elevated volatility and lower returns, barring a major market correction most portfolios should remain in positive territory, despite what has transpired the first half of August. If nothing else, we encourage investors to take a long-term view of the markets and not overreact in times of market stress, as stepping back and taking a longer-term view of the markets indicates that 2019 has been a profitable year to date.

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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.