Category: Chart of the Week

Is the U.S. Economy Headed for a Recession?

The U.S. Treasury yield curve, as measured by the difference between 10-year Treasuries and 2-year Treasuries, has flattened significantly over the past several years, decreasing from 2.65% on December 31, 2013 to 0.65% on November 15, 2017. In fact, this is the flattest that the yield curve has been since November 4, 2007, just prior to the onset of the “Great Recession,” and this has sparked concerns about a potential recession on the near-term horizon. A flattening yield curve has typically been associated with concerns about future economic growth, so mounting worries about a potential recession are understandable.

However, these concerns appear to be a bit premature. First, it is important to note that every recession since 1980 (including the “Great Recession”) was precipitated not only by a flattening yield curve, but by an inverted yield curve, meaning that yields on longer-term (i.e. 10-year) Treasuries were below yields on shorter-term (i.e. 2-year) Treasuries. Given that yields on 10-year Treasuries are currently 0.65% higher than yields on 2-year Treasuries, we are nowhere near an inverted yield curve. Second, it is worth noting that it is fairly common for the yield curve to flatten during rate hike cycles when short-term rates tend to rise faster than long-term rates. Given that the Federal Reserve Bank has increased interest rates four times since 2015, a flattening yield curve is not an unexpected occurrence. Finally, it is important to note that the yields on U.S. Treasuries — particularly the longer-end of the curve — have been significantly impacted by the actions of other central banks around the world. In 2013, the Bank of Japan launched a $1.4 trillion quantitative easing program that primarily focused on purchasing longer maturity Japanese government bonds. In 2015 the European Central Bank launched a $1.2 trillion quantitative easing program that primarily focused on purchasing longer maturity European government bonds. These large-scale bond purchase programs drastically lowered interest rates on Japanese and European government bonds, enticing investors from around the world to purchase U.S. Treasuries, which offered significantly higher relative yields. Between December 31, 2013 (when the spread between 10-year and 2-year Treasuries was 2.65%) and November 15, 2017 (when the spread between 10-year and 2-year Treasuries was 0.65%), yields on 10-year U.S. Treasuries actually decreased from 3.03% to 2.34%, while yields on 2-year U.S. Treasuries increased from 0.38% to 1.69%.

While the flattening yield curve is somewhat concerning, it appears that this combination of Federal Reserve rate hikes boosting the short end of the curve and quantitative easing programs from global central banks depressing the longer end of the curve is the primary driver of the flattening yield curve, not concerns about future economic growth in the United States.

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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.

Wages, Labor, and Productivity: Looking for a Rebound

This week’s chart examines the average annual growth rates for wage gap, labor productivity, and real hourly compensation in the nonfarm business sector during various business cycles. Due to the cyclical nature of productivity data, business cycles are employed to allow for a standardized comparison through time.

The average labor productivity growth for the cycles examined is 2.3%, average compensation growth is 1.7%, and wage gap growth is 0.5%. The last business cycle saw dips for all of these averages: labor productivity growth came in at 1.1%, compensation growth is 0.7%, and the wage gap is 0.4%. These data points further reinforce the notion that U.S. growth is sub-par, despite the length of time for which the economy has been expanding. A lack of productivity growth may be a reason why wages have remained stagnant as the economy has continued to grow. Going forward, positive developments for all these metrics should be accretive to U.S. economic growth.

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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.

Falling Correlations Boost Hedge Fund Returns

When looking at hedge fund performance in 2017, equity hedge has been by far the best performing strategy, with the HFRI Equity Hedge Index up 9.6% through the end of the third quarter.

What has made the environment so appealing for equity hedge performance in 2017? This week’s chart looks at the CBOE S&P 500 Implied Correlation Index over the past year. The index measures the expected average correlation of price returns between S&P 500 Index components, implied through SPX option prices and prices of single-stock options on the 50 largest components of the SPX. The index hit a low of 13 during the month of October, as correlations continued to trend lower.

An environment in which correlations are lower is a positive for active managers, particularly those that are both long and short individual stocks. When correlations fall, we expect stocks to trade more off fundamentals versus moving with the general market. We believe this is one factor that has helped equity hedge strategies during 2017, and should continue to be accretive to returns if correlations remain depressed.

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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 Emerging Sector in EM Equity

This week’s Chart of the Week examines how investment opportunities in emerging markets have changed over the last seven years. Historically investors have associated emerging markets with commodities but this view is becoming outdated. In 2011, Financials, Energy and Materials were the three largest sectors within the MSCI Emerging Markets (EM) Index. The Information Technology (IT) sector constituted 12% of the benchmark. Fast forward to present day and IT has now more than doubled to 27% while Energy and Materials have both halved.

This evolution speaks to the economic developments several emerging countries have experienced over the last two decades, with increases in population and income. This can be especially seen in China where companies like Alibaba, Tencent, and Baidu have capitalized on the expanding middle class. Investors have taken notice of the growth potential and the IT sector within EM has led the way in 2017 returning just over 50% through September. Investors can debate whether these stocks have gotten ahead of themselves but the shift in investment opportunity over the last decade is unquestionable.

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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.

Increased Appetite for Private Equity

Over the past two decades there has been a steady decline in the number of companies listed on U.S. stock exchanges. In 1996, during the dot-com peak there were more than 8,000 public companies, but this has declined to just over 4,300 as increased regulation and consolidation has more than offset the number of IPOs and corporate spinouts. Over 2,000 companies were delisted between 1997-2003 as the maturity, composition, and fundamentals of these businesses were not able to attract institutional capital and thus failed to meet the listing standards of U.S. exchanges.

Meanwhile, the perception of the private equity industry continues to evolve as more capital and managers gravitate towards the space. There are over 7 million businesses in the U.S. and the number of private equity-backed companies has steadily increased to now over 7,100 companies. Investors continue to be attracted to the return potential, alignment, and innovation within the private markets. With nearly $1 trillion of dry powder in the private equity industry and near record fundraising we are almost certain to see the number of private equity-backed companies increase over the next decade.

Furthermore, it will not be surprising to see investors shift more of their allocations into private equity. Private markets offer a larger and growing opportunity set, and further upside than the fully valued equity markets. With both the number of managers and investment options increasing, we are likely to see a widening range of returns produced by the industry which will make manager selection even more critical for investors.

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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.

Where’s the VIX?

In a time when there is a lot of fear and uncertainty surrounding political turmoil, geopolitical issues, and tension with North Korea, the market appears remarkably calm. For this week’s chart of the week we take a look at the widely followed CBOE Volatility Index (VIX) which is considered to be the best gauge for expected fear in the markets over the next 30 days. On October 5th, the VIX dropped to a 23-year low closing at 9.19, a number not seen in almost two decades. Leading up to this record close was an impressive eight-day stretch of closes below 10, the longest streak of its history.

Why do the markets seem to be resilient to the ever-concerning news cycle? While impossible to know for certain, speculation includes positive macroeconomic signs, stronger earnings growth, gaining popularity of passive index investing, and complacency of the markets. Although the VIX is well below its historical average of 19, it is worth noting that fear can quickly resurface. In the meantime, it will be interesting to see if further VIX index levels can be achieved which would likely be paired with the markets reaching additional record highs.

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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.

Info Tech Surpasses Dot-Com Peak – Is This Time Different?

With U.S. equities enjoying the second longest bull market run on record, it has become a frequent occurrence to see equity indices hit new closing highs.  The S&P 500 has recorded 39 new closing highs during the first three quarters of 2017 alone.  A noteworthy milestone recently occurred for the S&P 500 Information Technology (“IT”) sector.  This sector now trades at levels above its prior March 2000 dot-com peak.  IT is the best performing sector of the S&P 500 thus far in 2017 with a year-to-date return of +27.4% through September and is now the largest weighted sector in the S&P 500 with a weight of 23.2%.  Like most sectors of U.S. equities, the information technology sector trades near the high end of its historical valuation range.  Strong performance from this sector in recent years has led to comparisons with the prior dot-com bubble, but is this time different?

While few would disagree that we are nearing the later stages of the current market cycle, the typical excess and euphoria seen in prior market peaks do not appear to be present.  Compared to the prior dot-com peak, the information technology sector today is on noticeably better footing.  Companies in this sector today tend to have healthier balance sheets and hold greater cash levels.  Valuations, while elevated, are not nearly as overvalued as the prior peak.  On a 12-month forward P/E basis, the IT sector trades at 19.5x versus a level of 56x seen in March 2000.  There are certainly individual cases of overvalued securities, but in aggregate the sector is valued much more reasonably than during 2000.  Additionally, the main driver of long-term stock returns has historically been growth in corporate earnings.  Today, the IT sector generates healthy levels of earnings growth and cash flows; many companies during the dot-com era did not have actual earnings to justify their lofty valuations.  While market bubbles are only identified on a post-mortem basis, investors today can at least take comfort in knowing that the IT sector possesses healthier fundamentals and less euphoric valuations than seen in the past.

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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.

Brick and Mortar is Still Alive

Contrary to popular opinion, not all shopping centers and retail stores are headed to the graveyard. Although some such retailers are already dead or heading in that direction, our chart of the week shows that while the absolute number of net store openings has dropped, they are still positive and expected to outpace store closings. Additionally, the overall composition of retailers has changed over the years. Today, store openings are less flashy than they used to be and companies are more cautious in their plans for growth. We are seeing strength in the retail space from discounters such as TJ-Maxx; “fast-fashion” retailers like Zara and H&M; beauty brands such as Ulta and Sephora; and fitness companies like Soulcycle and Orange Theory Fitness.

So what does all this mean for real estate investments? The majority of retail exposure for real estate funds in the NCREIF-ODCE index is typically in community and regional centers with heavy foot traffic. This includes grocery-anchor malls and areas where store openings remain positive with minimal exposure to the large mall anchor stores that dominate the headlines. These investments should flourish in today’s market, as real estate investment managers anticipate future shopping patterns of the ever changing consumer.

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The Return of Earnings

One of the biggest challenges investors face today is navigating the current equity environment as valuations are well above their historical averages. The P/E ratio for the S&P 500 climbed over 45% during the past five years resulting in several new all-time high index levels. Given the length of the current bull market many have begun to prepare for a correction over the past few years, yet we are still waiting.

In early 2016 equity markets appeared to be in trouble as earnings repeatedly disappointed. Instead, stocks ultimately rallied with Trump’s pro-growth agenda, as investors anticipated increases in infrastructure spending and lower taxes. But with the failure to pass any major legislation so far, it seemed these gains were in danger of being wiped out. However, this time it was earnings to the rescue, as they climbed more than 10% over the trailing 12 months. This allowed stocks to rise even higher while stabilizing valuations.

While earnings are unlikely to continue growing at this pace, during 2013 and 2014 they did average a more reasonable 6.5%. If earnings can maintain that level once again markets may be able to postpone a correction and further sustain the current bull market. Should they fall, however, there may not be other factors to support valuation levels and hold off significant losses.

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This Market is One Cool Cat

Hurricanes Harvey and Irma substantially impacted the lives and infrastructure of all that was in their paths. They also directly impacted certain investments, namely catastrophe bonds, (“cat bonds”). Catastrophe bonds can help diversify a bond portfolio’s rate, credit and currency risk with non-correlating nature risk. Cat bonds are issued by insurance companies that pool property and casualty policies. They pay coupons to the bondholder using the policy premiums received. However, when a natural disaster occurs, the principal of a cat bond can be used to pay insurance claims on the pool of policies. Historically, annual cat bond returns average 5% to 10%.

This week’s chart shows the Swiss Re Cat Bond Index on the top compared to the Credit Suisse High Yield Bond Index on the bottom. Hurricane Harvey caused only a negligible 0.3% decline in the cat bond index followed by a 0.5% rebound, since the most severe damage came from flooding. Flooding is generally not covered by cat bonds, as cat bonds primarily cover hurricane damages associated with wind. However, Hurricane Irma caused a 16% initial decline, as the index has roughly 20% exposure to Florida hurricanes. Moreover, the state of Florida requires that all homeowners hold hurricane insurance.

Hurricane Irma qualifies as one of the top 10 costliest natural disasters ever recorded, with damage estimates ranging from $50 billion to $100 billion. It is akin to the 2008 housing crisis for the corporate credit and equity markets. The bottom chart shows the high yield bond index declining during the 2008 housing crisis by 33% peak-to-trough, which was over twice the initial decline of the cat bond index due to Hurricane Irma. With recent damage estimates adjusted downwards from an initial overshoot, the Swiss Re Cat Bond Index has already rebounded by 10% only a few days after Irma struck. This makes its net decline 6% to-date as the index continues to recover, showing inherent resilience in the cat bond market. Our thoughts are with those affected by these recent disasters.

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