Topic Tags: Fixed Income - Investment Grade

Certainty Over Uncertainty: Biden Nominates Powell for Another Term as Fed Chair

In a move especially pivotal given today’s elevated inflation as the economy is resuscitated out of the pandemic, President Joe Biden announced yesterday morning (November 22nd) that he would nominate the incumbent Jerome Powell for another term as Chair of the Federal Reserve. Additionally, Biden nominated Lael Brainard as Vice Chair. Both Powell and Brainard had been under consideration for the Chair role in uncharacteristically lengthy deliberations on the part of Biden, who had interviewed both for the position on November 4th.

This newsletter provides background on Powell and Brainard, covers the market reaction to Biden’s announcement, and analyzes expectations for interest rates and inflation in the coming years.

Read > Certainty Over Uncertainty: Biden Nominates Powell for Another Term as Fed Chair

 

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.

Is the 60/40 Portfolio Dead Forever?

Model portfolios — or those which adhere to a specific set of guidelines surrounding asset allocation and rebalancing — are often utilized by investors because of their rules-based nature, which eliminates the need for constant monitoring. One such model is the “60/40 portfolio,” which consists of a 60% allocation to diversified equities and a 40% allocation to a broad basket of fixed income securities. Due to the imperfect correlation between stock and bond returns, the 60/40 model has enjoyed decades of success at both providing its users with strong absolute returns and suitable protection during market drawdowns. Additionally, there is an intuitive attraction of the 60/40 portfolio due to its relative simplicity of holding just stocks and bonds as its underlying investments. That said, skepticism abounds regarding the model’s viability going forward in light of the current interest rate environment and low forecasted equity returns, particularly for those investors like endowments and foundations with specified spending requirements.

The aim of this paper is to assess the effectiveness of the 60/40 model going forward and provide guidance to investors whose spending targets require an expected return that is consistent with the historical performance of 60/40 portfolios, which has typically hovered around 8%.

Read > Is the 60/40 Portfolio Dead Forever?

 

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 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.

Q3 2021 Market Insights Video

This video features an in-depth analysis of the third quarter’s performance by Marquette’s research team, reviewing general themes from the quarter and risks and opportunities to monitor through the end 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 notified when we publish new videos here.
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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.

What Does Fed Tapering Mean for U.S. Yields?

Last week, Federal Reserve Chair Jerome Powell indicated the potential tapering of bond purchases at some point in the future aimed at weaning the U.S. economy off the large-scale monetary stimulus that has been necessary during the COVID-19 pandemic. As exhibited by the current forward rates displayed in this week’s chart, the forecasted Fed tapering may result in gradual increases in the 10-year U.S. Treasury yield in the coming months. Since yields move opposite prices, the Fed’s expected Treasury-buying reduction is leading the Treasury forward market to anticipate prices to potentially decline with the lowered demand and yields to rise. Likewise, as the U.S. economy gradually recovers from the pandemic, the Treasury forward market might also be pricing in reduced Treasury purchases from the broader market as investors switch to riskier growth assets such as credit or equities. That said, these actions will likely cause fewer disruptions in the markets than those taken at the onset of the Taper Tantrum, which began roughly eight years ago. Investors were caught off guard when Fed policymakers announced the potential reduction of asset purchases in 2013, which led to a bond sell-off fueled by widespread fears of future price declines. These sales drove down the prices of fixed income securities significantly, causing the 10-year Treasury yield to skyrocket in a very short period of time. In addition to current forward rates, this week’s chart also illustrates this dramatic increase in the 10-year Treasury yield during the Taper Tantrum, including a surge from 1.70% to 2.61% within a three-month window. This movement is in stark contrast with current market expectations, which project the 10-year Treasury yield to increase from 1.50% to only 1.68% over the next nine months.

Although there are ongoing concerns surrounding COVID-19 and the possibility of contagion from a fallout in the Chinese real estate sector that may hamper markets in the near term, investors seem to be reacting to forecasted Fed tapering more favorably than they have in the past. This may be due to the belief that strong economic growth can support the Fed’s gradual pullback of monetary stimulus. It is also possible that the Fed has simply done a better job telegraphing future actions this time around and investors are comfortable with the gradual nature of the forecasted tapering program. It should additionally be noted that tapering will not start immediately, as policymakers are only looking to reduce support when they think the economy can sustain itself as conditions normalize.

Print PDF > What Does Fed Tapering Mean for U.S. Yields?

 

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.

Have Things Been Too Quiet?

Although this is only the second iteration of my quarterly letter series, Marquette has always produced quarterly market narratives in one shape or another. And in almost all cases, it has been relatively straightforward to formulate a narrative that stitches together the primary headlines from the prior three months. But as I sit here today, things seem quiet…too quiet, almost. Of course, it is the first summer after a crippling global pandemic that shuttered the economy and constrained us almost exclusively to our homes for the better part of the year. Summer is in full swing and the images of crowded beaches overlaid with higher prices for airline tickets and hotel stays illustrate that people are getting back to their pre-pandemic lifestyles, both socially and economically. Anecdotally, my email volume slowed over the last quarter as well; whether this is pure coincidence or a function of markets generally behaving in conjunction with economic re-openings and summer vacations remains to be seen.

Nonetheless, the purpose of this letter series is to track the pulse of the financial markets and let our readers know what we’re thinking about (worrying about?) when looking at the overall financial market landscape. Given that objective, the following outlines several market factors that we believe bear monitoring as the remainder of the year plays out.

Highlights from this edition:

  • Market volatility and reversion to the mean
  • COVID-19: new uncertainty with the Delta variant, vaccination progress
  • Interest rate expectations
  • Inflation following a crisis
  • Valuations: signals from the credit and equity markets

Read > Have Things Been Too Quiet?

 

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.

 

2021 Halftime Market Insights Video

This video features an in-depth analysis of the first half of 2021, reviewing general themes from the second quarter and risks and opportunities to monitor in the coming months.

Our Market Insights video 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 notified when we publish new videos here.
For more information, questions, or feedback, please send us an email.

Spreads Largely Pricing in a Full Recovery

Spreads for industries that were beat-up during the early 2020 COVID panic — energy, retail, and transportation — as well as for industries that proved more stable — financials, technology, and utilities — are now generally tighter than pre-pandemic levels in the bank loan and high yield markets. From here, spreads could tighten further as issuer fundamentals continue to improve, widen in a correction, or be volatile, blowing out and tightening back in throughout the economic recovery.

While a lot of progress has been made on the vaccination front, there is still more work to do. The fully vaccinated rate in the U.S. is currently 39%, not yet at 70% herd immunity. Globally, the fully vaccinated rate is only 5%, not even close to 70% herd immunity. While this leaves the economic recovery vulnerable, markets are forward-looking. In the bank loan and high yield markets, maturities have been pushed off, which is a positive, thanks to the large volume of issuance over the past year. Leverage levels of bank loan and high yield issuers are currently high, but due to decline, another positive, as earnings rise in the economic recovery. Use of proceeds from bank loan and high yield issuances¹ and aggressive issuance² are at benign levels, and defaults have been declining — more positive indicators. On the negative side, equity valuations are already at all-time highs and continuing to rise.

In summary, fundamentals are attractive, but valuations are not. We could potentially see spreads tighten further, but uncertainty is high, and we could also see a correction given the high valuations and frothy sentiment. While further spread tightening will be accretive to returns, it will limit short-term future price appreciation for fixed income strategies. Overall, this is a dynamic that bears watching, particularly as economic growth accelerates and the pandemic continues to fade.

Print PDF > Spreads Largely Pricing in a Full Recovery

¹ Such as towards refinancings (a sign of conservativism) versus acquisitions and LBOs (a sign of frothiness).
² Such as CCC bank loan and high yield issuance and 2nd lien bank loan issuance.

 

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.