News & Insights

Europe Turning the Corner?

The picture may be brightening for European stocks and economies. The STOXX 600 returns over the past three months are largely in line with broader U.S. indexes such as the Russell 3000. The STOXX 600’s first-quarter earnings exceeded expectations, slipping only 3% rather than the negative 12% estimate just six weeks ago. The consensus is for earnings to turn positive in the second quarter and then increase by double digits during the second half of 2024. Despite the optimism, earnings growth for defensive sectors has outpaced that of cyclical sectors, with investors yet to buy into a cyclical rebound in Europe.

The backdrop for the rebound has been better fundamentals for both the Eurozone and U.K. economies, with macro data coming in better than expected, especially in the U.K. The Eurozone Manufacturing PMI Output Index, Germany’s Manufacturing PMI Export Conditions Index and the U.K.’s Composite Output Index are all showing significant improvement when compared to last year..

The European Central Bank’s rate cut on June 6, with expectations of more cuts to come, should provide a tailwind for Europe’s economies. A significant increase in real wages and still large excess savings should also support growth. Risks remain for exports to the still-soft Chinese market and exposure to energy price spikes.

Stoxx 600 Q1 2024 Earnings Estimates

Source: LSEG I/B/E/S

European Cyclicals’ Relative Earnings Growth Weakens

Source: Bloomberg, JPMorgan

The Privatization of America

In his recent annual letter to shareholders, JP Morgan CEO Jamie Dimon lamented that the number of public companies is shrinking, and he called for regulatory changes to reverse the trend. Private equity and debt markets have grown enormously since the National Securities Markets Improvement Act of 1996 made it easier for privately held companies to raise capital. Meanwhile, the compliance burden for public companies has increased due to the Sarbanes Oxley Act of 2002. The combined effect of these acts has encouraged founders to stay private where decision-making is easier and compliance costs and regulatory scrutiny are less onerous.

As the number of venture capital deals balloon, private markets capture the most innovative companies while they’re still in their infancy, hold on to them longer and essentially steal small cap indexes’ seed corn. The number of IPOs has fallen sharply, with the average tech IPO now much larger than it has been historically, extending the median holding period for a private equity fund from four years to just over five and a half years. This has resulted in very large private market companies, which enter the public markets as large-cap stocks, skipping the small- and mid-cap stages.

With the rise of private equity, higher borrowing costs, volatile markets and a sour IPO environment, the quality of small public companies is deteriorating, with a record high of 40% percent of the Russell 2000 currently unprofitable. The significant valuation discount of small-caps relative to large-cap U.S. stocks reflects the worsening return on equity and the higher leverage of small companies, explaining much of the discrepancy.

Startup Acquisitions Now Outnumber IPOs

Source: National Venture Capital Associationt

Average Tech IPO is Now a Large Cap

Source: BC Research

Lubing the Pig moving through the Boa – Treasury Market Edition

The Congressional Budget Office projects that the supply of Treasuries will expand by a breathtaking $22 trillion over the next decade. Some pending policy changes may help meet this challenge by enhancing liquidity and transparency in the Treasury market. This impending challenge may also explain the scaling back of the Fed’s quantitative tightening policy, which drains liquidity from banks. Compared to the pre-pandemic period, volatility is up in the Treasury market and liquidity is much worse.

The repo crisis of September 2019, involving a sudden spike in rates on overnight repurchase agreements, followed by the freeze in the Treasury market of 2020, drove home an acute need for enhanced liquidity at times of market stress. The Treasury Department is devising new methods to lessen liquidity issues, ramping up central clearing for bonds and notes. A large share of Treasuries will be required to pass through either the Fed’s automated clearing house or a private-sector ACH operated by some of the world’s largest banks. This will help reduce counterparty risk and should improve liquidity during inevitable periods of stress.

In addition, the Treasury Department has started to buy back off-the-run Treasuries (bonds that are not newly issued) to improve liquidity. This ironically results in a near-term financial gain in the extinguishment of bonds that are lower cost for the federal government, while replacing them with bonds with higher long-term interest costs. These buybacks are starting on a small scale, but soon will ramp up to a quarterly rate of $30 billion. None of these changes helps to solve the fundamental issue of huge fiscal deficits or the rising tide of federal debt and annual interest payments, but they could provide some useful liquidity tools during the next market hiccup.

US Government Securities Liquidity Index

Source: Bloomberg

Chicago Fed NFCI Risk On-The-Run Vs Off-The-Run 10 Year Treasury Liquidity Premium

Source: Bloomberg

About Frost Investment Advisors, LLC

Frost Investment Advisors, LLC, a wholly owned subsidiary of Frost Bank, one of the oldest and largest Texas-based banking organizations, offers a family of mutual funds to institutional and retail investors. The firm has offered institutional and retail shares since 2008.

Frost Investment Advisors' (FIA) family of funds provides clients with diversification by offering separate funds for equity and fixed income strategies. Registered with the SEC in January 2008, FIA manages more than $3.9 billion in mutual fund assets and provides investment advisory services to institutional and high-net-worth clients, Frost Bank, and Frost Investment Advisors’ affiliates. As of May 31, 2024, the firm has $4.5 billion in assets under management, including the mutual fund assets referenced above. Mutual fund investing involves risk, including possible loss of principal. Current and future portfolio holdings are subject to risks as well.

To determine if a fund is an appropriate investment for you, carefully consider the fund’s investment objectives, risk, charges, and expenses. There can be no assurance that the fund will achieve its stated objectives. This and other information can be found in the Class A-Shares Prospectus, Investor Shares Prospectus or Class I-Shares Prospectus, or by calling 1-877-71-FROST. Please read the prospectus carefully before investing.

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Frost Investment Advisors, LLC provides services to its affiliates, Frost Wealth Advisors, Frost Brokerage Services, Inc. and Frost Investment Services, LLC. Services include market and economic commentary, recommendations for asset allocation targets and selection of securities; however, its affiliates retain the discretion to accept, modify or reject the recommendations.

Frost Wealth Advisors (FWA) is a division of Frost Bank [a bank subsidiary of Cullen/Frost Bankers Inc. (NYSE: CFR)]. Brokerage services are offered through Frost Brokerage Services, Inc., Member FINRA/SIPC, and investment advisory services are offered through Frost Investment Services, LLC, a registered investment adviser. Both companies are subsidiaries of Frost Bank.

This commentary is as of July 1, 2024, for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. All indices are unmanaged, and investors cannot invest directly into an index. You should not assume that an investment in the securities or investment strategies identified was or will be profitable.

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