Topic Tags: U.S Economy

Back So Soon?

Over the past decade, U.S. private equity firms have returned to market sooner and sooner. The fundraising environment for these organizations remains attractive due in large part to strong performance and the persistent gap between private and public market valuations. Furthermore, the current robust dealmaking climate, both in terms of platform investments being made and potential add-on activity throughout the period during which portfolio companies are held, means that managers are both investing their funds more quickly and holding additional capital in reserve. These factors have resulted in more frequent fundraises.

This dynamic of accelerated capital deployment introduces incremental risks for private equity investors, including increased vintage year risk with the potential for greater return dispersion throughout an economic cycle. Moreover, more frequent fundraising could put stress on a private equity firm’s team, both with respect to the investment professionals leading deals and the operational resources executing value creation plans. Finally, more frequent fundraising, if not accompanied by shorter hold periods, will require private equity firms to return to the market more regularly with less realized performance, as potential gains stemming from recently deployed capital will be largely unrealized.

The trend of private equity firms deploying capital more quickly and returning to market sooner puts pressure on limited partners to continuously think strategically about portfolio construction. Thoughtful, consistent investment pacing that is supported by a robust go-forward pipeline of compelling fund opportunities will help to mitigate many of the aforementioned risks. Additionally, a deliberate approach will allow limited partners to prioritize opportunities in which they have the most conviction, gain access to those funds, and capture the outsized return potential of private equity investments.

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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.

The Impact of the Delta Variant on the U.S. Economic Reopening

Thanks to a rollout of effective vaccines at the beginning of 2021, daily new cases of COVID-19 in the United States steadily declined from roughly 250,000 in January to 12,000 in July. That said, daily new infections then quickly reverted to over 80,000 in about one month. This uptick was mostly due to the outbreak of the Delta variant, a more contagious form of SARS-CoV-2 which now accounts for nearly all new cases in the U.S. With the nation now better prepared to combat the strain using both vaccinations and regulations including mask mandates, new daily cases of the Delta variant have since declined to around 54,000 in recent days. This week’s chart assesses the impact of the Delta variant on the domestic economic reopening by examining travel and dining trends using datasets from OpenTable — an online/mobile restaurant reservation service — and the Transportation Security Administration. To measure the scale of the economic slowdown caused by the coronavirus pandemic, the chart shows the percentage change in the number of restaurant diners and air travelers compared to pre-pandemic levels in 2019 (e.g., 10/10/21 vs. 10/10/19). Seated diners are individuals who dined at a sample of restaurants in the United States using OpenTable via online reservations, phone reservations, and walk-ins. Air travelers are those individuals who were screened by TSA agents at security checkpoints within airports in the U.S.

As can be inferred from the chart, both datasets clearly indicate a complete economic shutdown in March of 2020 following the onset of the pandemic. This was followed by an economic reopening several months later, represented by consistent upward trends in both data series leading up to June of 2021. When the Delta variant started circulating in July, seated diners and air travelers decreased by 20% and 30% in the following periods, respectively (compared to 2019 levels), marking a shift in the trends that had been exhibited in previous months. That said, both series picked back up shortly thereafter, reaching -4.8% and -18.4% in October, respectively (again, when compared to levels recorded in 2019), as daily new cases of the Delta variant have subsided. All of this is to say that the impact of the Delta variant on the U.S. economy pales in comparison to that of the original COVID-19 outbreak, as individuals and businesses alike seem better equipped to balance protection against the virus with economic activity. If daily new cases of the Delta variant continue to decline and the vaccination rate in the United States improves, the data indicate that a full economic reopening could take place in the foreseeable future.

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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.

What Are the Ramifications of a Debt Ceiling Breach?

With an agreement finally showing promise to resolve the U.S. government’s potential and impending debt ceiling breach, investors are assessing how this development might affect underlying portfolios. The debt ceiling is the maximum level that the U.S. government is permitted to borrow. This threshold was set by Congress over 100 years ago to make sure government borrowing does not reach excessive levels. Historically, every time the ceiling has been close to being breached, Congress has legislated a higher debt limit. However, the current situation is especially concerning given how close to the deadline we are and how contentious this issue is in Congress right now.

This newsletter examines the key issues of the debt ceiling, important dates both past and present, and the potential impact of a breach.

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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.

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.

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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.

Build Back Better Act: Proposed Tax Changes by the House Ways & Means Committee Legislative Update

The House Ways and Means Committee released 881 pages of a proposed bill that would make changes to the tax code impacting income, estate, and gift taxes on September 14th, 2021. The bill will most likely see some changes to reach a majority vote in the Senate, but even with some revisions to the current proposal, major tax reform is expected in 2022. In this legislative update, we provide a summary of potential tax code changes based on the most recently available information.

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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.

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.

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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.

Multifamily Matters

Amid ongoing vaccination progress and an improving U.S. economy, we are seeing a recovery across property sectors – those that were most impacted by the pandemic as well as those that proved relatively resilient, like the multifamily sector. Apartment landlords have greater flexibility to adjust rents at a faster pace than other core sectors, allowing the group to better adjust to landscape changes accelerated by the COVID pandemic and near-term inflationary trends. This, in turn, gives investors the opportunity to position their portfolios to capitalize on these relative advantages.

Already, overall apartment occupied stock has increased to a level 20% above the prior 2000 peak. This demand has driven up effective multifamily rent growth, as seen in the chart above. While expected to moderate from here, national apartment rent growth is forecasted to stay above recent levels, increasing an average of 4.7% and 4.5% in 2021 and 2022, respectively1, driven by ongoing economic expansion and an expected hiring boom. The U.S. economy is expected to add an estimated 12 million new jobs between 2021 and 2023, particularly impacting demand across sunbelt regions and tech hubs, where suburban rentals have outperformed and urban core sub-sectors have rebounded. ² On an ongoing basis, flexible work from home policies will impact where people prefer to live, likely pushing the demand for additional living space and driving effective rents across unit types.

From here, with the added uncertainty brought on by COVID-19 variants, we may see multifamily demand and rent continue upward, or we may see the sector lose momentum from increasing supply or the downstream effects of the recent end to the eviction moratorium. Ultimately, we will continue to look for the best risk/reward opportunities in the evolving real estate space, helping our clients maneuver through the changing dynamics.

1 Real Page, CBRE-EA, Clarion Partners Investment Research, Q2 2021. Note: U.S. apartment rent growth forecast is provided by RealPage as of July 2021

² Moody’s Analytics, CBRE-EA, S&P CoreLogic Case-Shiller National Home Price Index, Clarion Partners Investment Research, August 2021

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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.

The Turn of the SKEW

Domestic stock indices have rebounded from pandemic-induced lows exhibited in the spring of 2020 with relative ease, and U.S. equity market volatility has remained largely muted since that time as a result. The CBOE Volatility Index (“VIX”), a popular measure of expected volatility in the S&P 500, ended August at a level of 16.6, below the index’s 30-year average of 19.5. Based solely on recent performance and volatility levels of broad-based indices, the investor outlook for U.S. stocks going forward appears mostly positive. That said, other gauges of sentiment may indicate more discord among market participants. The CBOE SKEW Index (“SKEW”) is one such barometer. Unlike the VIX, which uses at-the-money S&P 500 Index options to assess expectations of near-term market fluctuations, the SKEW examines the implied volatility of out-of-the-money options to gauge perceived U.S. equity market tail-risk, or the chances of an extreme price change in the index. The SKEW Index ended August at a level of 155.9 after reaching an all-time high of 170.6 in late June of this year — both figures are well above the 30-year average for the index of 120.5. The recent upward movement in the SKEW indicates that investors have grown increasingly wary of an outsized move in domestic equity indices in the last several months.

It is important to note that an elevated SKEW Index is not necessarily a harbinger of a tail-risk event. Since 1990, the average 30-day return for the S&P 500 Index subsequent to the SKEW spiking into the 90th percentile of its history was roughly 0.9%. The inverse is also true — extreme S&P 500 returns are not always precipitated by an elevated SKEW Index. In the two years leading up to the Tech Bubble Crash and Global Financial Crisis, the SKEW averaged levels of 115.4 and 116.6, respectively, both of which are below the long-term mean for the index. All of that said, there are obvious risks currently facing markets that could lead to pullbacks and may be contributing to heightened SKEW measures. For instance, valuations of most U.S. equity indices remain elevated relative to historical norms and heightened inflation could ultimately prove less transient than currently expected by market participants. Additionally, the S&P 500 Index has experienced a maximum drawdown of just 4.1% so far this year, well below the median annual drawdown for the benchmark of 9.7% going back 30 years. While this data point alone does not portend a correction, a near-term drawdown is certainly possible given the myriad factors at play. In light of the current landscape, we believe it is imperative for investors to remain diversified across the asset class spectrum in order to gain exposure to a potential continuation of recent positive equity performance while also helping to protect portfolios in the event of a correction.

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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.

What Does the Labor Shortage Mean for Inflation?

Employers have faced a number of challenges throughout the COVID-19 pandemic — most recently, a labor shortage. As of the end of June, the Bureau of Labor Statistics reported a record high of more than 10 million job openings (including either newly created or unoccupied positions where an employer is taking specific actions to fill those positions), and as of the end of July, 8.7 million people looking for employment (people who are without work, currently available for work and seeking work), creating a disconnect in the labor market.

While this is not the first time job openings have exceeded the number of people looking for work, the imbalance is more meaningful now as companies attempt to fulfill pent-up demand caused by the pandemic with sharply less labor availability. To help combat this shortage, states have started to cut unemployment benefits, though these actions so far seem to have had minimal effect. Employers must now find a way to incentivize workers to apply to openings and accept offers. This is likely to put upward pressure not only on wages but on consumer prices. In order to protect profitability, companies will have to pass on the additional costs to the consumer, adding to inflationary pressures. While many signs point to higher inflation being transitory, the labor shortage — which could continue even after extra unemployment benefits expire, given demographic trends and a shift toward the gig economy — could be a longer-term issue. We will continue to monitor inflation, its underlying drivers, and the potential impacts to our clients’ portfolios carefully.

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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.

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.

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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.