FAMO - Fear you Already Missed Out
The debate seems to be over “for now” on the recovery in capital markets. If you voted V shaped, you are likely happy with your results. After being down over 30% the Nasdaq is positive for the year and as of the end of April was off less than 10% from its all time high. The S&P/TSX was down slightly more at just over 15% but up over 30% from its lows in March. Many securities have however lagged indices leaving opportunities for further growth. One place to look is in credit with unprecedented support and dislocations that include: (1) Government stimulus packages targeted to support credit not equity valuations (2) Inefficient auction based bond markets and (3) Individual credits with defined paths back to par.
To date global stimulus measures have reached $8T and are expected to surpass $10T. Governments have been careful to not repeat the perception of corporate bailouts from 2008-09. Payments are going directly to individuals or supporting companies to allow them to service debt and stay in business. On April 20th Royal Dutch Shell cut its quarterly dividend 66% and said it would not proceed with the next tranche of its share buyback plan sending shares down over 15% during the day. Many companies will have to follow Shells’ lead of significant belt tightening or dividends cuts which in some regions is a prerequisite of receiving government aid. With the worst of the financial carnage likely to come in the following quarter the impact to equity holders could spread to more sectors while bond holders benefit from cost cutting, dividend cuts and government support. Memories of “buy what the Fed is buying” is echoing from the global financial crisis.
An often under appreciated aspect of capital market operations is the lack of transparency in bond vs. equity markets. Bonds trade through auction, there is no physical exchange in contrast to equities. This operational inefficiency magnifies volatility in bond trading especially during periods of crisis. Bond managers several of who levered up portfolios to enhance yield only to be forced sellers in March further increased dislocations. High-grade credits that sold at par in the first week of March dropped to between $60-$70 two weeks later with huge bid/ask spreads. Add $2T of Fed buying targeting specific asset types while avoiding others and dislocations in credit are increasingly technical open for skilled managers to make gains in your portfolio.
In the case where volatility persists credits clearer path to par through its maturity date can be an attractive feature. A maturity date acts as a pull to par that does not exist with equities. An underpriced equity can stay underpriced for a long time as there is no mechanism to pull it to intrinsic value outside of the collective activities of market participants. As long as the market believes the company has the finances to continue to service the debt, which the government has created more assurances they will the bond will approach par as it approaches maturity. You don’t have to watch the markets day by day to see if you are making money, with bonds you can have far greater transparency of income and capital gains.
The severity and speed of the market decline in March 2020 created outcomes that few participants modelled in their assumptions. The indiscriminate selling created opportunities in both equities and credit. For those that fear they already missed out on the equity rebound or are considering their next move credit may provide the solution for future growth, predictability and a risk tolerance more acceptable than equities.