Self-Awareness During Challenging Times

An eight minute review of markets, the investment climate, and activity in client portfolios over the past few weeks.

Jeffrey Addis:

Welcome to our podcast. My name is Jeffrey Addis. 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, on to our podcast. I am pleased to introduce David Fishman, our Deputy Chief Investment Officer.

David Fishman:

Today is Thursday, June 11th, 2020. Over the past month, we have seen America continue to reopen and economic data has improved. I’m not an epidemiologist, but the growth rate of the spread of the coronavirus appears to be stabilizing in most states. Certain states are seeing a rise, but on the whole economic recovery is beginning to take shape. It looks like the hurricane has passed. The number of workers receiving unemployment benefits and new weekly claims has been easing. The May Jobs report last Friday was a huge positive surprise with payrolls up two and a half million, and the unemployment rate fell to 13%. Although, many have raised questions about the veracity of the release, as it stands, it appears the job market may have bottomed in April and rehiring has begun. That would be a relief for a massive unemployment problem, which is recovering from near an 80-year-high, so-called underemployment remains over 20%.

Many essential consumer retailers are figuring out how to do business in the new environment, and along with big tech, many reported strong quarterly earnings since we last spoke. We heard more good news from Inovio Pharmaceuticals on the race for a vaccine. Housing has been resilient so far. In the words of Bank of America, “Housing is benefiting from a new source of intrinsic value in the work from home economy at the expense of commercial real estate to be sure.” Mortgage applications to purchase a home remain at multi-year highs for this time of year. US treasury yields have come down from the top of the recent range on better than expected data, twos and fives are about flat in the past month, while a 10-year treasury yield is up about six basis points, a 30-year is up about 13 basis points. The slope from twos to tens is about unchanged while tens to thirties is up about 10 basis points.

Volatility have been coming down but recently has trended back up and is about unchanged in the past month. Credit spreads are tighter. IG spreads have come in about 60 basis points to 150, while high yield has tightened about 200 basis points to 560. Total returns on a year to date basis are up about 6% for the Bloomberg Barclays Ag, while high yield is down about 2%. US equities are down from 5% on the Dow to up 12% on the NASDAQ. Overseas, EM and European equities are down about 10% year to date. On the past month, European markets have been on a tear. EMEA equities are up about 20% in the past month as optimism about the reopening outweighs fears of a second wave of coronavirus. Further, Europe has announced coordinated plans for recovery aid and asset purchase programs. This all reduces tail risk of another sovereign debt crisis.

Japan added more than a trillion of physical stimulus to combat the economic impact of the virus. The worst observations from overseas is the continued deterioration in US China relations. It is taking too long for each eye to see they need each other, and yet the economic green shoots are in contrast to ongoing unrest that is a symptom of growing inequality here and abroad. The situation in our country is now as ugly as I can recall in my lifetime. On May 25th, George Floyd was tragically murdered and many of us are sad and angry by what we see everywhere we look. I struggle to find the words that properly address this. The injustice, systemic racism and inequality that surrounds us has been made worse by coronavirus. As Federal Reserve Chairman Jerome Powell put it last Sunday, “The economy to fully recover people will have to be fully confident.” We’re a long way from that.

As my parents told me, and I tell my children, we cannot control events that are out of our control, but we can control the way we react to them. To be honest, I find myself being very emotional about the tragedies we are living through each one compounded by the other. I acknowledge my privileged position in a leafy suburb. Having our groceries delivered out of convenience is one small example, but last week we heard choppers overhead in response to threats of looting. My 11-year-old saw tanks moving through town and I saw soldiers actively guarding the National Guard facility down the street with armed Jeeps pointing out at the surrounding neighborhoods. Gerald Baker described my emotions best in this weekend’s Wall Street Journal when he said, “It’s a broad-based collapse of confidence in the system that America has pioneered, propagated, and led for the last half century,” and yet things can get worse.

This event did not pop up out of nowhere. It is highly probable that another tragic incident will occur while we are dealing with multiple crises already. Time and time again, our country has repeated the hamster wheel of death, protest and no change. I hope I’m wrong because it feels like we are one crisis away from another meltdown. Many cities and states are already struggling under 20 to 30% plus unemployment. Without additional stimulus, the unemployed faced the prospect of $1,200 stimulus checks running out soon and the $600 weekly, but temporary increase in unemployment benefits are scheduled to end in July, yet we cannot be emotional investors. The market is developing a better conscience with the growth of ESG, but it does not have emotion. Growing income and wealth inequality are likely to increase the focus on S, for social risk factors in ESG.

As part of our commitment to ESG, we need to ask ourselves if any of the securities we hold contribute to the economic injustices that are being protested. Within my focus area, CMBS, Freddie and Fannie have been unsuccessful in improving the affordability of rents despite their mandates, raising questions as to potential changes and policy that could disrupt the status quo toward the goal of economic justice. In other areas of structured products, the current environment poses the first test of the many non-bank lending platforms since they were created to fill a void post-crisis. Investors have debated their ethics and credit for several years now. So as not to end on a downward note, as usual, I find myself looking for reasons to be optimistic. The May Jobs report, if accurate, certainly helps. Maybe the protest will not lead to a major second wave of infections, that would go a long way to further reopening the country.

On several occasions, I have had friends and colleagues relate that they’re optimistic that our circumstances have forced people to pay attention while confined to their homes and glued to their screens. It is showing everyone just how much of a problem this truly is and why there is a need for change. So I see and I hear a hope that the current call to action will make lasting changes. We need to listen, so I’ll leave my comments on this topic at that. What has the investment team been doing? We continue adding selectively across credit and structured. Notably, we have been adding RMBS and reducing CMBS. RMBS was a good trade in short term bond earlier in the year, and now we are adding more broadly across strategies. Mortgages were a rare sector to experience widening in May despite fed support. In addition to mortgages, additions and structured include prime autos and heavy equipment, but fed intervention has made availability of bonds an issue.

In IG Corporate, adds have been in technology, telecom and finance. The rally in risk has brought many of the credit sectors back to levels that suggest the fed may not even have to utilize their rescue plans. On the other hand, an area that is being utilized is the Muni Program, which continues to be expanded to serve more issuers. For the trillions of dollars that have been spent, it would be nice to see some make its way to local schools, healthcare and social services dealing with all of these crises at once. In the near term, the path of least resistance is likely still tighter spreads as the economy continues healing with the fed acting as a backstop. Until next time, I look forward to speaking with you again in the coming weeks.

Jeffrey Addis:

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 Merganser 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.