Category: Chart of the Week

Reluctant to Spend

In recent years, the Chinese economy has struggled to return to pre-pandemic levels of consumption and economic growth. This lackluster rebound can be attributed to factors including prolonged lockdowns from the country’s zero-COVID policy, regulatory crackdowns on private sector companies, and pervasive weakness in the country’s property sector. Recently, the Chinese government, in tandem with the People’s Bank of China (PBOC), has enacted measures to address the country’s myriad issues. For instance, the PBOC announced a monetary easing package in the third quarter that included interest rate reductions and cuts to reserve requirement ratios for Chinese banks. While the Chinese equity market saw a sharp September rally as a result of these measures, investor excitement has since waned, with the MSCI China Index down roughly 20% over the last two months.

One key reason measures to restore growth in China have been unsuccessful is that they have failed to boost domestic demand, of which consumption plays a large part. Economic uncertainty has made Chinese households reluctant to spend and consumer confidence in China remains well below long-term average levels, a trend outlined in this week’s chart. While a general malaise contributes to this lack of confidence, there are aspects of the Chinese economy that pose unique challenges for the government as it relates to economic revitalization efforts. One such challenge is the distribution of citizens’ wealth. To that point, approximately 80% of household wealth in China is comprised of real estate assets, rendering Chinese consumers particularly vulnerable to the ongoing instability in the country’s housing market. Additionally, only 10% of Chinese citizens own stock (as opposed to 70% of U.S. citizens), meaning any propping up of the Chinese equity market by the government may not result in a commensurate increase in domestic wealth and consumer demand. Consumer confidence in China has also been hampered by the country’s high levels of youth unemployment, as the jobless rate for 16–24-year-olds exceeded 17% at the end of the third quarter. Young educated Chinese workers in particular are facing a weak job market, along with a mismatch in job availability and their skill sets. These and other challenges have plagued the Chinese government for years, and while policymakers are now taking action to address them, whether new measures are sufficient to restore business and consumer confidence in China is yet to be determined.

First-Time Buyer Beware

Over the last 20 years, U.S. homeowners’ total home equity value has risen by more than 150% to roughly $35 trillion. This meteoric rise in home prices has helped many Americans build wealth but has been hazardous for a particular demographic: first-time homebuyers. These higher prices, along with high mortgage rates (the average 30-year fixed-rate loan is around 7.0% as of this writing) and reluctant sellers, have combined to keep potential first-time buyers largely out of the housing market. In 2024, a record low 24% of U.S. home purchases were made by first-time buyers; this figure is down from 50% in 2010. The median age of first-time buyers has also increased to 38, significantly higher than a historical average that is nearly 10 years younger.

With no signs of U.S. housing prices falling, many prospective buyers will be forced to continue to rent. This dynamic should sustain tailwinds for multifamily housing rentals, to which investors can gain exposure via core ODCE funds. Indeed, as of the end of the third quarter, multifamily housing constituted nearly 30% of the NFI-ODCE index. These trends in home affordability have also led institutional investors to increasingly move into the single-family housing market. While some cities have seen a glut of multifamily supply in recent years as investor capital has poured in, broader fundamentals remain sound.

At Odds

In the weeks leading up to the 2024 presidential election, many thought the contest would be one of the closest in recent memory, with most polls showing a toss-up race between Donald Trump and Kamala Harris. The Economist notably listed a 56% chance of Harris defeating Trump in its final election projection, which relied heavily on traditional polling data. Ultimately, however, the election was not as close as many predicted, with Trump defeating Harris 312-226 by electoral vote count and 50.2% to 48.1% by popular vote count (as of the time of this writing). The discrepancies between polling data and the results of this and other recent contests beg the question: Is there a better way to predict the outcome of elections? Enter the betting markets…

While betting directly on election outcomes is new, indirect betting is not. In 2016, Sam Bankman-Fried (yes, that Sam Bankman-Fried) and Jane Street, a global proprietary trading firm, built robust models that incorporated data all the way down to the county level to help predict the outcome of that year’s election. While the firm could not bet directly on the outcome of the race, it could take positions that the team believed would be profitable based on the model’s projected result. To that point, Jane Street was able to front-run election updates from major media outlets and build a short position in the S&P 500 Index, as the team thought a Trump victory, which their models projected far before the mainstream press, would be negative for markets. While this trade initially showed signs of promise, it ultimately led to some of the biggest losses in the history of the firm as equities turned positive in the wake of Trump’s first electoral victory.

This presidential election cycle provided more opportunities for speculators to bet directly on the outcome of the race, with odds updating by the minute. Shortly after the first presidential debate on June 27, for instance, betting markets exhibited much higher odds of Harris winning the presidency than then-nominee Joe Biden. Then on July 21, Harris replaced Biden at the top of the Democratic ticket, a move forecasted weeks earlier by betting markets. While Harris surged in betting markets in the weeks following this change, Trump became the odds-on favorite to win the contest in the days leading up to election day, with a 54% chance of taking the presidency. Betting odds started moving quickly last week on election night when results began pouring in. Roughly 40 minutes after the first polls closed, betting markets began shifting heavily toward Trump despite the electoral count being just 23-3 in his favor (with 512 electoral votes outstanding). Harris was a longshot bet in a matter of hours despite still having several paths to victory, as betting markets indicated a 95% chance of a Trump victory before midnight. The Associated Press finally called the election for Trump at 5:34am.

Going forward, odds markets may be better predictors of election results than more traditional polling data. This is due to the wisdom of crowds, the incorporation of extensive data in odds calculations, and the fact that people tend to be more honest when betting than they are with pollsters.

Presidents, Real Estate, and Consistency

With the 2024 presidential election in the books, investors have now turned their focus to what the incoming Republican administration might mean for the performance of various asset classes. As it relates to the real estate space, the Trump victory did lead to a subsequent swing in both mortgage rate levels and the prices of housing-related equities, which are highly rate-sensitive. To that point, the average rate on a 30-year fixed mortgage climbed 9 basis points yesterday to more than 7.1% and housing stocks dropped, with home builders and materials companies like Lennar, D.R. Horton, and Home Depot down more than 3% during yesterday’s trading session.

While it is too early to forecast the impact that the new administration will have on commercial real estate specifically, readers should note that returns of the NCREIF Property Index, which tracks private real estate owned by institutional investors, have been nearly identical across Democratic and Republican administrations throughout history. Specifically, the index has posted an average annual return of roughly 8.7% under each party dating back to the 1970s. This consistency suggests that real estate performance is more closely aligned with economic cycles, long-term fundamentals, demographics, and property demand than it is with the political landscape.

Earnings Don’t Grow to the Sky

Loyal readers of Marquette research publications are likely aware that a small handful of U.S. large-cap technology-oriented stocks, dubbed the “Magnificent 7,” has comprised an outsized portion of performance of the overall domestic equity market over the last several quarters. Specifically, Apple, Microsoft, Amazon, Alphabet, Nvidia, Meta, and Tesla have accounted for roughly 55% of the total cumulative return of the S&P 500 Index since the beginning of last year. Much of this performance has been fueled by the remarkable earnings growth exhibited by these companies since early 2023, which can be observed in this week’s chart. Readers will note the striking periods of 3Q23, 4Q23, and 1Q24, during each of which the Magnificent 7 posted year-over-year earnings growth of more than 50%. This is in stark contrast to the growth notched by the S&P 500 Index during those periods, which was never more than 8%. As a result of these dynamics, the Magnificent 7 stocks have surged to a combined weight of roughly 32% of the S&P 500 Index as of the time of this writing.

Many of the Magnificent 7 companies are set to report third quarter results later this week, and this basket of stocks is expected to post year-over-year earnings growth of more than 18% for the period (compared to roughly 4% for the S&P 500 Index as a whole). While outsized results like these are expected to continue into the fourth quarter, analysts expect a moderation of earnings growth for these high-flyers in 2025. Specifically, by the end of next year, consensus forecasts call for only a 3% differential between Magnificent 7 earnings growth and that of the S&P 500 Index. Investors may have already started to take note of these moderating expectations. To that point, since July 10, which represented the culmination of a 22% rally to begin 2024, the Bloomberg Magnificent 7 Index has fallen by roughly 2%. This performance figure lags that of every major S&P 500 Index sector during that time.

While the healthy forecasted earnings growth by the Magnificent 7 over the coming quarters should reassure investors that these businesses remain fundamentally sound, it is fair to question the extent to which these stocks will drive S&P 500 Index performance going forward. Investors should certainly expect more moderate returns, both on an absolute basis and relative to the broad market, from this cohort in the years ahead. Remaining broadly diversified across sectors, industries, and geographies, as well as thoughtful exposure to products (i.e., equal-weighted indices) that help mitigate market concentration risks where appropriate, are some tactics equity investors can use to navigate an environment of slowing earnings growth for the Magnificent 7.

A New Tariff in Town?

During his presidential term, Donald Trump increased tariffs on Chinese imports to address unfair trade practices including intellectual property theft. Specifically, using Section 301 of the Trade Act of 1974, the Trump administration imposed an initial 25% tariff on certain Chinese imports in 2018 that triggered a trade war that persists to this day. After this initial levy, Chinese imports fell by 17% on a year-over-year basis in 2019 and an additional 4% in 2020. That said, imports from China returned to pre-trade war levels in 2021 and 2022. There are a few reasons for this trend. First, in 2019, Trump administration officials feared trade restrictions would ruin the holiday season for American consumers and delayed the enactment of tariffs on certain holiday gift favorites including toys, video game consoles, smartphones, laptops, and computer monitors. Simultaneously, the COVID-19 pandemic shifted consumer preferences away from services and toward goods, resulting in increased demand for Chinese imports despite the tariffs. Additionally, from 2019 to 2022, Chinese imports unaffected by the Section 301 tariffs increased by nearly 50%, offsetting the decline in taxed imports. These factors resulted in an unexpected net increase in overall Chinese imports into the United States over that period.

While certain tariffs have expired, the Biden administration has reinforced several Trump-era trade policies. Earlier this year, for instance, tariffs were increased on goods like steel and aluminum, electric vehicles, battery parts, solar cells, ship-to-shore cranes, syringes, and needles. Given the upcoming U.S. presidential election, it is interesting to note that both major political parties seem to agree that China’s trade practices warrant a continuation of tariffs. To that point, semiconductor tariffs will likely increase from 25% to 50% over the next year. Additionally, in two years, tariffs on lithium-ion non-EV batteries will likely increase from 7.5% to 25%, and those on graphite permanent magnets will likely increase from 0% to 25%. Since the effect of these future tariffs is ultimately unknown, investors should maintain a diversified portfolio to mitigate the fallout from a potential escalation in the current trade war between the U.S. and China.

Mexico Winning the Battle with Inflation

Like many countries in recent years, Mexico has grappled with higher-than-average inflation levels, primarily driven by elevated food and producer prices. Mexico notably began tackling its inflation problem earlier than most developed countries in the wake of the COVID-19 pandemic. To that point, Banxico, the central bank of Mexico, started to raise its key rate in June of 2021, roughly 9 months before the U.S. Federal Reserve began its hiking cycle. This key rate reached a peak of more than 11% in early 2023 shortly after Mexican inflation, as measured by headline CPI, achieved a record high of 8.7% on a year-over-year basis. After leaving its key rate unchanged for nearly a year, Banxico finally started to loosen its policy earlier this year given a moderation in both core and headline CPI. Indeed, the most recent reading of core CPI, which came in at a multi-year low of 3.9%, likely allows Mexican policymakers to feel confident that their battle with inflation may be coming to an end. Going forward, lower inflation could portend additional rate cuts by Banxico. This dynamic, in tandem with nearshoring trends that have led to an increase in Mexican manufacturing activity and exports, could be conducive to strong performance for equities in the region.

The Elusive Small-Cap Revival

U.S. small-cap equities have trailed their larger peers for over 13 years. Although the asset class has shown intermittent signs of strength throughout that period, including at the end of 2023 and in July of this year, a lasting shift in leadership continues to be elusive. When assessing the prospects of small-cap equities going forward, it may be helpful to analyze the high yield bond market, as the behavior of high yield spreads can serve as an indicator of small-cap strength. The primary reason for this relationship is likely that tighter spreads indicate economic strength and lower recession risk, and performance of small-cap stocks is closely tied to the health of the economy. To that point, over the last two decades when high yield spreads retreated below key levels outlined in this week’s chart, small-cap equities have tended to perform well. A recent example of this phenomenon came in late 2020, when spreads fell sharply, and the Russell 2000 Index advanced by over 22%. Spreads fell again in November of last year and remain tight to this day, and the Russell 2000 Index has advanced by roughly 36% over this period.

Although large-cap stocks continue to propel markets into the fourth quarter, there are several potential catalysts for small-cap equities that could be unlocked in the near future. First, forward valuations (e.g., price-to-earnings ratios) for small caps relative to large caps sit near historic lows. Additionally, investors may see a shift in Federal Reserve policy as a trigger for a market regime change, as small-cap equities are more negatively impacted by higher interest rates given the larger debt burdens these companies typically carry. Put simply, lower interest rates have historically been a tailwind for small-cap stock performance. Perhaps most importantly, the fundamental backdrop for small caps shows signs of improvement. Specifically, easing pressures from interest expenses and a reacceleration of sales may support earnings growth, which has fallen short of lofty expectations from the beginning of the year. Finally, the benefits of reshoring and recent government spending that will likely accrue to smaller companies have yet to be fully realized.

Despite these potential catalysts, a revival within the small-cap space remains elusive, at least for now. While a softer inflation reading in July spurred a brief rally in small-cap equities, the Russell 2000 Index has retreated by roughly 50 basis points since the Fed cut its policy rate. This figure is well below the 2.4% return notched by the S&P 500 Index since that time. Indeed, large-cap stocks may currently be perceived as a safe haven amid higher levels of market volatility, economic risk, geopolitical conflicts, and consumer weakness. Still, Marquette believes a dedicated allocation to small-cap stocks will ultimately prove beneficial to investors in the future given the diversification benefits offered by the space and the potential catalysts for stronger performance outlined above.

Can Interest Rate Cuts Revive Private Equity?

It has been well documented that private equity has been experiencing pressures over the past two years, marked by declines in both deal activity and recent performance relative to the strong returns generated in prior years. Since the asset class is heavily reliant on leverage to fund deals, the private equity landscape has been impacted by the historic rise in interest rates that has made debt more expensive over the last several quarters. That said, the Federal Reserve has now shifted its policy stance with inflation seemingly contained, and several rate cuts are expected to occur in the near term. But will lower rates drive a rebound in private equity activity?

While a recovery in activity likely won’t occur overnight, private equity firms seem to be preparing for a significant increase in deal making on the horizon. Due to the high financing costs associated with higher interest rates, recent years have seen a shift away from debt-laden leveraged buyouts (LBOs) and towards growth and expansion deals, as those transactions typically require minimal leverage. Over most of the last 15 years, LBOs consistently accounted for a larger share of U.S. private equity deals relative to growth and expansion transactions, but this dynamic reversed in 2023. We do not expect recent trends to continue in perpetuity since lower borrowing costs should usher in a new wave of LBO activity. More broadly, M&A activity appears to be showing signs of turning a corner. To that point, in the first half of this year, North American M&A activity advanced by roughly 13% on a year-over-year basis in terms of both deal count and value (including estimates for unreported deals).

In short, recent shifts in monetary policy may provide tailwinds for the private equity sector. In addition to lower borrowing costs that will likely underpin future deal activity, rate cuts also benefit existing portfolio companies by easing the debt service burdens on their balance sheets. This offers companies the flexibility to pursue new acquisitions, initiate organic growth initiatives, and, ultimately, drive potential returns higher for investors. As always, we continue to closely monitor the emerging trends and their implications for the performance of the private equity asset class.

Lower Rates, Better Fates?

With the first Federal Reserve rate cut of the current loosening cycle in the rear-view mirror, investors are now questioning how markets will react to a new era of macroeconomic policy. While each rate cycle is unique, examining how the S&P 500 and Bloomberg Aggregate indices have responded to prior instances of rate cuts can give investors some insight on what to expect going forward. To that point, this week’s chart highlights the returns of these benchmarks following the first cut of last six periods of easing by the Federal Reserve. Although rate cuts have historically portended higher near-term equity returns, there have been two instances of negative S&P 500 Index performance in the wake of Fed easing. Specifically, the 1- and 3-year returns following rate cuts in 2001 (the Dot Com Bubble) and 2007 (the Global Financial Crisis) were both negative. That said, performance of the Bloomberg U.S. Aggregate Bond Index was positive during both of those periods, as well as during the other four easing cycles shown in this week’s chart. Even during the 3-year period following July of 2019, which included six months of rate hikes in 2022, the fixed income benchmark returned 0.4% on an annualized basis. In summary, although Fed rate cuts have historically coincided with recessions in the U.S., investors can gain comfort from that fact that both equities and bonds have fared relatively well amid periods of monetary policy loosening.