Week of November 13, 2023

Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation

While U.S. retail sales are holding up, consumer sentiment measures remain puzzling. The two most prominent sentiment indices, one from the University of Michigan and the other from the Conference Board, usually track each other very closely. But the gap between the two is close to historic highs, with the Michigan participants feeling very gloomy and the Conference Board more upbeat.

The University of Michigan focuses on the state of household finances and the willingness to spend, while the Conference Board assesses the view of the labor market and business conditions. Positive views of the labor market are trouncing downbeat views of household financial conditions. Maybe the gloom results from households running down their savings, seeing wages cool or still experiencing relatively high prices. But when asked about work, they perk up.

Meanwhile bond markets seem very clear about the world of tomorrow. Bank of America’s roundup of global fund managers shows a record number expecting lower long-term rates next year, with around three quarters expecting a “soft landing” or no setback for the global economy.

Much of this is already reflected in forward markets. And record inflows from investors into 10-year Treasury exchange-traded funds also reflect expectations that rates will drop, allowing price gains to emerge. This year’s volatility has certainly tested that commitment, but for now investor conviction appears to be holding steady that rates will start to drop by the middle of next year.

Sources: Bloomberg, Financial Times, 2023.

Richard Familetti, CFA , Chief Investment Officer, U.S. Total Return Fixed Income

Trying to predict economic statistics is always difficult – and even harder when economic dynamics are in flux as they are now, and have been since the start of the pandemic. We assume some investors did well in the wake of the Consumer Price Index (CPI) readings on November 14, but we think there’s a fair amount of luck baked into that kind of prediction. At the same time, we have harped on the idea that any break lower in inflation could help risk assets. The CPI numbers were better by just 0.1% compared to expectations, and that small divergence produced a rally in risk assets and debt securities. The rally was broad based as well: small caps (as gauged by the Russell 2000 Index) and the equal weight S&P 500 Index both performed strongly.

Notwithstanding any further severe escalation in the world’s conflict-affected areas, we believe that risk assets can continue to do well toward year end. If inflation continues to moderate and we avoid a recession in 2024, we believe this could be the start of a rally rather than a blip in the bear market. In credit markets we think spreads are somewhat attractive and could easily test the tights of 2023. In our view, supply/demand dynamics are still strong, fundamentals are somewhat worse but not enough to be overly concerned about and, perhaps most importantly, lower rates can heal bank balance sheets at a time when commercial real estate valuations are in decline – a helpful offset to potential bad loans.

Source: Bloomberg, 2023.

Linda Kong Ting, CFA , Senior Director and Credit Analyst, Asset Management

Currently, the differential between BBB corporate credit and BB high yield credit is just shy of 100 basis points (bps), which is on the low end of the range of the post-pandemic hiking cycle in the past year or so. For context, this range has been 100–200 bps approximately over the past two years. However, this can mask even greater dispersions in credit quality at the company and sector level. At the macro level, traditionally riskier sectors in the BBB space, such as energy and metals/mining, have become significantly more conservative over the past five years in their capital allocation and priorities.

However, the differences can be even more stark at the ticker level. Such a divergence was readily on display in this week’s new financial issues, as a couple of business development companies (BDCs) – containing 60%–90% secured first lien or unitranche loans to mid-market corporations – came to market with mid-8% coupons. Meanwhile, a low-BB high yield Canadian subprime loan company offered a coupon of 9.25% for a book that comprises a majority of unsecured personal loans, accompanied by riskier auto and real estate secured loans. For us, this signals a potential opportunity for investors who are able to perform credit analyses at the company or tranche level. Of course, even BB corporate credit spreads of around 240 bps may appear small to those investors who are able to delve into BBB commercial mortgage-backed securities, where the index is now wider than at the depths of 2020, at well over 900 bps.

Sources: Bloomberg, Moody’s, 2023.

Andrew Kleeman , Senior Managing Director, Head of Corporate Private Placements

The investment grade (IG) private credit market has been busy, which leads us to two observations. First, the concept of “shelf space” applies in the market. There have been so many investment opportunities that it is difficult for bankers to get investors to focus on some deals. Launching a new deal with the appropriate structure and price talk is critical to avoid investors declining it early and moving on. In our experience, a firm with deep analytical resources can be in a position to catch some of the deals that “rebound” when the original price talk or structure leads to less competition in the market.

Also, the market is busy because this is essentially the last opportunity to get deals priced in 2023 as the U.S. Thanksgiving holiday approaches. Issuers needing money in 2023 must be in the market already. There are a handful of December deals, but some investors will be out of budget or focused on year-end processes instead of underwriting new deals. Consequently, December deals frequently offer a bit of a premium to attract investor attention.

Source: Private Placements Monitor, 2023.

The information may include statements which reflect expectations or forecasts of future events. Such forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. All opinions and commentary are subject to change without notice. SLC Management is not affiliated with, nor endorsing, any third parties mentioned within this article.

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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