Not Your Father’s Recession

Following a risk-on second quarter, we pause to reflect on fixed income valuations, the state of the economy and the impact of recent stimulus measures.

Welcome to our podcast. My name is Jeffrey Attis. I am the president and chief operating officer of Merganser Capital Management. Before we begin, a few important regulatory disclosures. This presentation is for informational purposes only and should not be considered as an investment advice or a recommendation of any particular issuer security strategy or investment product. Now onto our podcast, I am pleased to introduce David Fishman, our Deputy Chief Investment Officer.

Since we last spoke, the country continues to be ravaged by rising virus cases. While it appears we have bent the curve as far as the death rate, the absolute level of cases is staggering. Four months into this with a record high level of new cases across the Sunbelt, while the Midwest show some worrying signs. Goldman Sachs reports that states representing three quarters of the US population have paused or reversed reopening plans. While the impact was expected to be temporary, we are now dealing with longer lasting challenges. There’s talk of another trillion dollar stimulus and accommodative fed and continued progress in treatments and vaccine developments are reason for optimism. In light of real time, high frequency mobility data pointing to the economic recovery losing momentum in recent weeks as cases surge. According to Jeffries, small business activity, retail foot traffic, restaurant bookings, traffic congestion, public transportation ridership, and web traffic to unemployment portals have all changed direction and point to worsening conditions.

On the market side, treasury yields continue to trade in a range we’ve seen since April, with a downward bias as expectations mount that it will be hard to maintain economic momentum. Across the curve. Rates are within 10 basis points of where we were at the end of June. As of July 20th, the investment grade Bloomberg Barclays Agg is now up 7% for the year with high yield down only 2%. Credit spreads continued to tighten about 15 basis points in IG and 70 basis points in high yield. Since the end of June, equity markets have continued their strong showing the S&P is flat. The Dow is down only 7% and the NASDAQ is partying like its 1999. Again, up almost 20% for the year. Emerging market and European equities have also continued to recover down only five to 10% year to date. Richmond Fed President Barkin said, “There are signs of strong momentum as the economy reopens, but it’s prudent to be aware of the level of activity, not only the rate of change.”

While the trajectory of cases in the US is obviously very different than China, it is worth noting there are strong rebound and real GDP, up 3.2% for Q2, above expectations. Back to the US we get Q2 GDP next week. Expectations are for a sobering 33% annualized quarterly decline. The policy response to this staggering shock has created a strong growth uptick that has surpassed expectations so far. The city economic surprise index hit record highs as expectations have been too low for too long. That index peaked last week at multi-year highs as expectations were too downbeat for too long. Perhaps it’s a local bias effect of Wall Street economists given the hell they’ve been through recently. To that end, June’s jobs report continued to surprise, up 4.8 million, and the unemployment rate fell to 11.1%. While the actual rate may be higher due to flawed reporting, the number of jobs added appears strong.

Weekly claims data has stopped improving at a still very high one and a half million. Retail sales data also continues to be a standout, nearly all the way back to pre Covid levels. Core retail sales are actually up 4% year-over-year ending what have been three straight year-over-year declines. In the last recession, we experienced 16 consecutive months of yearly declines in core retail sales. The divergence we see in many sectors is evidenced here as well. Online, no surprise, up 30%, department stores, again, no surprise down 12%. Apparel stores down almost 25%. And restaurant and bars down nearly 30%.

Recent bank earnings highlighted how this is not a typical recession. They reported a spike in loan loss reserves, but so far no spike in delinquencies or charge-offs as would be expected with 11% unemployment given massive government aid and stimulus. To paraphrase Jamie Diamond, in normal recessions, unemployment goes up, delinquencies go up, charge offs go up, home prices go down. None of that’s true here. Hopefully, the abundant liquidity can continue to mitigate what should be large increase in bad loans still to come across sectors and geographies. For now, generous modification of forbearance programs are masking underlying stress, which should lead to an increase in delinquencies, should forbearance and stimulus programs abate.

Continued uncertainty over the spread might imply higher level of volatility than we are experiencing and significant economic headwinds are likely to continue into the third quarter, but we should also continue to expect stimulus to keep the economy running without additional shutdowns. For now, spread sectors are not exhibiting concerns that Covid will impact us indefinitely.

ABS new issue has returned in force along with corporates. Generic ABS sectors have retraced most of their widening. Strong demand there points to positive sentiment. Last week’s saw 10 billion of new issuance, the second highest of the year, trailing only 11 and half billion from one week in February.

High yield also saw a record month of new issue in June. CMBS new issue has been limited. Still too many unknowns over tenant’s ability and willingness to pay rent across property types. Multifamily apartment issuance has been active as that sector benefits from a strong fed backstop. The investment team has been active, although it has slowed down with earning season and midsummer doldrums. Despite the uncertainty, we continue to view many portions of the market to be attractive as unprecedented Federal Reserve support for markets with continued government support for the consumer, encourage taking measured risks. A record amount of cash in the economy and a record high savings rate suggests there will remain a reach for yield that can slowly tighten spreads generally, but choosing the winners and losers is more important than ever. As many asset classes see divergence with an increase in corporate bankruptcies. We expect the market to experience bouts of volatility, but overall risk positioning will be rewarded as we move toward virus containment. Let’s hope that day comes soon.

With the uncertainty on the course of the virus, we have been more aggressive in places like corporate credit versus securitized sectors, especially CMBS. We also continue to see some marginal opportunities in RMBS fundamentals and technicals favor residential over commercial mortgages, we continue to prefer 15 year over 30 year MBS. We should be better positioned with regards to prepay and duration risks and the sector’s underperformed for a while now.

Housing continues to benefit from another new record low mortgage rate, now below 3% with room to come down further still given what is still a widespread. Mortgage applications also remain strong. We look forward to speaking to you again in the coming weeks.

This commentary contained or incorporated by reference certain forward-looking statements which are based on various assumptions, some of which are beyond our control. Opinions and estimates offered constitute our judgment and are subject to change without notice as our statements of financial market trends, which are based on current market conditions. No part of this presentation may be reproduced in any form or referred to in any other publication without the express written permission of Merganzer Capital Management. For more information, please visit our website at Thank you.

A Bird's-Eye View of the Bond Market: Merganser Capital Management

A Bird’s-Eye View of the Bond Market offers real-time analysis and commentary covering the major themes and issues driving the U.S. investment grade markets. Subscribers will have the chance to hear from different members of the Merganser investment team, allowing listeners the opportunity to gain valuable perspective on corporate credit, securitized, government markets and the economy. The idea behind the creation of this podcast is simple: offer our listeners a consistent source of valuable fixed income market intelligence at the click of a button.