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Credit and a Virus Outbreak: Déjà vu?


As volatility in equity markets ratcheted up in the last week, the focus on the credit markets is the panic buying of U.S. Treasuries and various other risk-off debt classes. The move in the 30-year U.S. Treasury market is nothing less than astounding. In the last year the yield on the 30-year has declined from 3.04% on March 14, 2019 to the low of 1.28% at the close on Friday. A Treasury with a 3% coupon with a 30-year maturity bought at slight discount to par would theoretically be pricing up 41% currently. In what may be the most obvious statement, this is the highest return on record to start a year.

Some other noted moves:

  • The U.S. dollar has declined by 4% in just the last three weeks.
  • The total of negative yielding debt has increased by nearly 34% from its low in January to total $14.6 trillion.
  • The four largest central banks from a GDP basis have a total of $20.16 trillion on their balance sheets.
  • There has been over 2,400 basis points cut by all global central banks, not including certain hyper-inflationary economies that reside in South America.
  • Germany’s government has ended its Black Zero stipulation in which spending must equal receipts. This allows flexibility to implement a larger fiscal stimulus program that is greatly needed.
  • The Federal Reserve has announced that they are willing to look at implementing the asset purchases that the European Central Bank and the Bank of Japan has implemented. This will ultimately be read as an asset price backstop should they broaden their purchases…and this does not constitute a good long-term solution for those who desire open markets.

So far, those who increased holdings to longer-dated quality have been rewarded handsomely.

 

Month to Date

Year To date

U.S. Treasury

2.81%

8.12%

U.S. Corporates AAA/AA/A

2.06%

6.21%

U.S. Corporates BBB

1.61%

4.96%

U.S. Corporates

1.96%

5.75%

Tax Exempt Municipal

0.26%

3.38%

Taxable Municipal

2.85%

10.95%

U.S. High Yield

-0.44%

-1.08%

U.S. High Yield Intermediate

-0.55%

-2.05%

U.S. High Yield Long

1.22%

2.23%

Source: Bloomberg Barclays data (blended returns on Corp AAA/AA/A) through 03/06/2020 | Past performance is not indicative of future results.

The paper profits on the taxable municipal has been the most under reported of all the debt classes. The move on Friday has seen spreads in the Investment Grade and High Yield jump above their 25-year median.

lloyd1_030920

lloyd2_030920

When you scrutinize some of the underlying metrics, an intriguing metric jumps out. This run up has created a potential opportunity for those who may be more risk tolerant. In looking at the last two decades of bond prices and spreads to corporate investment grade corporates, one sees that two other dates match up with the both metrics.

lloyd3_030920

Do these two points coincide with increasing risk or decreasing risk? Consider the returns in the next year and two years in both investment grade and high yield.

For those who wish to look at coincidences, there is one other thing to take into consideration: SARS occurred leading up to the peak in July 2003 and the West Nile Virus in 2012.

 

1-year Total Return

2-year (Total Return/ Annualized)

Investment Grade Corp (06/2003)

0.22%

8.40% / 4.11%

Investment Grad Corp (07/2012)

1.47%

8.87% / 4.33%

High Yield Corp (06/2003)

10.29%

22.30% / 10.57%

High Yield Corp (07/2012)

9.65%

22.37% / 10.59%

Source: Bloomberg Barclays | Past performance is not indicative of future results.

In our opinion, this reveals that those in the credit market should consider using the recurring spread and price action for a serious conversation about shifting into the areas that suffer the most. It also spells out having a professionally managed portfolio with a long track record of being able to evaluate the value and delineate the substance from the noise. We would expect more headline risk and some increased price swings in the near term as the lack of depth in markets gets tested. The ideal place, in our view, could be argued that a muted duration portfolio of “quality” high yield investments may offer the best opportunity for those who see this as an opportunity.

History has continually shown rhyming patterns that create potential opportunities of various degrees. The one common theme is that these potential opportunities occur when the preponderance of data and market action conclude that the worst is yet to come. It also follows the increase of the smarter bear theory that justifies why a bottom is not close to being set as they extrapolate current negativity into a further and implied permanent decline. Historically, this has proved poor advice for the long-term investor time and time again. The strains of investing during the most tumultuous times are only understood from past experiences and feel like you’re “flying a kite in a hurricane.” There is a classic phrase that sums up the behavioral finance component that sees the repetition of tragic investment action: “When the time comes to buy the market, you won’t want to.”

 

CRN: 2020-0302-8074R


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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