Week of November 6, 2023
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
There is a common refrain that the stock market is not the economy. That usually conjures up images of a market that is recklessly bullish even as the economy is in the doldrums. While this is generally not how it works, there can be disconnects. Over 60% of the S&P 500 Index is related to manufacturing and the sale of goods. Meanwhile about 60% of U.S. economic activity is all about services – in other words, what we spend our paychecks on.
The reason this prelude is important is that the S&P 500 Index, after three quarters of year-over-year earnings declines, is now perking up. Third quarter earnings have grown, and Wall Street is forecasting solid earnings growth next year. The earnings slump reflected the economy’s dramatic shift from goods to services as everyone caught up on missed experiences from the pandemic-disrupted years. Now with summer travel behind us, consumers are rebalancing back to normal habits and demand for goods has picked up.
At this point, the earnings recession seems to be over. Corporate margins have weakened a little but are still strong as companies have managed their costs well. Are we returning to a more synchronized view between the market and the economy? If so, then the odds of a soft landing are improving.
Source: Bloomberg, 2023.
?
Richard Familetti, CFA , Chief Investment Officer, U.S. Total Return Fixed Income
Investment grade credit curves are as flat as they have been since 2011. When comparing the Bloomberg US Long Credit Index with the Bloomberg Credit Index, the average curve has been 18 basis points (bps) since 1989. Over the last five years the average is 38 bps, and currently we are inside of 10 bps. Over those same two periods the maximum flatness (inversion) was -131 bps (since 1989) and -15 bps (last five years). The large inversion occurred during the Global Financial Crisis and the more recent inversion occurred at the outset of the pandemic. Looking further into the past, flat or inverted credit curves commonly occur during times of stress. Simply put, when market stress is high the risk of default rises and the price of short-term debt, even investment grade short term debt, underperforms longer-term debt.
In the banking sector we have seen this phenomenon play out in 2023. Credit curves for bank names, particularly regional banks but even global systemically important banks (G-SIBs), have flattened and in many cases have inverted. Credit spreads for some regional banks were significantly wider for short maturities earlier in the year although that has abated somewhat. This has clearly contributed to flatter credit curves on average. What’s unusual about the current period is when credit curves have flattened in the absence of any apparent stress. High quality non-financial corporate debt curves have also flattened. This is the result of demand from longer duration buyers of credit – like pension funds (through asset managers) and insurance companies – and a lack of long duration issuance.
If new stresses do not enter credit markets, we would expect some mean reversion on credit curves. Lower long-term rates would also alleviate this phenomenon.
Source: Bloomberg, 2023.
领英推荐
?
Andrew Kleeman , Senior Managing Director, Head of Corporate Private Placements
Most investors in investment grade private credit invest in the asset class for the additional yield available over comparable public investment grade bonds. The difference in the spread between public and private bonds is frequently referred to as an “illiquidity premium.” We think that term is a misnomer. Part of the relative value is certainly tied to the illiquidity of the private bond, and the price for illiquidity can vary by sector and market conditions. However, this brings us to the other important aspect of the spread differential, which we like to call the “hassle factor.” There can be a significant premium for deals with complex structures or in niche sectors. These deals are more difficult to originate and underwrite. Some of these transactions are on a bilateral or club basis and can take several months to negotiate and document.
For these deals, a portion of the premium is compensation for the work, and not just a reflection of higher risk or illiquidity. It takes a large team and dedicated specialists in different sectors to originate and appropriately underwrite the risks, and clients and investors are compensated for that work.
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.
SLC-20231109-3224265