Week of December 5, 2022
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
As we quickly turn the page on the year, expect 2023 to be less about monetary policy risk and more about growth. And one striking feature, from all the forecasts bubbling up, is how subpar and divergent growth is expected to be. Across developed economies, the range of GDP forecasts are some of the widest in decades. That level of uncertainty ranges from recession to underwhelming growth for many.
Higher rates and varying local and geopolitical challenges will take a toll and mute activity. For instance, China’s growth will continue to be vulnerable to rolling COVID lockdowns, particularly as the country renews its efforts to fully reopen. The eurozone still needs to navigate the threats of energy supply dislocation and escalating prices. While it skillfully built gas storage for this winter it will soon need to begin restocking for next season. North America looks more resilient and still expects to post modest growth, but with considerable risk that the region could struggle economically for a few quarters.
Where does that leave global asset allocators? Well, on the bright side, it could be the year for yield. After decades of muted yields on sovereign and credit related debt, the torrid pace of central bank rate hikes has transformed that. Yields are high and 2023 could be the year that fixed income finally gets to shine.???
Source: Bloomberg, 2022.
Daniel Lucey, CFA , Senior Managing Director, Senior Portfolio Manager, Total Return Fixed Income
Credit has defied the odds of many macroeconomic challenges recently, putting on an impressive show of tightening over the past several weeks. The same can’t be said about other structured credit subsectors, which have lagged the move in investment grade corporate credit. AAA-rated collateralized loan obligation paper at close to +200 basis point spreads is one example of this phenomenon. While many of the same issuers underneath the hood of the CLO structures are the same leveraged finance issuers as high yield, the corporate high yield market reached the low +430-bp range recently before backing up as of late.
Another glaring example is commercial mortgage-backed securities credit. While AAA-rated CMBS have started to rally and catch up with higher quality corporates, single A and BBB- CMBS conduit credit has lagged severely. In fact, with the most recent new issue conduit CMBS deal pricing at +820 bps in spreads and investment-grade corporates in the aggregate index bouncing around +130 bps, we have never seen a market where BBB- CMBS spreads were this wide while corporates have been at these relatively tight levels – the latest new issue deal was 6.3-times IG corporate spreads in the aggregate index. Looking back at 2008 data before the mortgage-led Great Financial Crisis, tranches weren’t comparable as they had far more leverage and less credit support before the industry renewed itself in 2009 and 2010 with “CMBS 2.0” structures. So, while the headwinds remain palpable in many commercial real estate subsectors, such as office origination and demand, CMBS credit is pricing in more macroeconomic fundamental challenges, leaving it cheap relative to corporate credit markets.
Source: Bloomberg, 2022.
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Randall Malcolm, CFA , Senior Managing Director and Portfolio Manager, Public Fixed Income
The Bank of Canada hiked its overnight lending rate by 50 bps on Wednesday. Investors had been split between expectations of a 25 or 50 bp hike going into the meeting. While the rate hike move was more hawkish than expectations, movements in the yield curve post announcement were fairly muted, as the BoC left something on the table for the doves as the central bank signaled any further hikes will now be data dependent. While employment and economic growth have performed relatively well, we are seeing some weakness in the consumer sector as rate hikes start to take hold. The BoC now seems happy to see if and how its recent hikes have started to trend inflation lower, while not hurting employment. Every central bank is chasing this “Goldilocks” scenario of lower inflation plus a soft landing for the economy.
Source: Bank of Canada, 2022.?
Linda Kong Ting, CFA , Senior Director and Credit Analyst, Asset Management
Liquidity was a strong theme this week in credit markets as two Blackstone credit funds, Blackstone Real Estate Income Trust (BREIT) and Blackstone Private Credit Fund (BCRED), both hit redemption limits as investors attempted to avoid the markdowns that are coming due to higher interest rates. A public office REIT also priced a five-year bond at +400 bps, with no tightening from the initial price talk and well back of the secondary curve.
These data points suggest that investors are worried about the gap between implied valuations versus the risk-free Treasury rate and current mark-to-market valuation of illiquid assets. However, it is relevant to differentiate between asset classes, as the underlying asset values in private credit are far less challenged given that loans are already repricing with higher coupons and have some protections from their position in the capital structure, as well as from various covenants. Therefore, while credit risk is undoubtedly higher today – and this is contributing to the recent widening – there is less of an absolute valuation challenge than in illiquid REITs and slightly higher liquidity. It is also relevant that enthusiasm for private credit has not waned to the same extent either, as BCRED claimed to have observed net inflows despite redemptions from some investors, and “real-money investors” are still selectively adding funds to this space. We are more balanced in our views of private credit compared to illiquid REITs given these fundamentals, but agree that caution on illiquidity is warranted.
Source: Bloomberg, 2022.?
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.
SLC-20221208-2631501