Topic Tags: Commodities

The Holiday Party Guest List

Though the leaves have only started to change color, holiday party planning is in full swing. And while ample food and drink are necessary inputs for any type of holiday celebration, it’s the guests who ultimately make the party…or break it. In a way, this dynamic isn’t all that different from the markets — at any given time, the prevailing economic and market conditions will dictate investor returns. Given this analogy, we thought it could be fun to take a survey of the “attendees” in the current market environment and see if we can draw a connection with real-life examples along with what each guest means to the success of the party…and investor. Oh, and one caveat as we go — similar to actual party planning, sometimes we don’t want to invite someone, but we have to invite this person; circling back to the financial markets, we can’t control what forces exist in the markets, but we will do our best to determine those that will be merry and those that will not. Confused? Don’t worry, I am too, but we’ll figure this as we go through the invite list.

Highlights from this edition:

  • The Delta variant’s impact
  • Consumer spending
  • The credit and equity markets
  • The coming Federal Reserve taper
  • Earnings peak for equities
  • Labor market shortages
  • Commodity returns
  • Inflation concerns
  • The Evergrande debt crisis

Read > The Holiday Party Guest List

Watch our Q3 2021 Market Insights Video for an in-depth analysis of the third quarter’s performance by Marquette’s research team.

 

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.

Commodities: The Full Story

The first three quarters of 2021 have seen positive performance from a variety of asset classes ranging from U.S. and international equities to bank loans, which have exhibited returns close to their 10-year averages. However, one segment of the market that has experienced strong, aberrational performance on a year-to-date basis is commodities. Through the end of September, the S&P GSCI, a broad-based index that includes futures contracts on physical commodities, has returned 38.3% since the beginning of the year, far in excess of its long-term average. Recent performance for the asset class has largely been driven by surging demand for raw materials amid economic reopenings, coupled with pandemic-fueled supply chain dislocations, which caused the prices of many commodities to skyrocket. For instance, both lumber and copper experienced all-time highs during the first half of 2021, while agricultural commodity prices reached a 7-year peak earlier in the year as a result of strong demand for meat. Oil consumption also hit a seasonally adjusted high in July of 2021, which led to a 50% increase in the price of crude futures from the year prior. As the global economy continues to reopen, labor shortages, supply chain bottlenecks, and strong demand for raw materials will likely persist, meaning that positive performance from commodities may continue into 2022.

As investors assess the prospects of the commodities space going forward, it is important to keep historical context in mind. To that point, our chart this week examines both the 10-year annualized returns and standard deviations for eleven different asset classes to better understand the long-term performance profiles of each one. As displayed in the chart, the real estate space, as measured by the NCREIF index, has posted strong returns in the last decade as well as a low standard deviation (though the illiquid nature of the asset class may lead to some volatility smoothing). Equities have tended to exhibit higher levels of return and standard deviation than fixed income, while Small Cap indices have notched both higher returns and volatility than their larger peers across the geography spectrum. Interestingly, each of the asset classes profiled in the chart has yielded positive performance in the last 10 years with the exception of one: commodities. For the 10-year period ending September 30th, 2021, the S&P GSCI posted an annualized return of -4.8%. Additionally, the index has experienced an annualized standard deviation of 21.4% during that same period, which is again the most extreme of any of the asset classes in the chart above. Put simply, commodities have exhibited both the lowest returns and highest levels of risk of any major asset class in the last 10 years. As investors assess recent strong performance from the space and look to the future, it is crucial to avoid recency bias and keep history in mind. Prudence dictates a diversified approach to asset allocation in order to hedge uncertainty and achieve optimal risk-adjusted returns.

Print PDF > Commodities: The Full Story

 

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 is Inflation Headed?

Despite a number of commodity prices, including lumber, corn, and pork, retreating from recent highs, inflation remains a key focus for investors, especially as the Delta variant rages on and vaccination rates slow. Our chart this week looks at what the data can tell us about where inflation is headed.

Actual inflation, as measured by year-over-year growth in the headline Consumer Price Index (CPI), is shown in green in the chart above. CPI ran hot in 2008 just before the Global Financial Crisis (GFC), fell into negative territory in 2009, and then peaked twice before turning a corner, declining in 2011 and normalizing from 2012 to 2014.

The market’s expectations for average annual inflation are shown above in purple and teal, over the next two and five years, respectively. The breakeven inflation rate measures the difference in yield between U.S. Treasury bonds and Treasury Inflation-Protected Securities (TIPS) of the same maturity. This difference is the return that the TIPS provide to protect from inflation, or the inflation rate where an investor would be indifferent between owning the two instruments.

What do these three lines tell us? First, actual CPI does loosely follow, on a lag, the two-year and five-year breakeven rates. Both breakeven rates fell and recovered ahead of CPI in 2008 and 2009. The difference between the two-year breakeven and five-year breakeven also provides critical information. In the post-2008 GFC recovery, the five-year breakeven remained higher than the two-year breakeven from 2009 to 2011, with the market expecting inflation to rise and be higher on average over the next five years than over the next two years as the global economy continued to recover. In 2011, the five-year breakeven fell below the two-year breakeven, showing that the market began to forecast that average inflation over the next five years would be lower than average inflation over the next two years. Actual CPI peaked not long after that, declining and normalizing from 2011 to 2014.

What could these indicators mean for inflation going forward? Actual CPI is again running hot at 5.4% in both June and July. However, the two-year breakeven, despite characteristically falling faster than the five-year breakeven at the height of the COVID panic in 1Q20, is already higher than the five-year breakeven, a leading indicator of CPI peaking and something that didn’t happen after the GFC until 2011. Additionally, both the two-year and five-year breakeven appear to be plateauing. Both breakeven rates have been fluctuating around 2.5%, meaning the market believes annual inflation will settle around an average 2.5% over both the next two and five years, supporting the idea that heightened near-term inflation is more transitory. While this market-based data does have its limitations, it is a helpful input as we look to help our clients prepare for the future.

Print PDF > Where is Inflation Headed?

 

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 Lumber Experience

“The lumber experience,” as coined by Federal Reserve Chair Jerome Powell, has become the poster child for transient inflation. After a brief pullback during the early days of COVID, lumber prices moved up sharply in 2020 to an unprecedented peak in May 2021. In the two months since, prices have been cut in half to roughly $790 per thousand board feet. While still nearly double pre-pandemic levels, the move is clearly meaningful.

Lumber embodies the different moving pieces of the inflation debate, impacted by easy monetary policy, fiscal stimulus, pandemic-related supply chain issues, and evolving consumer preferences spurred by COVID. Lumber, like other commodities, is priced based on the balance between supply and demand. The lumber market had initially braced for a COVID-related housing pullback that never came. Instead, increasing housing and renovation demand, fueled by record-low interest rates, extra cash, and newfound time at home, combined with restricted supply amid pandemic-related shutdowns led to a more than 250% increase in prices. Then, supply and demand adjusted. Sawmills ramped production and consumers put off purchases. Homebuilding permits fell to a seven-month low. This change in behavior is counter to conditions typical of runaway inflation and should help ease the worst of those concerns.

While it is unlikely lumber falls back to pre-pandemic levels given the severe housing shortage in the U.S., the correction, along with that in other commodities like copper, soybeans, and corn, does help the Fed navigate the thin line between fostering economic growth and managing inflation. In June, the Fed indicated we could see rate hikes start in 2023, up from previous expectations of 2024, though some analysts think this will be pulled forward again into 2022. The path of rates is important to markets — as we saw with the rate increases in 2018 and the rise in the 10-year earlier this year — and we will continue to look to leading indicators, like lumber prices in this case, to help inform our outlook and client recommendations.

Print PDF > The Lumber Experience

 

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 Strong Decade for Private Markets, Led by Growth

While it has been a very strong decade for private market returns, not all private market strategies have provided the same level of risk-adjusted returns. Growth-oriented strategies like Growth, Private Equity, and Venture Capital have delivered the highest 15-year horizon IRRs and with lower standard deviation than other lower-returning strategies like Real Estate, Infrastructure, and Oil & Gas. We believe these growth areas are better positioned to generate higher IRRs within closed-ended funds given their large opportunity set, accelerated ability to deploy capital, opportunities to drive operational improvements, and ability to generate attractive exit opportunities.

Asset allocation mix is of increasing importance as investors seeking higher return potential within portfolios look to scale up their illiquid allocations. The last decade shows that not all private markets investments are equal. We believe Growth, Private Equity, and Venture Capital are likely to continue to be the most attractive strategies for investors looking to maximize the returns generated from their illiquid allocations. Manager selection also remains a critical investment decision within private markets strategies, where there is typically a wider range of performance dispersion than in more traditional public market asset classes.

Print PDF > A Strong Decade for Private Markets, Led by Growth

 

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.

Can’t Buy a Thrill

In the spring of 1973, the lyrical geniuses Walter Becker and Donald Fagen of the musical group Steely Dan released the song “Reelin’ In the Years.” The third and fourth lines of the first stanza proclaim:

Well, you wouldn’t even know a diamond if you held it in your hand
The things you think are precious I can’t understand

At first glance, the reproving lyrics underscore the disagreement of value between two parties and one’s inability to recognize an object of high value. Arguably, value is subjective as the intersection of what the most pessimistic seller and most optimistic buyer are willing to accept. Fagen and Becker could have been students of economic policy, prophesizing the creation of Bitcoin more than 35 years later and critical of inflation, which would reach 6.2% in 1973 and 11.1% in 1974.¹ While I am hesitant to put Fagen and Becker in the same category as Keynes, Smith, and Friedman, I do believe their words inspire a debate on the meaning of value.

Gold has historically been accepted as an alternative to cash and a hedge against inflation. As expected, inflation has been on the rise this year, with the Consumer Price Index up 4.2% YoY in April, the highest in 12 years.² At the same time, contrary to conventional wisdom, gold has underperformed. Through May 14th, 2021, gold is down 3.4% YTD and up only 2.6% over the past year. Alternatively, the cryptocurrency Bitcoin is up over 50% YTD and over 350% over the past year. While there are a number of different factors behind Bitcoin’s latest rally, its status as “digital gold” may be one of them, with its finite supply and detachment from central bank policy particularly attractive right now.

The discussion around cryptocurrencies and inflation is a complicated one, given the nascency of the asset class and the limited data available given the general lack of inflation over the last several years. Making long-term decisions based on short-term information does not typically lead to beneficial outcomes. With that said, it is often hard to grasp the magnitude of innovation at its earliest stages. As the debate over the value of Bitcoin and the value of gold as an inflation hedge continues, we recommend investors be prudent and diligent in accounting for new data and information while weighing it against past lessons in uncertain periods.

Print PDF > Can’t Buy a Thrill

¹ World Bank, 1960–2019 data. “Inflation, consumer prices (annual %) – United States.”
² Cox, J. 12 May 2021. “Inflation speeds up in April as consumer prices leap 4.2%, fastest since 2008.”

 

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 Lasting Effects of a Temporary Trade Stoppage

In late March, one of the busiest waterways in the world came to a standstill after the Ever Given, a 1,300-foot container ship, became lodged in the Suez Canal. Nearly 30% of the world’s daily shipping container freight passes through the Suez Canal, and with supply chains already disrupted amid the COVID pandemic, the timing could not have been worse. While only a one-week stoppage, with approximately 7% of the world’s oil and 12% of global goods trade flowing through the canal, it is estimated that each day lost delayed more than $9 billion worth of goods.¹

In this Chart of the Week, we analyze the impact that the Suez Canal closure had on maritime shipping costs and the contribution to inflation. The chart above shows the daily price movement of the Shanghai Containerized Freight Index (SCFI). As one of many proxies for global trade and ocean freight health, the SCFI reflects the weekly shipping spot rates of Shanghai container exports along 15 major trade routes, including Shanghai to the United States (east and west coasts), Europe, South Africa, and South America. In contrast to the highly-cited China Containerized Freight Index (CCFI), the SCFI focuses solely on exports in these 15 individual trade routes, rather than nationwide import and export container transport, which would include more contractual and futures rates. Rates surged throughout 2020 amid increasing demand for goods over services and tighter supply. The blockage, which may take months to fully recover from, combined with pent-up demand and economic re-openings has exacerbated the imbalance and sent SCFI spot shipping costs up another 20% over the last month. Rising inflation has been an increasing concern for investors this year and, given current dynamics, we do not expect the contribution from higher global shipping rates to abate anytime soon.

Print PDF > The Lasting Effects of a Temporary Trade Stoppage

¹Lloyd’s List Intelligence

 

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.

One Year Later, What’s Next?

Welcome to our inaugural quarterly client newsletter! As a way of introduction, I am Greg Leonberger, Director of Research here at Marquette. I have had the privilege of meeting many of you over the years, and for those that I have not worked with previously, please accept this virtual introduction; my hope is to meet many more of you in person once in-person meetings resume. As I embark on this newsletter series, the goal each quarter is relatively simple: provide you with our views on capital markets, the economy, emerging risks as well as opportunities, and hopefully stitch in a few anecdotes to make for a more engaging connection with our readers.

Highlights from this edition:

  • One year anniversary of the equity market trough in 2020
  • COVID-19: lingering uncertainty, vaccine progress, economic recovery
  • Equities update: value and small-cap outperformance, valuations, TINA
  • Fixed income: reflation trade and interest rates, spreads
  • Alternatives: opportunities in real estate, hedge funds, and private markets
  • Inflation worries: money supply and commodity prices

Read > One Year Later, What’s Next?

 

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.

Commodities: Cycle or Cyclical?

A commodities supercycle is generally defined as a sustained period of broad-based above-trend movement. In the first quarter of 2020, almost a decade of commodities price weakness was capped off with a more than 20% drop, and since then, prices have rebounded more than 40% to levels last seen in 2018, inspiring headlines debating whether this is the start of the next supercycle. Proponents argue reopening demand, a potential uptick in global growth and inflation, and a weaker U.S. dollar, among other factors, point to yes. Skeptics contend that an initial demand normalization complicated by temporary supply disruptions does not a supercycle make, at least yet. Commodity price movements can be especially volatile given lumpy physical market characteristics. Oil prices moving into sharply negative territory last April demonstrate exactly that. Whether this latest move is cyclical and temporary or structural and sustainable is still to be determined.

In this newsletter, we explore a few of the key factors that could support or suppress a sustained commodities bull market.

Read > Commodities: Cycle or Cyclical?

 

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 Stagflation?

The coronavirus pandemic has disrupted everyday life and caused a devastating impact on the global economy. At the peak of the outbreak, the U.S. unemployment rate reached 11.1% and real GDP growth fell by 9.0%, which marked the second worst economic crisis since the Great Depression. On the bright side, the COVID relief programs and expansionary economic policies projected an air of optimism; as of January 2021, the unemployment rate came down to 6.3% and real GDP growth has started to recover since cratering during the first half of 2020. However, these figures are still at concerning levels, and an emerging fear is that the magnitude of economic stimulus may create a surge in inflation, in spite of middling economic growth. This week’s chart examines the nature of stagflation and how the markets perform under this condition.

The term “stagflation” comes from “stagnation” and “inflation” and can be identified as a period of slow economic growth, high unemployment, and high inflation. An example of stagflation was in the 1970s as shown in the chart. The inflation and unemployment rates (blue and orange lines) stayed in a 10–15% range when the economic growth (purple line) was slow or negative. The typical cause of stagflation is an external shock that breaks the inverse relationship between the inflation and unemployment rate; the high inflation usually indicates that the demand for goods and services is high, the economy is expanding and unemployment is low. In this case, the supply shock of oil was the main contributing factor for driving prices higher, discouraging consumption, and resulting in a recession. Stagflation is not only detrimental to the economy but also difficult to address. For example, contractionary policies such as increasing interest rates to reduce inflation may make unemployment even worse.

As shown at the bottom of the chart, the U.S. stock, international stock, bond, real estate, and commodity markets held up well during stagflation in the 1970s. The S&P GSCI commodity index returned 54.3% per year and the other markets returned 25% to 28% per year. The international stock market outperformed the U.S. stock market. The commodity market performed best but highly fluctuated with a 0.72 correlation with inflation.

The economic crisis from the pandemic coupled with the aid to boost the economy may seem like a recipe for stagflation. However, impending stagflation is unlikely. The current inflation of 1.3% is well below the central bank’s 2% target, oil prices are stable, the personal consumption expenditure is down but has recovered to 96% of its pre-pandemic level, vaccines are becoming more accessible and IMF projections are generally positive (dotted lines). As the economy further re-opens later this year, the threat of stagflation should dissipate as attention turns toward renewed economic growth.

Print PDF > Should Investors Be Concerned About Stagflation?

 

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.