Category: Chart of the Week

Equities Continue Their Wild Ride

It has been a wild ride since the equity market peaked on September 20th. Almost three months later, the S&P 500 is down 14.0%, marking the second market correction this year. Corrections occur when the market falls more than 10% from its market peak. Investors have been caught off-guard by this year’s volatility given last year’s slow and steady rise. While we predicted that 2018 would most likely be more eventful than 2017’s record-breaking tranquility, we could not predict to what extent. Year to date, we have seen market movements in excess of 1% in one out of every five days this year, and four of the five largest Dow Jones Industrials Average point drops ever despite strong positive economic data within the United States.

Market pauses occur frequently. Since 1920, the S&P 500 has on average experienced a 5% pullback 3 times a year, a 10% correction once a year, and a 20% bear market decline every 3 years.¹ What’s important is that corrections are merely temporary movements and have little impact on returns over the long-term. Since the bottom of the market in 2009, the S&P 500 has returned over 350% cumulatively and 15% annualized. The chart above shows the S&P 500’s cumulative returns after every correction this market cycle.

Markets are constantly under pressure from external events; recent history includes 2010’s Sovereign Debt Crisis, the 2011 U.S. debt downgrade, and fear of slowing Chinese growth in the winter of 2016. Today, market returns are almost flat since February’s market correction. Returns have eventually rebounded after each correction (including the global Financial Crisis) due to the underlying fundamentals of the economy and not elements of fear.

We acknowledge that while global growth did not meet investors’ expectations in 2018, the United States continues to meet or even exceed expectations. Third quarter GDP came in at 3.5%, unemployment is a low 3.7%, personal income is up, corporate earnings are strong, and inflation is a healthy 2.2%. The fundamental backdrop is still positive for the U.S. and is a stark contrast to the market’s performance quarter-to-date. While the recent volatility can be uncomfortable, waiting for market performance to realign with economic fundamentals can be rewarding over the long-term.

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¹ Fidelity Investments, Viewpoints, November 5, 2018

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 Do Higher Rates Mean for Asset Class Returns?

Higher interest rates coupled with signs of a global slowdown and roughly two months of market volatility — including several periods of a selloff — have clouded an otherwise positive picture of the U.S. economy. Despite this, many investors are still worried future increases in interest rates will hinder the economy, given growth in the U.S. and other regions is likely to slow down next year.

An analysis of the performance of different asset classes during U.S. rate hike cycles since the 1990’s suggests the opposite — these cycles were largely positive for investors. In fact, during the most recent hike cycle (Jan-16 to Nov-18), annualized returns for both private and public markets (excluding real estate) were well above their 1-year annualized rates of return before the initial hike began. The orange bars, which illustrate the various asset classes’ 1-year returns before the hike cycle, are well below their annualized returns during the cycle, as depicted by the colored columns. U.S. equities (S&P 500) outperformed other asset classes, gaining almost 12% during this period. U.S. buyout, non-U.S. equities and fixed income gained roughly 6%, 4%, and 1%, respectively. Real estate appears as the outlier with this most recent cycle, but comes on the heels of a considerable run for real estate after the Great Recession.

When looking at 1-year annualized returns after a hike cycle occurred for the prior three rising-rate regimes in 1994, 1999 and 2004, the data paints a similar picture. As illustrated in the graph, annualized returns 1-year after the hike cycle ended (when the effect of an increase/decrease in interest rates will be felt on a wide scale) were on average higher than returns during the cycle. This is depicted by the gray bars (1-year returns after the hike) being on average well above the returns during the hike cycles.

The volatility we have seen thus far in the market is typical for the later stages of an expansion and should not be solely attributed to the Federal Reserve’s tightening policy. It is important to note that interest rate hikes alone will not adversely affect asset class performance, but rather, the economic backdrop of each rate hike cycle will determine the market outcome. Given the uncertainty surrounding the current cycle’s path moving forward, investors should expect continued volatility and watch closely for upward-trending inflation.

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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 Be Concerned About Yield Curve Inversion?

After eight post-recession Fed rate hikes since 2015, the U.S. Treasury yield curve continues to flatten. On Monday, December 3, the yield curve inverted by one basis point between the three-year yield at 2.84% and the five-year yield at 2.83%. The next day, that inversion intensified to two basis points, with the three-year yield at 2.81% and the five-year yield at 2.79%, causing an 800-point correction in the Dow. The bellwether steepness indicator — the difference between the two-year yield and 10-year yield — remains upward sloping, however, but narrowed from 15bp on Monday with the two-year at 2.83% and 10-year at 2.98% to 11bp on Tuesday with the two-year at 2.80% and 10-year at 2.91%.

Based on previous market cycles, an inverted yield curve has predicted a recession six months to two years after inversion. Prior to the 2008 crisis, the first sign of inversion occurred in the 4th quarter of 2005, when the three-year and five-year inverted first, followed by the two- and ten-year inverting in the same quarter, roughly two years before the crisis that began in early 2008. This week’s chart shows the actual yield curve at the end of the day on December 4, along with the predicted yield curve at the end of this year and the next three years based on Treasury forwards. We can see that the market expects the curve to be generally upward sloping for the rest of this year, but to further invert in the front of the curve to the belly, and remain inverted in that region, for the next three years. However, the market still shows the 10s minus 2s to be upward sloping, even in the outer years.

Over the last few quarters, the expectations for the Fed’s hikes declined from one this December plus four more in 2019 to one this December plus only one more in June 2019. With this first sign of inversion, the Fed may pause on a hike for December, but it has communicated the hike so much that it may have to move forward with it or risk a loss of credibility. As 2018 heads to a close, this recent inversion bears watching and will no doubt have an impact on this month’s as well as next year’s capital markets.

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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.

Are Bonds Approaching Moderate Value?

This week’s chart looks at how bonds have fared during the global volatility of the last two months. In summary, bonds have retrenched a bit but have protected principal overall as expected and served as good diversifiers to other asset classes such as equities and alternatives. Spreads have widened moderately and are now showing some value across the board.

The four sections of the chart show the spread versus the average for core bonds, bank loans, high yield bonds and emerging markets debt. The timeframes are from the end of 2008 to today, but the averages are based on the last 20 years excluding 2008 and 2009 as outliers. As we can see, each of the spreads are rising and approaching averages. They are no longer near post-2008 tights anymore. This signifies that there may perhaps be some moderate value in fixed income today.

The fundamentals and the global macro backdrop support a moderate outlook. U.S. and European high yield and leveraged loan default rates remain low. Leverage, coverage, issuance and outstanding amounts do not point to a frothy market. Aggressive issuance is experiencing a shift away from high yield and into bank loans but remains modest overall. As the effect of Trump’s tax cuts continues to be felt through strong corporate earnings and the global tariff escalation continues to evolve, the Federal Reserve has enough optimism about the economy to warrant its continued pace of rate hikes. Collectively, these trends suggest stable if not improving valuation, fundamental and macro factors as we approach the New Year.

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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.

America’s Infrastructure Report Card

Pending a final vote count in Florida, the U.S. midterm election results are in with the Democrats regaining control of the House and Republicans maintaining majority control of the Senate. While a split Congress may lead to gridlock on various policies, one thing both parties should be able to agree on is the need for infrastructure investments in the U.S.

The historical under-investment, coupled with the lack of available public-sector funding, has impaired the government’s ability to deliver public services at adequate levels. The American Society of Civil Engineers (ASCE) estimated that $4.5 trillion needs to be invested through 2025 to upgrade the nation’s infrastructure. In its annual report, the ASCE in 2017 gave an overall “D+” grade for the condition and capacity of infrastructure in the U.S., further highlighting the need for additional investment.

Consequently, governments and public agencies have begun looking beyond the traditional funding methods to private investment in infrastructure via privatizations and public-private partnerships (“PPPs”). As a result, ownership and operation of infrastructure assets has been gradually moving from the public to the private sector on a global level. With this trend, the role of government has shifted from the provider of services to that of a regulator. This has provided a stream of investment opportunities and fueled development of a distinct alternative asset class for institutional investors that complements fixed income, public equities, real estate, and traditional private equity investments, and whose popularity is likely to increase as more investments and hence products come to fruition.

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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 U.S. Equities Rally to Finish the Year?

U.S. equities experienced a sharp correction last month with broad market indices erasing virtually all their year-to-date returns. The October pullback was especially jarring for investors since it followed an unusually quiet third quarter and had seemingly few changes in the economy or corporate earnings to warrant such a sell-off. Unlike the volatility seen in the first quarter of 2018, the S&P 500 didn’t record a single daily move of more than ±1% in the third quarter. During October, the S&P 500 saw a total of ten daily moves greater than ±1%, surpassing the total number seen in all of calendar year 2017. The recent resurgence of equity volatility coupled with the anticipation of midterm election results has created uncertainty in the outlook for risk assets in the near-term.

While stock prices are ultimately affected by a variety of factors, the fourth quarter has historically yielded the highest percentage of positive market returns compared to other quarters. In addition, market returns following midterm elections tend to be quite strong. Examining S&P 500 returns during midterm election years dating back to 1946, we see that the S&P 500 has never ended the year below its October closing low. The average return over these last 18 midterm elections is +10.6%. Although the sample size for post midterm elections is small, it is reassuring to know that we are in a historically strong period for equity markets.

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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.

Buying the Dip Takes a Hit

Historically, investors have attempted to capitalize from market drops by buying at the new lows in hopes that the stocks would rebound shortly thereafter. “Buying the dip” has generally proven effective ­— albeit by small margins — however 2018 has been an interesting exception. Notably, October’s steady trend downward has caused 2018 to flip into the red; through September, the “buy the dip” theory was still rewarded.

Our chart tracks data back nearly twenty years, through 1999, and throughout this data set the only other negative calendar years were 2000–2002. This suggests that currently, investors may be more leery of equity markets and less optimistic that the markets will rebound after a negative day. While investor sentiment certainly impacts the market, this is only a short-term bearish indicator. Midterm elections are right around the corner and historically the November of midterm election years has outperformed Novembers of other years, giving investors some optimism of what the end of 2018 may have in store for their portfolios.

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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.

Market Anomaly or the Beginning of the End?

So far, October has been a forgettable month for equity performance. Internet and technology companies — once the darling of this rally — have been among the hardest hit, as many investors appear to be taking profits as signs of slower earnings and economic growth have started to appear. Meanwhile, industrial companies have also been hit hard, as trade war rhetoric continues to grow between China and Washington, and China’s GDP growth was its weakest since the financial crisis. Through Wednesday, the materials, energy, industrials, and technology sectors all are in correction territory, with the following losses:

  • Materials: -13.0%
  • Energy: -12.5%
  • Industrials: -11.6%
  • Technology: -10.8%

Not surprisingly, volatility — as measured by the VIX index — has skyrocketed as equities have sold off.

More generally, October’s sell-off has been related to the health of the global economy; investors appear concerned about rising U.S. interest rates, a strong U.S. dollar, slowing global growth and trade wars. Only time will tell if October is part of a larger sell-off in global markets and the end of a nine-year bull market in the U.S., or just an anomaly. Going forward, investors will dissect third quarter earnings and be focused on company guidance going into 2019. If growth prospects for 2019 look tepid, many expect this sell-off to continue into year-end and the VIX to remain elevated.

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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.

Italy Looks to Increase Its Budget Deficit

The yield on Italian 10-year government bonds has risen this year as investor concern about the country’s fiscal policies mounts. This week Italy approved its 2019 budget targeting a 2.4% deficit to gross domestic product — a larger number than markets anticipated and a higher targeted deficit than 2018’s 1.8%. The Italian coalition government is targeting higher spending to implement a monthly income for low-income citizens and reduce the retirement age despite its high public debt to GDP ratio, 131% in 2017. The European Union will provide its formal comments on the proposed budget in the coming weeks and this will likely create some short-term market movements.

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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 Shining Light for China?

On September 25, MSCI, Inc. — a leading global provider of research-based indices and analytics — announced its plans to consult on a further weight increase to China A-shares in the MSCI Global Investable Market Indexes. The changes under consideration include quadrupling the weighting of Chinese A-share large companies in its global benchmarks, adding mid-cap names, and including ChiNext as an eligible stock exchange segment. This consultation follows the successful implementation of an initial 5% inclusion of China A-shares in the MSCI China and related composite indices (such as the MSCI Emerging Markets Index) in May and August 2018.

Let’s unpack the full proposal, piece by piece. The first change would be an increase to the inclusion factor of China A-share large cap securities from 5% to 20% over two phases. Specifically, MSCI would target a 7.5% increase coinciding with their May 2019 semi-annual index review and another 7.5% bump up with their August 2019 quarterly index review. Second, MSCI would increase the list of eligible Chinese stock exchange segments by adding the ChiNext board of the Shenzhen Stock Exchange during the May 2019 review. The ChiNext board, where most technology firms make their debut, represents 20% of the total China A-shares opportunity set and has a larger free-float adjusted market capitalization than Shenzhen main and SME boards. Lastly, China A-share mid cap securities would be included with a 20% inclusion factor as part of the May 2020 semi-annual index review.

MSCI’s rationale for the suggested expansion of A-share inclusion is largely driven by the incremental improvements in market accessibility implemented by China. Since the announcement of MSCI China A shares inclusions in July 2017, the daily trading limit and number of new accounts opened has significantly increased within the Stock Connect program, which is an investment channel between Hong Kong, Shanghai, and Shenzhen that allows international and mainland Chinese investors to trade securities in each other’s markets. There has also been a considerable drop in the number of trading suspensions. For example, the number of large cap trade suspensions in the MSCI China A International IMI Index has decreased from 16 to zero over the past 15 months.

The above chart depicts the pro-forma country weights should these changes be implemented. As indicated, Chinese A-shares’ portion of the index would increase from 0.7% to 3.4%. The anticipated net effect would be a slight increase in China’s overall representation in the MSCI Emerging Markets index by 1.0%.

While MSCI’s consultation may or may not lead to changes in the MSCI indices, this proposal indicates growing confidence in market liberalization within China. And, if implemented, these moves will increase foreign investor inflows into China’s $7 trillion stock market. Chinese markets have been able to handle increased trading volumes. This reaffirms our view that institutional investors will increasingly have exposure to China’s local markets over medium to long term.

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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.