Investment Strategy

Private markets’ expanding and diverse opportunity set

The S&P 500 Index boasted an impressive 15% return over the first half of the year,¹ and the large-cap bellwether has also outperformed many other equity indexes in recent years. However, much of the stellar performance was driven by a handful of mega-cap technology companies. For example, so far this year, the top four companies jointly contributed over 50% of the S&P 500 Index’s return and accounted for over 20% of its weight. Given this growing concentration in public markets and narrow leadership, we believe it is increasingly important for qualified investors to diversify beyond public markets and to incorporate private-market allocations in their long-term portfolios.

In our view, private markets offer unique and diverse opportunities — as shown in the chart below, more than 90% of companies are privately held. According to The World Bank, there used to be around 8,000 companies publicly listed on the U.S. and European stock exchanges each in the late 1990s to early 2000. Since then, the number of public companies has declined by about 35%. In contrast, more than 68,000 companies are currently owned by private equity, based on Preqin data.

Chart 1. Private equity-backed companies outnumber publicly listed companies by a wide marginSources: Wells Fargo Investment Institute and Preqin. Data as of March 31, 2024. Numbers shown are U.S. companies and exclude foreign-based companies.

One potential driver of this trend is that a growing number of companies have chosen to stay private longer. Prior to 2000, startup companies on average grew as private entities for eight years before going through an initial public offering (IPO).² In the past 20 years, the average age of a company at IPO has increased to 11 years, likely due to the maturing financing system and growth support available in the private markets. Another benefit is that by staying private, a company’s management can focus on long-term growth and does not need to worry about quarterly public reporting or fluctuations in its market price.

Private companies don’t just outnumber their publicly listed counterparts, they also offer diverse opportunities. According to Preqin, private companies exist in different sizes, from startups with promising products and exponential growth prospects to well-established enterprises with historically profitable business models. Private-market opportunities also span a wide array of sectors and industries that support the growth of the broader economy, and we believe many private companies feature prudent financial leverage and high-quality growth while being offered at an attractive valuation.

Given the unique opportunity set, private-market assets have grown at 14% per annum in recent decades — as shown in the chart below, assets under management have increased from less than $1 trillion in 2000 to over $15 trillion in 2023. The historical returns of private capital also showcase its diversification benefits as private assets have offered lower volatility in returns and featured a low correlation to traditional public markets. Therefore, we believe qualified investors should consider expanding their opportunity set in private markets when building a diversified, long-term portfolio.

Chart 2. Private capital assets under management have seen significant growth in recent yearsSources: Wells Fargo Investment Institute and Preqin. Data as of September 30, 2023. The private capital assets include private equity, private debt, and private real assets.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

¹ From January 1, 2024, to June 30, 2024

² Based on Professor Jay Ritter's IPO data

The consumer stock story

Recent macroeconomic data, companies’ C-suite commentary, and sentiment surveys suggest that the consumer is weakening. Does the stock market offer any conflicting or confirming data points to the discussion? At first glance, with the S&P 500 Index near all-time highs, the casual observer may assume that there is a clear disconnect between strong stock performance and the softening consumer story that recent data — and our forecast — tell. Upon deeper examination, however, stocks paint a similarly downbeat outlook on the consumer. In fact, while the S&P 500 Index has posted a roughly 17% return, stocks tied to the consumer—both high- and low-income cohorts — have languished since the first-quarter rally and are down year to date (see chart below).

The Consumer Discretionary sector has underperformed the S&P 500 Index by nearly double digits so far this year. This underperformance is especially impressive when considering that the sector includes two of the Magnificent 7³ behemoths driving recent stock-market gains.

Our outlook is that the economy and consumer will likely continue to weaken over the coming months, and we believe it too early to upgrade the Consumer Discretionary sector. For now, we remain positioned for a consumer that is being squeezed by high prices, dwindling savings, a softening labor market, and a slowing economy.

Consumer stocks paint a downbeat picture of consumer strengthSources: Bloomberg and Wells Fargo Investment Institute. Daily data: January 1, 2024 – July 9, 2024. Indexed to 100 as of the start date. High-income consumer is represented by the Goldman Sachs Consumer High Income Index. Low-income consumer is represented by the Goldman Sachs Consumer Low Income Index. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

³ The Magnificent 7 is made up of Apple, Amazon, Microsoft, Nvidia, Tesla, Alphabet (Google), and Meta Platforms.

Is the recent U.S. bond rally technical or fundamental?

From the peak of 10-year U.S. Treasury note yields near 4.70% at the end of April through the latest breaking of the 200-day moving average around 4.28% in early July, the question has been asked: are the factors driving the U.S. Treasury rally mainly technical in nature, or is the drop in yields signaling something more fundamental, presaging a much-anticipated slowdown in the economic outlook? We believe the simple answer is, “both”.

That technicals played a role in the early part of the rally cannot be dismissed. What appeared at first mysterious — falling Treasury yields as inflation prints ticked slightly higher than prints early in the year and equities extended gains — could be explained, at least in part, by a tightening of the supply-demand situation for U.S. Treasury securities (see the chart below), even as the Fed continued reducing its balance sheet during this period.

However, we believe it would be wrong to suggest that the move has been purely technical. More fundamentally, growing concerns about a slowdown in economic growth have helped push yields lower, especially with the expectation that the Fed will still be able to cut policy interest rates later this year if the disinflationary trend resumes. In our view, 10-year Treasury yields can remain within our year-end 2024 target range of 4.25% and 4.75% for the remainder of the year given that other factors around the U.S. government deficit, amount of debt outstanding, upcoming elections, and implications of potential changes in leadership could influence the term premium⁴ to the upside.

U.S. Treasury net issuance has declined over the past ten monthsSources: SIFMA and Wells Fargo Investment Institute. Monthly data from June 2021 to June 2024. *U.S. Treasury net issuance data includes T-bills. Net issuance = gross issuance minus gross retirement.

⁴ The compensation that investors require for bearing the risk that interest rates may change over the life of the bond. Since the term premium is not directly observable, it must be estimated, most often from financial and macroeconomic variables. Federal Reserve Bank of New York.

U.S. crude oil demand improving

After a soft start to the 2024 driving season, U.S. crude oil demand has improved and is now in-line with its typically strong seasonal pattern. In the final week of June alone, U.S. consumption grew to an impressive 21 million barrels per day, which pushed the four-week consumption average to its highest point so far in 2024. In response to higher demand, U.S. crude inventories fell by 12 million barrels — its largest one-week drop in 11 months.

For context, U.S. crude oil demand is often driven by seasonal patterns. Extra traveling between May and August, called the summer driving season, is regularly one of the strongest patterns. Near the start of this season this year, however, some worried that U.S. crude oil demand would be weaker than normal due to weakening consumer finances.

Many U.S. consumers have indeed faced weakening finances in 2024, but their demand for crude oil products has proved resilient. The improving demand trends for gasoline and jet fuel can be seen in the bottom panel of the chart below. More evidence of these improving demand trends could be seen in travel data recently released from the Transportation Security Administration. The data highlighted U.S. airport travel activity growing to an all-time high of 2.82 million passengers per day in the final week of June. Overall, we maintain our positive view on crude oil prices and the Energy sector. Improving U.S. consumer demand for crude oil and shrinking inventory levels help bolster our positive stance.

Four-week averages of U.S. crude oil, gasoline, and jet fuel demandSources: Bloomberg, Energy Information Administration, and Wells Fargo Investment Institute. Weekly data is from January 1, 2022 – June 28, 2024. Demand data reflects implied demand, which is a calculation based on the disappearance of oil and products from facilities and activities in the supply chain. To display domestic consumption, exports are excluded from the demand calculation.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, July 15, 2024.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Forecasts are not guaranteed and based on certain assumptions and on views of market and economic conditions which are subject to change.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

Goldman Sachs (GS) Consumer High Income Index is a basket of US consumer stocks that tend to have high-income consumers as their core customers. Stocks are selected fundamentally by the GS Consumer Sector Specialists. This basket is modified liquidity weighted and rebalanced at the discretion of the specialists.

Goldman Sachs (GS) Consumer Low Income Index is a basket of US consumer stocks that tend to have lower-income consumers as their core customers. Stocks are selected fundamentally by the GS Consumer Sector Specialists. This basket is modified liquidity weighted and rebalanced at the discretion of the specialists.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

An index is unmanaged and not available for direct investment.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

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