Topic Tags: U.S. Equity

The VRP Opportunity From Here

Volatility Risk Premium (“VRP”) strategies have struggled this year. The market’s extreme moves led to losses for put writing strategies on the way down and losses for call writing strategies on the way back up. Obviously not to be ignored, but the last six month period has truly been an outlier event. Now with the dust seemingly settled, we assess the opportunity from here. With rates near lows and equity valuations near highs, VRP strategies screen favorably, offering a more independent return stream.

In this paper, we look at correlations between returns and multiples, showing the relative advantage of VRP strategies, as well as the outsized opportunity created by today’s elevated levels of uncertainty.

Read > The VRP Opportunity From 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.

How Will the 2020 Election Affect the Markets?

The 2020 presidential election is fast approaching on November 3rd and key election issues pertaining to the economy will be viewed with respect to a backdrop of crisis and uncertainty more than ever. Curbing the spread of COVID-19 is at odds with reopening the economy while racial injustice remains a focal point. A potential Biden presidency and Democrat-controlled Senate could result in tax increases aimed at stimulating the economy through public projects and providing a social safety net. In contrast, a second term with Trump would likely mean more of the status quo in terms of keeping the 2017 tax cuts, further trade negotiations with China, and his attempt to nullify Obama’s Affordable Care Act.

In this newsletter, we assess the platforms of both Biden and Trump with a focus on Biden’s proposed tax policies and a perspective on how they are expected to affect the economy and markets. We next examine the historical effect of politics on the markets such as equity performance based on which party controls the White House, Senate, and House of Representatives. Lastly, we take a look at 2020 election expectations based on recent polls and markets.

Read > How Will the 2020 Election Affect the Markets?

 

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 Key Rebalancing Consideration: Drawdowns

In times of market turbulence, investments may sustain peak-to-trough declines known as drawdowns. The COVID-induced drawdown in March was no exception. Our chart this week illustrates the drawdown history for core bonds, bank loans, high yield bonds, and hard currency sovereign emerging markets debt (“EMD”) compared with the S&P 500. While past performance is not indicative of future returns, historical drawdown risk associated with past market volatility is a helpful metric to consider in the recovery from the current global health pandemic. As evident in the chart, each of the fixed income plus sectors¹ is correlated with the S&P 500, but the magnitude of plus sector drawdown risk is much less than the magnitude of equity drawdown risk — with one notable exception. In the 1990s EMD exhibited larger drawdowns than equity. At that time, EMD was very thinly traded, less mature, and more susceptible to dramatic swings.

While rebalancing from equity to fixed income plus sectors increases credit risk and introduces some drawdown risk, the magnitude of that drawdown risk from plus sectors is expected to be less than the expected drawdown risk from equity. As such, in this low Treasury yield environment, we recommend that investors consider both fixed income plus sectors and equity as ways to achieve greater total return potential and yield in portfolios. A diversified portfolio that takes advantage of the lower correlations between bank loans, high yield, EMD, and equities may benefit from greater efficiency and a higher Sharpe ratio in addition to the lower-magnitude drawdown risk from plus sectors.

Print PDF > A Key Rebalancing Consideration: Drawdowns

¹Bank loans, high yield bonds, and emerging markets debt.

 

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 Now a Good Time for Equity Long/Short Strategies?

The investment landscape looks different post-COVID. Real interest rates have fallen into negative territory. The outlook for investment portfolios built on a fixed income allocation has meaningfully changed. The stock market is just off of new highs, increasingly disconnected from the underlying economy. Are equities unstoppable, or set up for a massive correction on any negative vaccine news or a pullback in stimulus? And how will the November election impact portfolios?

Clearly, there are many moving pieces for asset allocators trying to balance risk and return. Given the current environment, part of the solution may be an allocation to equity long/short hedge funds. Equity long/short strategies can improve portfolio diversification, help protect capital in periods of market weakness or heightened volatility, and increase overall risk-adjusted returns. In August, Hedge Fund Research noted that institutional investors were actively looking to increase exposure to hedge funds in the second half of the year as a direct result of the volatility of the first half. In this newsletter, we outline a few reasons why.

Read > Is Now a Good Time for Equity Long/Short Strategies?

 

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.

Do Presidents Play a Role in Equity Performance?

With market volatility already heightened due to the COVID-19 pandemic, the U.S. presidential election this year poses another layer of uncertainty that investors may view as added risk to their portfolios. In particular, there is inevitable speculation about how the market will react upon which candidate or political party wins the election. This week’s chart illustrates equity performance over the last nine presidents since 1969.

The question most asked is how the stock market will perform under Republican or Democratic leadership in the White House. Based on the data above,¹ the equity markets have averaged 14% annualized total returns when the president has been a Democrat and 8% when a Republican has been president. However, we caution that equity markets are subject to many market forces and most importantly, the sample size from this data set is not large enough to support these trends in a statistically significant manner. The good news is that regardless of political party, the stock market has averaged 10% a year over the time period shown in the chart.

As we look towards the November election, it is critical to understand the platforms of each candidate and how they can broadly impact the economy and by extension, equity markets. Understanding each candidate’s position on a variety of economic and social issues will inform the market’s likely reaction to the election results and help formulate expectations for investors. In the coming weeks, we will release a paper that examines these very topics in greater depth to establish baseline expectations of each candidate’s policies, market impact, and historical market performance of political party leadership in Washington across the White House, Senate, and House of Representatives. If nothing else, we know the election will be contentious and scrutinized, with market participants closely watching the ultimate result.

Print PDF > Do Presidents Play a Role in Equity Performance?

¹ For measuring equity performance, a total return index was used to account for shares that pay dividends and represent more accurate performance by reinvesting dividends back into the index.

 

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.

We’ve Come So Far, but Maybe It Was Too Fast

It had been smooth sailing in equity markets since the first quarter’s bear market. The S&P 500 index eclipsed the February 19th all-time high and in August the volatility index grazed lows not seen since the beginning of the year. However, over the past week, equity markets have been in turmoil with the S&P 500 falling nearly 7.0% and the NASDAQ 100 falling into correction territory, declining 10.9% in the last three trading days.¹ The turmoil has been concentrated in the most unlikely place: growth stocks.

In this newsletter, we provide a recap of recent volatility in the U.S. equity markets and assess the sources of ongoing investor uncertainty.

Read > We’ve Come So Far, but Maybe It Was Too Fast

 

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.

Market Recovery: A Closer Look at Sector Performance

The S&P 500 hit its Covid-induced trough on March 23rd, closing at 2237 points. Since then, it’s more than made up its losses, setting new records in the process. As detailed in a May Chart of the Week, “There’s FAAMG and Everyone Else”, technology companies have driven this recovery, spurred by a variety of increased demand attributable to remote work and schooling, online shopping, and virtual socialization, among others.

Despite technology companies grabbing the headlines, not all are classified as Information Technology by the GICS® sector classification system used by Standard & Poor’s, as one might assume. For example, the top five constituents within the S&P 500 in order are Microsoft, Apple, Amazon, Facebook, and Google parent Alphabet (FAAMG stocks), only two of which are classified as Information Technology (Microsoft & Apple). Amazon is Consumer Discretionary because of its retail focus, while Alphabet and Facebook are Communication Services. Amazon as a Consumer Discretionary stock helps explain the sector’s on par performance with Information Technology since the market bottom. Its stock price increased by 81% from March 23rd through August 31st, while Apple’s recovery over this same timespan was +131% with Facebook (+98%) not far behind.

Financials has been one of the weaker performing sectors in the recovery, as banks and other financial services companies have seen their bottom line potential shrink with Fed rate cuts. This only added to the struggle that these traditionally value-oriented firms have had keeping up with their new economy, growth-oriented counterparts. Berkshire Hathaway is the only Financials company in the top ten of the S&P, and the conglomerate’s lackluster recovery (+34% through this time period) resembles the sector as a whole. Visa is also a top ten index constituent; however, it’s classified as Information Technology. It has seen a moderate recovery of +56% over the noted timeframe.

As shown in the chart, the S&P 500 sits near the middle in recovery performance when compared to individual sectors. The S&P 500 ex-Information Technology isn’t far behind, which is surprising at face value but more understandable after considering that some tech behemoths fall into other sector classifications. As technology continues its ever expanding importance in the economy and daily life, it’s safe to assume that products and services based on technology, but outside the realm of traditional IT, will continue to grow in size and relevance.

Print PDF > Market Recovery A Closer Look at Sector Performance

 

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 Quality of Index Construction

Index choice plays a pivotal role in investment management. Passive investors utilize indices to gain exposure to a specific segment of the market or asset class, while active managers look to them as a benchmark of success or failure. For small-cap investors, the choice rests between two options: the S&P 600 Index and the Russell 2000 Index. While 93% of the eVestment Small Cap Core strategies utilize the Russell 2000 as a benchmark, the S&P 600 has been a superior investment over the long-term. The S&P has outperformed its more heavily-utilized peer by more than 1.8% on average across rolling three-year periods. On a cumulative basis, the S&P has generated more than 140% outperformance to the Russell since the turn of the century. This week’s chart seeks to understand the nuances of each index and share insights on why the “quality”-focused S&P index has begun to lag the Russell 2000 in the current market environment.

Launched in 1984, the Russell 2000 measures the performance of the smallest stocks in the United States. FTSE Russell ranks the entirety of the U.S. equities market by market capitalization in descending order. Stocks with a rank of 1,001st to 3,000th are included in the Russell 2000 Index. This approach effectively captures the breadth of the small cap market in its totality with objective, predictable, and transparent construction. On the other hand, the S&P 600 Index takes a committee-determined more concentrated approach, investing in just 600 stocks in the small cap universe. In addition, S&P utilizes an earnings screen for new constituents. For a company to be included, the sum of the most recent four consecutive quarters of GAAP earnings must be positive, as should the most recent quarter. We view this requirement as a proxy for quality. Without this screen, non-earning stocks have risen to more than 40% of the Russell 2000 Index.¹ Relative to large-cap peers, small-cap companies tend to be rife with debt, unproven business models, and inexperienced management teams. While this lends itself to market inefficiencies and opportunities for active management, it is important to view the asset class through a quality lens.

These indices utilize vastly different construction processes and yet both are tasked with measuring the performance of U.S. small-cap equities. The driving force behind the S&P 600’s outperformance lies in the earnings screen. Over the long-term, small-cap companies with higher return on equity (ROE) have historically outperformed their low or negative ROE peers.² In other words, companies that make profits have outperformed those that do not. However, history shows us that markets are cyclical. In the latter stages of a bull market, earnings tend to take a back seat to momentum and speculation. At such a point, investors are risk seeking – as shown in the lead up to the early 2000’s Dot.com bubble – crowding into popular “high-tech” offerings despite deteriorating fundamentals. This echoes today’s environment and while every economic downturn is unique, themes tend to persist. Today we have an abundance of capital injected into the economy by the Federal Reserve, allowing small-cap companies to fund operations in the face of falling demand and narrowing margins. Market dynamics have been dictated by winners and losers of the pandemic, allowing the S&P 500 to reach new daily highs as the top-heavy index continues to soar regardless of record high unemployment and cratering corporate earnings. Eventually, investing in quality will reign supreme as it has – on average – over the last two decades. As the cycle continues its course, remaining invested in companies with positive earnings will pay off in the long run.

Print PDF > The Quality of Index Construction

¹ Strategas
² Factset; The top quintile of the IWM ETF outperforms the bottom quintile of cumulative return by ROE by 7.4% over a 7 year period ending July 31, 2020.

 

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.

And the Beat Goes On…

This week, the S&P 500 index closed at 3,389.78, setting its first record high since previously peaking on February 19th, 2020; it is up 4.9% year to date. This post-bear market recovery is officially the fastest ever. For the sake of comparison, it took more than three years for the S&P 500 to reclaim its peak after the Global Financial Crisis. However, the S&P 500 was not the first broad market index to reclaim its high in 2020. The NASDAQ 100 index surpassed its previous peak more than two months ago on June 5th and is up 30.5% year to date. On the other hand, the Dow Jones Industrials Average (DJIA) is still more than 5% off its record high and negative for the year.

How is it that each of these indices is considered to represent the broad domestic equity market, but they have such wide performance differences? The main reason is the calculation and composition of the indices. Let us begin with the Dow, the oldest index out of the three indices. Founded in 1896, the Dow is comprised of 30 stocks that are selected by their size and influence on American business (with the latter clearly being subjective). In addition, the DJIA is a price-weighted index which means that the companies with the highest share price have the highest weighting in the index. For instance, Apple, which trades at $462 a share¹ is the largest constituent in the DJIA with an 11.4% weight. The next largest constituent is UnitedHealth Group, which trades at $316 a share² and has a 7.8% weight in the DJIA. As a result, large price increases or declines in these stocks will have an outsized effect on the returns of the index. Consequently, the price decline in Boeing, a top 10 Dow constituent, due to delays in the Max 8 and lower demand from the COVID-19 pandemic has had a large impact on the Dow’s year-to-date return.

The S&P 500 and NASDAQ 100 indices are market capitalization-weighted indices. This means that the weightings of their constituents are based on the product of the stock price and the outstanding shares. As a result, stocks with high prices and the largest number of shares outstanding will have the greatest impact on the index’s return. In the case of the S&P 500, which tracks the largest 500 companies in America, this means that Apple, Microsoft, Amazon, Google, and Facebook are the largest constituents in the index. As discussed in my previous post, “There’s FAAMG and Everyone Else,” investor enthusiasm has propelled these stocks to new highs even though most of the companies in the S&P 500 are still negative for the year.

Technology companies have been the biggest beneficiaries of the COVID-19 pandemic and the NASDAQ 100, a proxy for the Technology sector, is more concentrated than the S&P 500 and more tech-centric than the DJIA. The NASDAQ 100, which was created in 1985, tracks the largest non-financial companies listed on the NASDAQ exchange. The FAAMG stocks are still the largest constituents in the NASDAQ 100, but Technology makes up over 55% of the NASDAQ 100 relative to 27.5% for the S&P 500 and 26.9% for the DJIA. It is also important to note that the Dow does not include Amazon, Google, or Facebook.

Over the short term, index calculation methods and composition differences can cause wide performance divergences. However, these divergences come and go based on the performance of the underlying sectors and companies. This year’s divergence has been exacerbated by the COVID-19 pandemic and the outperformance of Technology. As other non-Technology sectors rise in economic importance, we would expect the S&P 500 and DJIA to post more attractive relative returns.

Print PDF > And the Beat Goes On…

¹ Apple’s closing price as of August 18, 2020. Apple has also announced a 4-for-1 split effective August 31, 2020, which will reduce its price to ~$115 a share. Thus, Apple’s weight in the DJIA will decline accordingly.
² UnitedHealth Group’s closing price as of August 18, 2020.

 

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.

2020 Halftime Market Insights Video

This video features an in-depth analysis of the second quarter’s performance and coincides with our 2Q Asset Allocation Update newsletter, reviewing risks and opportunities heading into 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.

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