Topic Tags: Fixed Income - Investment Grade

Portfolio Trick or Treat

Coming into 2023, investors were cautiously optimistic about 2023 market returns; cautious considering the broad losses across asset classes during 2022 but optimistic about more attractive valuations and the inherent upside potential stemming from these price points. Nine months into the year, which of these opportunities have been “treats” for investors, and which have been “tricks”?

In this edition:

  • The biggest trick of them all: Investment grade fixed income
  • But not all of fixed income has been a trick…
  • Tricks come in all sizes: U.S. small-cap equities
  • Trick, treat, or both? U.S. growth stocks
  • Currency movements still tricky
  • More treat than trick: Emerging markets
  • If you’re not surprised, it’s not a trick: Commercial real estate

Pause for Effect

With higher rates dragging on performance, investment grade fixed income securities experienced a challenging third quarter. While September CPI data may lead to a final rate increase by the Federal Reserve before the end of the year, a tactical pause by the central bank in the months following the next FOMC meeting appears likely. Based on prior pause cycles, investors may have reasons for optimism as it relates to the trajectory of investment grade fixed income in the near future.

The chart above highlights policy rate pause cycles overlayed with 1-year trailing returns of the Bloomberg U.S. Aggregate Bond Index and the upper bound of the federal funds rate over the last 45 years. For this analysis, a pause cycle was defined as a period immediately following a rate hike during which the policy rate was maintained at a single level for more than two consecutive FOMC meetings. As rate policy is dictated by economic data, looking beyond two FOMC meetings helps to distinguish pause cycles from stair-step rate increases. Based on this framework, there have been 13 such cycles since 1980, which have lasted roughly six months on average.

In Marquette’s most recent Quarterly Letter from the Director of Research, Halftime Adjustments, it was suggested that the overall yield environment, coupled with fewer Fed rate hikes going forward, could generally serve to benefit the fixed income space. This optimism is supported in part by the relatively strong bond market performance observed during 12 of the 13 pause cycles detailed above, with the lone exception coming in 1983 and 1984. This pattern aligns well with intuition, as a flat rate environment allows investors to collect coupon payments from bond holdings while prices hold steady, which leads to positive returns. Investors should remember, however, that the differences between past environments and current realities must be considered when assessing the return potential of all asset classes, including fixed income. While past performance does not guarantee future returns, Marquette will be watching closely to see if trends similar to those outlined above unfold over the coming months.

2023 Investment Symposium

Watch the flash talks from Marquette’s 2023 Investment Symposium livestream on September 15 in the player below — use the upper-right list icon to access a specific presentation.

 

Please feel free to reach out to any of the presenters should you have any questions.

Observations from Across the Pond

Marquette regularly sends a senior member of our research team abroad as part of ongoing manager sourcing and due diligence efforts. These trips include update meetings with investment managers with whom Marquette has existing relationships as well as on-site visits with potential new manager recommendations. The cadence of these trips was severely impacted by the COVID-19 pandemic, but with international travel now almost back to normal, Marquette sent Senior Research Analyst Evan Frazier on a whirlwind tour of Europe earlier this summer. Over the course of almost a week, Evan met with eight investment management firms across three cities.

In this newsletter, Evan shares the perspectives, as well as more anecdotal information, he gained while on the ground in Europe, including insights on the region’s economy, the corporate landscape, and the unique set of opportunities and challenges currently facing international markets.

Read > Observations from Across the Pond

 

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.

Fitch Downgrades U.S. Credit

Fitch Ratings unexpectedly downgraded the U.S. government’s credit rating one notch from AAA to AA+ on August 1, 2023. This is only the second downgrade in history, after S&P Global Ratings, then Standard & Poor’s, made the same adjustment shortly after the 2011 debt ceiling crisis; S&P has maintained the AA+ rating since. Moody’s — the third major U.S. rating agency — still has the U.S. at its highest Aaa rating. Fitch noted the downgrade reflects expected fiscal deterioration over the next three years, the country’s high and growing debt burden, and an erosion in governance over the last several years, marked by bipartisan standoffs and last-minute resolutions. The downgrade and timing have drawn criticism from the Biden administration and economists, citing economic strength and the minuscule risk of the U.S. actually missing any debt payments.

While in practice the downgrade will likely have minimal impact, with the U.S. government broadly considered one of the safest borrowers, markets are reacting. Treasuries initially rallied on the news, anticipating the same flight to quality seen in 2011, though that sentiment reversed this morning, with yields at one point breaching a key resistance level of 4.1% — a level last seen in November 2022. Also likely contributing to the move today is the Treasury Department’s announced plans to sell a higher-than-expected amount of longer-dated securities next week, as it works to replenish the Treasury General Account (reference Marquette’s recent newsletter for additional context). The U.S. dollar initially dipped on the news but has since rallied and is up on the day amid higher yields. U.S. equities, after a steep run, are down modestly today, with growth equities leading the group lower.

Print PDF > Fitch Downgrades U.S. Credit

 

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.

Halftime Adjustments

For anyone who regularly reads these letters, recall the market preview edition opined on the outlook for asset classes in 2023, particularly the likelihood of each delivering positive returns for the upcoming year. Given that we are halfway through the year, we would like to use this letter to make “halftime adjustments” to our outlook; with NFL training camps set to open later this month, we couldn’t resist the urge to borrow a football term. We hope this is a quick beach read as you enjoy your summer vacations and prepare for the second half of the year.

This edition re-assesses the outlook for fixed income, equities, and real estate for the second half of 2023.

Read > Halftime Adjustments

 

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.

2023 Halftime Market Insights Video

This video is a recording of a live webinar held July 19 by Marquette’s research team, featuring live, in-depth analysis of the second quarter and themes we’ll be monitoring in the second half of the year.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

Sign up for research alerts to be invited to future webinars and notified when we publish new videos.
For more information, questions, or feedback, please send us an email.

Don’t Fight the Flows

While not as commonly dissected as earnings and multiples, liquidity is a key driver of equity markets. An influx of liquidity set up both the tech and real estate bubbles, which burst as that capital dried up, leading to severe market corrections in the early 2000s and in 2008. The easy credit environment that followed the Global Financial Crisis facilitated one of the longest and strongest bull markets in U.S. history. An unprecedented amount of stimulus injected into the financial system amid the COVID pandemic led to the sharpest stock market upturn on record. And now in 2023, amid an increase in liquidity and despite heightened macro uncertainties, a hawkish Fed, and a banking crisis, the S&P 500 is up 14%¹ nearing the end of the second quarter while the CBOE Volatility Index (VIX) has retreated to below-average levels.

Read > Don’t Fight the Flows

¹Through June 27, 2023

 

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.

Raise the Roof

Investor questions continue to mount as the U.S. nears the Treasury’s estimated debt ceiling “X-date” of June 1. While there are some signs that progress is being made between President Biden and Republican leaders, the two sides still seem far apart on a deal to raise or suspend the country’s debt limit. Failure to do so would result in the U.S. defaulting on its debt for the first time and would have significant economic consequences. According to the Council of Economic Advisors, even a brief default could lead to the loss of half a million jobs, a 0.6% contraction in real GDP, and a 0.3% increase in the unemployment rate. An extended default would be even more dire, with a forecasted loss of 8.3 million jobs, a 6.1% reduction in real GDP, and a 5% increase in the unemployment rate.¹

As shown in this week’s chart, raising or suspending the debt ceiling has become a fairly common occurrence over the last several years, though the process can be political, contentious, and last minute. This week, amid continued talks between staff, President Biden and Speaker McCarthy, along with other congressional leaders, held a meeting both sides described as “productive.” Both parties are seeking a deal to prevent default, though agreeing on the details — future spending cuts, federal aid work requirements, and clawing back unspent COVID funds, among other Republican demands — remains a delicate process. Markets are closely following the debt-ceiling developments and, while the severity of consequences from a default will hopefully lead to a timely resolution, both equity and fixed income should brace for ongoing volatility from here.

Print PDF > Raise the Roof

 

¹Council of Economic Analysis, The Potential Economic Impacts of Various Debt Ceiling Scenarios

Down to the Wire: An Update on the 2023 U.S. Debt Ceiling Crisis

In February of this year, Marquette published a Perspectives piece entitled Is the Sky Falling? that detailed the history of the United States debt ceiling, as well as the early innings of negotiations surrounding its possible increase or suspension given the fact that the $31.4 trillion limit was reached on January 19. In the months since, the Treasury Department has been forced to resort to “extraordinary measures” in order to prevent the U.S. from defaulting on its obligations, including suspending sales of state and local government series Treasury securities. Those measures, however, will likely be exhausted in the very near future according to the nonpartisan Congressional Budget Office (perhaps as early as June), at which point the federal government will ultimately be unable to pay its obligations fully and, as a result, have to delay making payments for some activities and/or default on its debt obligations. This is commonly referred to as the x-date. It is worth pointing out that a number of large Wall Street firms have brought their forecasts of this date forward in recent days.

This newsletter analyzes potential repercussions of a U.S. default and options for a resolution of the debt limit impasse in Congress.

Read > Down to the Wire: An Update on the 2023 U.S. Debt Ceiling Crisis

 

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.