Topic Tags: Interest Rates

Flirting With a Bear Market: How Did We Get Here, and What Comes Next?

Quite simply, this has been the worst start to a year since the 1930s:

  • One of only 19 quarters since 1976 when both bonds and stocks posted negative returns;
  • One of only six of those quarters when bonds have underperformed stocks;
  • The worst four-month return for the S&P 500 since 1939.

2022 to date has featured a myriad of macroeconomic factors coming to a head: inflation at its highest level since the 1980s, the Federal Reserve responding with aggressive rate hikes, and increasing concerns about the health of the consumer leading to a possible recession. An evolving pandemic, a war in Eastern Europe, and draconian lockdown policies in the world’s second-largest economy and largest manufacturing hub have further added to the problem and complicated the solution. With these macro headwinds and uncertainties driving markets year-to-date, Marquette’s fixed income, U.S. equities, and non-U.S. equities teams discuss the impacts on their asset classes and weigh in on the outlook from here.

Read > Flirting With a Bear Market: How Did We Get Here and What Comes 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.

Can the Fed Thread the Needle?

All eyes are on rates this week as the Federal Open Market Committee (FOMC) convenes for the third time this year. In the seven weeks since the March meeting when the Committee raised rates an initial 25 basis points, continued inflationary pressures and an increasingly hawkish tone from Chairman Powell and other FOMC members have driven up market expectations for future hikes. The futures market has gone from pricing in a total of six 25 basis point increases and a year-end federal funds rate of 1.94% to ten hikes, including three consecutive 50 basis point increases, and a year-end rate of 2.81%. If market expectations prove correct, it would be the steepest pace of increases since the 1980s.

For a central bank that never quite normalized policy after the GFC, cooling decades-high inflation without tipping the economy into recession amid strained supply chains, a war in Europe, and COVID lockdowns in the world’s second-largest economy will be no easy task. Recent market volatility and sentiment reflect this uncertainty, with both equities and bonds down sharply year to date. While first quarter U.S. GDP “growth” of -1.4% missed expectations, the contraction was driven by trade and inventories as opposed to a consumer slowdown. The U.S. consumer is still strong, but the path forward is uncertain, with the yield on the 10-year Treasury — a key reference point for borrowing costs — briefly surpassing 3% yesterday for the first time since 2018. The Fed has to consider many moving pieces as it plans its path from here, and we look forward to hearing more about that process at Chairman Powell’s press conference tomorrow.

Print PDF > Can the Fed Thread the Needle?

 

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.

Looking for Sunshine

Here in Chicago, it has been a harsh spring. Below-average temperatures. Unrelenting rain. Snow flurries. Incessant clouds. Not the spring anyone was hoping for.

Investors would tell you the same thing, for different reasons. Stock market down 10% year to date.¹ Inflation at 8.5%, the highest in over 30 years. Bonds — the safe haven play in times of market volatility — down 9.5% year to date.² The ongoing conflict in Ukraine increasingly looks like a grinding war of attrition. Temporary yield curve inversion. Fed policy designed to slow inflation, though potentially at the expense of growth; either way, interest rates have more room to run. Not a lot of sunshine, indeed.

However, as April turns to May… hope springs eternal. Not all is lost for the year, and while most would agree that equity markets have not fully re-priced yet, there are hints — not unlike perennials sprouting each spring — that the worst of the market drop is behind us. Over time, markets have proven resilient and while the exact timing of market reversal is impossible to precisely call, one can look for signs of optimism. Here are some of the most compelling hints that we see.

In this edition:

  • Inflation
  • Yield curve inversion
  • War-driven market volatility
  • Earnings estimates
  • Opportunities for active managers

Read > Looking for Sunshine

Watch our Q1 2022 Market Insights Video for an in-depth analysis of the first 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.

Q1 2022 Market Insights Video

This video features an in-depth analysis of the first quarter’s performance by Marquette’s research team, reviewing general themes from the quarter and risks and opportunities to monitor in the coming months.

 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.

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For more information, questions, or feedback, please send us an email.

Buy Land, They’re Not Making It Anymore

Individuals commonly allocate 20–30% of their net worth into a primary residence, which oftentimes accounts for the single largest investment in their portfolio. The market value of one’s home is impacted by variables that include, but are not limited to, supply and demand relationships, property location, borrowing rates, and tax policies. Since early 2020, median home prices have increased over 25%, benefitting homeowners and their portfolios significantly.¹ The appreciation in home prices can partially be attributed to the shortage of homes built over the past decade. Not since the 1930s, when the country’s population was roughly 40% what it is today, have so few homes been built in the United States. The problem is further exacerbated by the average age of a home in the U.S. — 40 years,² well beyond its useful life — and current labor and material shortages that have been lengthening project timelines and delaying starts.

The sudden rise in housing valuations has homeowners and investors wondering if this could be another bubble, akin to the 2008–2009 mortgage crisis. While new home starts will likely remain low in the near and medium-term, rising interest rates may serve to stymie demand. Since the end of 2021, interest rates on a 30-year fixed mortgage have risen nearly 200 basis points to almost 5.0%,³ adding meaningfully to the cost of buying a home and potentially pushing ownership outside the reach of prospective millennial and generation Z buyers. However, opportunity exists in any inefficiently priced market, which is why more and more institutional investors are allocating “dry powder” to the residential real estate market. Ultimately, buyers, sellers, and lenders are justified in asking whether we are on the precipice of another housing crisis or if this is the start of a new normal with additional runway for growth.

Print PDF > Buy Land, They’re Not Making It Anymore

 

NOTES
¹ Lambert, Lance. “Homeowners struck gold during the pandemic—here’s the breakdown in every state.” Fortune. 23 Dec 2021.
² Jones, David. “Ages of Houses in the US.” BuyersAsk. Last updated 4 May 2021.
³ 4.96% as of April 4, 2022

 

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 Rising Possibility of Recession

Over the last several weeks, the risk of an economic downturn in the United States has increased with inflation continuing higher, Russia’s invasion of Ukraine triggering unprecedented sanctions, and the Fed beginning its rate hiking cycle. While inflation and the anticipation of rising rates have been driving markets for several months, the invasion of Ukraine in February and the resultant economic sanctions on Russia have added a new dynamic to the equation, driving up commodity inflation and making the Fed’s job of controlling pricing pressures without triggering an economic slowdown even trickier. With many U.S. stock indices dipping into correction territory this year, every new data point and indicator will be heavily scrutinized.

In this newsletter we examine these dynamics and try to provide perspective as it relates to the current market environment.

Read > The Rising Possibility of a Recession

 

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.

Trouble With the Curve?

Short-term interest rates have increased dramatically since the fourth quarter of 2021 amid inflationary pressures and concerns surrounding reduced global market liquidity. The 2-year Treasury yield ended February at 1.33%, up from 0.56% at the end of November 2021, and has continued to rise throughout the first few days of March. The yield on the 10-year Treasury has also ticked up in recent months, albeit at a much slower pace than that of the 2-year instrument. As a result, the spread between the 2- and 10-year Treasury yields has contracted significantly since the beginning of the year and currently sits at approximately 23 basis points, its lowest level since March 2020. Current yield curve dynamics could be exacerbated by the Federal Reserve, which, after holding short-term rates near zero for the last two years, is set to begin a hiking cycle later this month. Increases in the federal funds rate, though likely modest (25–50 basis points per increase), could number as high as seven in 2022 and result in additional yield curve flattening.

The relationships between Treasury yields of different maturities are important considerations for investors and traditionally serve as key indicators of macroeconomic trends. Typically, longer-dated debt instruments have higher yields than short-term bonds due to increased risk and liquidity premiums, resulting in relatively wide spreads and an upward-sloping term structure of interest rates, an indication of solid growth expectations and overall economic health. An inverted yield curve, marked by short-term yields that are higher than long-term yields, is commonly considered a bear signal, as it implies that the nearer term is riskier than the longer term. Each instance of a 2/10 inversion dating back to the 1990s has been followed by a recession in the United States within the next two years.

It is important to note that a narrowing 2/10 spread does not necessarily portend an economic downturn, as most economists expect positive economic growth in 2022 and beyond given solid corporate fundamentals and strong consumer balance sheets. Still, recent sell-offs in equity markets, elevated inflation, and supply shortages stemming from the conflict in Eastern Europe are causes for concern, especially when viewed in tandem with narrowing Treasury spreads. Marquette will continue to monitor the term structure of interest rates, as well as other leading macroeconomic indicators, and advise clients accordingly.

Print PDF > Trouble With the Curve?

 

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.

Life During Wartime: Assessing the Market Impact of the Russia/Ukraine Conflict

Recent days have seen an escalation of political tensions in Eastern Europe, and on February 24th, Russian forces began conducting large-scale military operations in Ukraine. These actions have drawn widespread condemnation from the international community, with NATO repositioning troops along its eastern flank and both the United States and European Union announcing intentions to impose sanctions on a variety of Russian financial institutions. The conflict has also threatened the stability of global markets, particularly those areas of the world economy that are most sensitive to energy and the performance of emerging market countries. The aim of this newsletter is to assess the ramifications of Russian actions vis-à-vis the broad market and determine the potential implications of further escalation of the conflict going forward, including:

  • Equity index performance
  • Index exposure to Russia and Ukraine
  • Commodity market expectations
  • Central bank policy and inflation impacts
  • Historical impact of similar exogenous shocks on equities

Read > Life During Wartime: Assessing the Market Impact of the Russia/Ukraine Conflict

 

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.

Russia & Ukraine: All Eyes on Energy

Escalating tensions between Russia and Ukraine have the world on edge. While the situation continues to evolve and the likelihood of a full-scale war remains unlikely, markets are attempting to price in the risk. This latest geopolitical clash builds on an already tumultuous start to the year for financial markets. In the U.S., the S&P 500 has fallen 8.1% from its all-time high on January 3rd amid concerns about rising inflation and consequential rate increases by the Fed. The latest year-over-year inflation figures for both the U.S. and Eurozone have reached alarming milestones, with the U.S. hitting a new 40-year high and the Eurozone setting a new record going back to 1991. Ballooning energy prices have been the greatest contributor to rising inflation, evident in the delta between consumer inflation and core inflation, which removes more volatile prices like energy- and food-related costs. The friction between Russia and Ukraine is only expected to worsen this dynamic, given Europe’s reliance on Russia for energy.

The European Union imports nearly 40% of its total natural gas consumption from Russia. While global oil prices tend to trade largely in tandem due to OPEC’s influence, natural gas prices are more sensitive to regional access and supply. The Dutch TTF Natural Gas price has historically hovered around $20/MMBtu but has surged more than 300% over the last 12 months, while U.S. Natural Gas is up just 36.9% over the same period. While geopolitical fears may continue to drive up the cost of crude as uncertainty builds, the more immediate impact is to the European energy markets via natural gas prices. In the most direct sense, the impact to global developed markets may be low, with the Energy sector comprising only 2.9% and 3.9% of the S&P 500 and MSCI EAFE indices, respectively, though knock-on effects may be broader, including economic sanctions and additional measures to combat inflation that could ultimately impact growth. Past geopolitical stress events provide little guidance with moving pieces always evolving. Tensions could deescalate and we could see little fallout, as was the case following the 2014 Crimean crisis, or pressures could mount with wide-reaching global implications. For now, we will continue to monitor and help our clients navigate the volatility.

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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.

Navigating Inflation from Up Here

Despite year-to-date turbulence, equity markets remain near all-time highs. While company earnings have more than recovered from the lows of early 2020, valuation multiples are also still well above pre-pandemic levels. Our chart of the week looks back at historical trailing P/E levels of the S&P 500 in different inflationary environments. Historically, in months when consumer prices were up between 6% and 8%, the S&P 500 traded at an average 12X earnings, below its long-term average of 17X. As of January 31st, the S&P 500 traded at 23.7X trailing earnings.

With most of these data points coming from the 1970s, this is more of an interesting anecdote than a prescriptive playbook, but does directionally make sense. Higher inflation tends to lead to rising interest rates, as the Federal Reserve looks to maintain price stability. Higher interest rates, in turn, put downward pressure on valuations, as the discount rate used to value a stream of future earnings increases. Companies whose value is largely derived from future growth in earnings see a pullback in the multiple investors are willing to apply to current earnings.

The Fed’s increasingly hawkish tone has already led to a meaningful correction in multiples, with potentially more volatility to come. While perhaps unnerving, the change in backdrop is creating opportunities for stock pickers. Active long-only and long/short managers should be better positioned to navigate market headwinds and add value for investors. While we of course do not have a crystal ball, we are looking forward to active managers hopefully capitalizing on an improved opportunity set this year.

Print PDF > Navigating Inflation from Up Here

 

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.