Week of October 16, 2023
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
Economists rarely pencil in recessions. It is not that they are exceptionally Pollyannaish, but rather they accept that recessions are hard to predict as they are usually the result of shocks. However, over the last 18 months most economists have been warning that a recession is right around the corner.
The alarm is defensible. As the U.S. Federal Reserve tightens at an historic clip, will something surely break? But the big surprise remains resilience. Households and corporations are still in good shape. Jobs are plentiful and rising rates are having little effect on companies that have locked in fixed rates years ago and mortgage holders that are in the same camp.
But there has been stress that makes this cycle look more like a series of unsynchronized sector adjustments or a rolling recession – which perhaps best describes this cycle and where it is heading.
For instance, take technology. After a major correction last year, firms trimmed staff but started to recover as AI enthusiasm picked up. Housing prices dropped from last year’s highs but have since recovered as inventory remains low. U.S. manufacturing has been in contraction territory for almost a year but is edging closer to expansion as supply chains heal and demand for goods stabilize.
Regional banks after recent failures have been shoring up their balance sheets as new regulatory capital requirements are proposed. Their stock valuations have taken a big hit, but seem to have hit a floor as markets assess risks from commercial mortgage holdings.??
The biggest concern within real estate is the office sector. With the future of office still uncertain, office real estate investment trusts (REITs) are trading at significant discounts as the market worries about rent durability. High yield companies that pay floating rates are still performing relatively well. With the dramatic increase in rates over the last year, stress in this sector is still fairly contained with defaults only slowly rising.
Therefore, through the lens of a rolling recession, technology, housing and manufacturing have seen stress and worked through it. Regional banks have stabilized at a significant discount while markets wait for commercial mortgage risk to emerge. In similar fashion, the office sector is still in discovery mode for its ultimate level of utilization. Meanwhile leveraged loans are holding up but could provide an early alert to the intensity of corporate debt stress.
Source: Bloomberg, 2023.
?
领英推荐
Linda Kong Ting, CFA , Senior Director and Credit Analyst, Asset Management
Bank earnings releases began in earnest last Friday, and the large global systemically important bank (G-SIB) institutions and the next tier of super-regional banks have generally justified their post-Silicon Valley Bank reputation for stability. Although deposit costs have started to rise incrementally, “cash sorting” behaviors (i.e., the movement from bank deposits to higher-yielding liquid money market funds and Treasury bills) are ebbing, and consumer credit deterioration remains measured. Although commercial real estate remains an area of concern, the largest banks appear well-reserved and have continued to prepare for higher defaults in this area despite little to report in terms of actual distress to date.
As a result, post-earnings bank deals have all gone relatively well, save for one curious Goldman Sachs 10-year offering. The deal priced with just 10 basis points (bps) of curve between the 10-year and the 5-year maturity, a curve that was unusually flat considering similar issuances from peers earlier in the week with curves closer to 20 bps. Given that spreads seemed to be unfavorably tight compared to other deals in the same curve at lower dollar prices, attrition was swift, with almost 70% of the initially over 7-times oversubscribed book dropping out and the deal leaking wider the next day. Therefore, despite the greater demand for duration at these higher belly and back-end Treasury yields, we see this as another example of investors setting healthier boundaries in the post-zero interest rate policy era.
Source: Bloomberg, 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.
SLC-20231019-3181754