Friday, 10th of July 2020
“Victory comes from finding opportunities in problems”
– Sun Tzu
Markets were mixed this week as investors’ nerves frayed a little due to the mounting coronavirus death toll in the Southern US, while weaker data took some of the shine off the nascent economic rebound. New cases of covid-19 have been rising sharply for several weeks; but, until now, the death rate has lagged significantly behind where it was in Spring. It looks unlikely that coronavirus mortality will return to the highs of April, given the more effective shielding of vulnerable groups and the much greater knowledge that health authorities now have about the coronavirus and its treatment. But the numbers are starting to creep higher. And with a record 60,000 new cases recorded on Tuesday alone, the US remains in a very challenging place as it navigates re-opening society. This apparent ‘second wave’ (or tail-end of the first) adds a layer of uncertainty to the near-term outlook and will need to be watched closely as we enter a period of thinner liquidity characteristic of the summer months (and exacerbated by the pandemic). That said, there is little doubt that the Fed and other central banks also have an eye on events and will deploy aggressive stimulus measures should there be a correction in July or August. This puts a floor under equities and suggests that dip buying will soon halt any large downwards move. Of course, it also supports our long-term bullish outlook for gold – a beneficiary of both volatility and money printing – which hit a new high of $1818/oz this week and is up around 20% for the year.
Looking at the major stock market indices this week, the S&P 500 Index is up +0.7% as of Thursday’s close and futures suggest it will give up most of these gains at the open on Friday. Meanwhile, the pan-European STOXX 600 is slightly down for the week after a decent bounce on Monday was followed by three consecutive days of losses. The only region that is still on a tear is EM, where the MSCI EM Index is up +4.5% (in USD) this week with one day to go. The EM benchmark has a large exposure to China, where the stock market received a huge boost from domestic retail investors after state media flattered the country’s progress and suggested that a bull market was now needed to power the recovery. Indeed, the move higher this month has been so aggressive that it has forced a change in tone from the Party-linked Securities Times, dampening some of the momentum. The subsequent downturn for Chinese stocks has also coincided with a toughening of political rhetoric over Hong Kong, with some members of the Trump Administration even floating an attack on the region’s currency peg in retaliation for the pervasive new Security Law imposed by the Mainland government. Although this outcome is not yet a serious prospect, it highlights the depths of acrimony in the US-China relationship.
There has been little change in credit spreads this week amid the more cautious market context. Given the rally since March, significant further spread tightening for HY and IG (at index-level at least) seems unlikely to us, and we are happy to have added IG bonds when they traded some distance wider than current spreads. A wave of defaults seems highly likely when companies leave government life-support in Q3/Q4 and are forced to confront the harsh reality of a post-covid-19 world where patterns of demand have been transformed by the pandemic. Many are in a perilous financial position already, having seen their cash reserves depleted to zero through months of lockdown and ongoing social distancing. And, as a result, many furloughed workers will soon wake up to a more permanent form of unemployment. Indeed, just this week, United Airlines told 45% of its workers that their jobs could be cut in September. There is little doubt that volatility in spreads will accompany this rollback of government schemes, and we favour active management and deep fundamental work in credit through the end of the year.
One fixed income strategy that we see as highly attractive in today’s market is opportunistic credit, with a focus on private deals but also with the flexibility to exploit any dislocations in public credit thrown up by the pandemic. Thin capital markets have created a situation where borrowers who face short-term financing stresses are forced to engage alternative lenders. This is particularly true when there is any degree of complexity associated with the balance sheet and has created a plethora of attractive lending opportunities for those who have the know-how to structure complex transactions effectively. The opportunity set today has probably never been better for these managers, given the global nature of the coronavirus crisis; and with central banks having injected vast quantities of money into public markets the relative value in such illiquid and private pockets of fixed income is vast.
To all our readers, please be aware that our Newsletter will be published on a fortnightly basis until the end of the holiday season in September. We hope you enjoy your summer staycations and vacations!