Week of April 24, 2023
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation?
Raising the U.S. debt ceiling, to pay bills already committed to, should seem like a routine signoff. Particularly for one of the most trustworthy nations in the world. But the theater of American politics doesn’t make it easy. While the debt level is the net cumulative effect of both the Democrats’ and Republicans’ fiscal programs over decades, it doesn’t prevent delays in approving any debt increase as politicians stall to blame each other.??
Markets tend to ignore the grandstanding and assume that as the “final day” arrives politicians will be pragmatic. Right now, that “final day” is estimated to be sometime between June and August depending on the strength of tax receipts, which look weak right now compared to historical trends.
While the risk of the U.S. defaulting on its debt is low, the risk of delay is rising. Markets are getting concerned. Treasury bills maturing close to the “final day” are trading at a higher rate, reflecting potential payment delays. Stocks of companies that do significant business with the U.S. government have also taken a hit. Using past episodes as a guide, the longer the stalemate continues the more long-term Treasury yields drop as markets price in a slowdown. This is not the kind of self-inflicted disruption the economy needs.
Source: Bloomberg, 2023.
Linda Kong Ting, CFA , Senior Director and Credit Analyst, Asset Management
Are we in the calm before the storm? Outside of a few unique regional bank situations, most companies reported solid Q1 earnings – potentially because the quarter was composed of 10 good weeks and just two bad ones. Pricing power seems robust for consumer products, as those companies reported double-digit revenue growth on relatively flat or even declining volumes. Credit card issuers have reported robust spending, but have increased loss provisions significantly, in keeping with signs that consumers are depleting their savings.
However, the forward outlook is significantly more cloudy, as signals like port traffic, shipping and freight rates suggest a rapidly slowing economy on the goods side, while consumer companies have noticed declining item counts, increasing popularity of smaller sizes and consolidation in store trips. Given that the majority of remaining inflation in the economy is now in services, the U.S. Federal Reserve’s path forward is relatively murky as strong wages and a stabilizing housing market sit alongside tightening credit, easing commodity and input costs, and slower hiring. In this environment, we continue to view BBB-rated industrials as expensive, and will consider cautiously adding exposure to global systemically important banks (G-SIBs) on any beta moves wider. However, we still think recovery in regional banks could be more protracted given the lack of clear resolution for some situations in the space.
Source: Bloomberg, 2023.
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John Bichajian III, CFA , Managing Director, Derivatives & Quantitative Strategy
Synthetic equity – the replacement of cash equity exposure (such as exchange traded funds) with futures contracts – can enable investors to better meet strategic mandates, such as income enhancement or duration goals, by freeing up cash to be deployed in the fixed income market. These contracts provide “cheap beta,” with low transaction costs and without the management fees and expenses associated with cash equity products.
Liability-driven investors often choose to deploy the cash into longer-dated bonds to better match their key rate duration exposures. In addition, holding this freed-up cash in local currency investments can help minimize the foreign exchange risk associated with owning foreign equities.
Like a forward contract, futures have an implied financing rate. Earning an investment rate on the liberated cash greater than the implied financing rate of the futures can lead to a strategy outperforming the cash index or ETF.
At SLC Management, we use futures contracts to replicate many global indices, such as the S&P 500, S&P/TSX 60, MSCI World, ACWI, EAFE, Emerging Markets and many more. Given that several of these contracts are currently trading at a financing rate cheaper than the London Interbank Offered Rate and the Canadian Dollar Offered Rate, now is a good time to explore the potential benefits of replacing cash equity exposure with futures and investing the unlocked cash in the fixed income market.
Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.
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