Take Five – Market Recap with our CIO

Jeffrey Addis:

Welcome to our podcast. My name is Jeffrey Addis. I’m the 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.

Alli Morse:

Hi everyone, and welcome to a Bird’s Eye View of the Bond market with Merganser Capital Management, where we invite leaders from our investment team to offer their analysis on the US investment grade bond markets and insights into key economic developments. My name is Alli Morse and I’m a relationship manager here, Merganser, and excited to have Andy Smock, our Chief Investment Officer joining us today for another episode of Take five with our CIO. Andy, Now that we’ve passed Labor Day weekend and head into year end, could you provide us with a brief update on the markets and where we are today in regards to rates the Fed and even thoughts on a potential recession?

Andy Smock:

Year to date, rates are up about 60 basis points from two-year point and further out, and the move in rates has shocked many people in the markets. They’re actually not that much higher than they were back in February, but after the February peak, they came back down and I think folks were ready for them to stabilize and they have clearly not stabilized yet. One of the differences though, on index total returns is that back in February, both the short-term bond index and the Agg had posted negative total returns year to date, and even though we’re at similar rate levels now, even a little bit higher, both are positive short-term bond at about 180 and the Agg at about 60 basis points. The difference being the income that we received between the two points, which makes a huge difference. Data has been coming through quite strong calls for recession anytime soon are fading quickly from an inflation standpoint, everybody agrees that battle is not over, but exactly what the battle looks like has gotten a little more confusing. Data coming in, jobs coming in, all looking quite good. Energy prices are high oils in the high eighties, it’s about where it was a year ago, has a big impact on headline inflation, less so on PCE or core inflation, but my view is given all of those factors, a pause is more appropriate now than ever.

Alli Morse:

Thanks, Andy. That was a great overview of the markets this year. I think it would be helpful to talk a bit more about our sector perspectives. Typically, post labor day market activity and issuance tends to increase, especially within corporate credit, but what are our views for the remainder of the year and how are fundamentals

Andy Smock:

From a corporate bond standpoint, as is typical in September, the first few days after Labor Day, there was a frenzy of activity this year with about $55 billion in those four days following Labor Day. As we look to the balance of the year, the market’s going to be focused on supply coming out of financials mostly as regional banks begin the process of issuing to meet updated regulatory requirements that’re going to be coming in 2026. The current backlog of M&A financing is relatively low outside of technology, which means there are fewer mega deals for investors to digest, and this is going to provide a positive technical to industrials, which are already quite tight. In fact, industrials are least favorite sector within corporates, not for any fundamental reasons, just purely based on where bonds are trading.

Alli Morse:

Could you share our thoughts on CMB S, which has definitely been a sector in the headlines this year?

Andy Smock:

In CMBS year-to-date, issuance is down about 50% in the private label side, the non-agency, it’s down about 67%. In agency, it’s down about 37%. All kinds of collateral types are getting done, but mostly issuance is down just because there are fewer transactions getting done because values are down and all the headlines you see in the market is just subdued right now. As buyers and sellers are trying to figure out what the clearing levels are, clearly there’s a huge difference in office between A property types and then B and C and then between different regions. Non-property CMBS fundamentals are looking quite good from self storage, industrial, things like that, all looking quite positive. AAA spreads in CMBS have recovered from the Q1 wides and they’re close to year end levels, which is pretty amazing given what we went through and all the headlines you continue to see about commercial real estate prices,

Alli Morse:

What about opportunities in a b s? Are we still finding strong relative value within that sector?

Andy Smock:

In ABS, the pipeline is also quite healthy and investor appetite has been strong. Post Labor Day weekend, there’s been about $10 billion in deals in marketing to investors, the time of announcement to getting done as much longer in ABS and in corporates, so these deals are still getting worked on, but spread levels are, I would say, modestly attractive. We’ve come in a lot from the wides of a couple months ago where we thought they were screaming cheap and now they’re just okay, and actually that’s a good transition to mortgages, particularly for short-term bond where we think season 15-year pass-throughs are some of the best opportunities out there. It’s a safe haven, low spread volatility, lots of liquidity. These are government guaranteed pass-throughs and we’re buying it 50 to the curve, 40 to 50 to the curve, and so industrials and corporates much tighter than that.

 

ABS is right around there or a little bit cheaper, but with more spread volatility further out the curve in mortgages, we also think they’re fairly attractive, mostly because so many other sectors are unattractive and it’s not that in the bigger picture. It’s not that spreads are historically tight. They’re probably at one year tights for most sectors but not historical tights. What really has changed is that they’re tight relative to the number of risks out there. The market is still digesting 500 plus basis points of hikes that we just went through our banking crisis in March and who knows what other risks remain over the next six to 12 months.

Alli Morse:

So clearly this year has presented quite a bit of market turbulence, but are we expecting that to continue for the remainder of the year?

Andy Smock:

Our baseline view is that spread volatility is going to continue and being agile and nimble is going to pay tremendous dividends, much more so than just buying and holding over the next three to six months.

Alli Morse:

Thanks Andy for sharing our views and thank you to our listeners.

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@www.merganser.com. Thank you.