The Cavalry Arrives
The first half of April could not contrast more with that of March as far as financial markets are concerned. The first three weeks of March saw market turmoil and at the start of March’s third week, a dislocated set of markets that barely functioned until central banks stepped in.
Markets have rallied strongly since March 24th and that has continued in the first two weeks of April aided by more stimulus packages from around the world but especially in the US. Sadly, many more lives have been lost to Covid-19 here and elsewhere.
The infection curve may be flattening in Europe but it has yet to do so in the UK. But hope of bending the curve has also helped financial market recovery. As we remarked in our blog last month, the descent in many markets’ prices was so rapid and fear based, often without much transaction volume, a bounce in risk assets was on the cards if a catalyst like significant financial support transpired.
Signs of deaths and infections abating in Italy and Spain have no doubt helped financial markets recover too but it has been governments and central banks’ support packages and their magnitude that has galvanised markets’ recoveries from the dislocated markets seen in mid-March – (read our blog here)
On the day before the Easter break, the US central bank, the Federal Reserve, arrived in cavalry-like style to put another substantial floor under US credit markets:
So, some ambiguity about high-yield bonds – no amount quoted and corporate bond ETFs that are mostly investment grade. No matter, probably the better of the two major high-yield ETFs, HYG, rallied 6.5% on Thursday after the announcement.
Source: The Wall Street Journal
A couple of issues spring to mind.
- As in other countries the independence of central banks has effectively ended. These are unprecedented times so a coordinated approach seems fair enough.
- ‘Fallen angels’ are companies that drop from investment grade into high yield. Many US companies chose to borrow money in the debt markets to use the proceeds to buy back their own equity. In the process, those companies leveraged their balance
sheets. As a consequence, companies targeted a BBB rating (the lowest investment grade rating). By the end of 2019, record amounts of corporate debt resided in the BBB credit rating. The question of moral hazard comes into focus. Should the US central bank be effectively endorsing the financial engineering activities of a number of well-known US companies who chose to buy back stock rather than invest in their businesses? It is a fair question. There should be greater liquidity in the corporate bond markets though – in both directions.
To quote Warren Buffet, ‘when the tide goes out, you’ll see who has been swimming naked’, The Fed has delivered a tidal wave to cover them up again. You do wonder about free-markets in the long run but for now, the cavalry arrived when needed.
In summary, credit markets, having overreacted on the way down have rebounded on good news but as we explained in our end of March blog, ‘We’re all in this together’ the best place to be should be in the top end of high yield and reasonably conservatively invested in investment grade.
During the first half of April, we continued to acquire or add to cheap assets where price falls in illiquid markets have created opportunity albeit limited by lack of inventory. In addition, we have continued to transition towards focusing on the beneficiaries we see in a post-virus world – the digital economy. Given the sheer size of central bank debt accumulation, we have topped up gold, held as an alternative currency, in Dynamic.
We hope you are well, staying safe, having enjoyed a different Easter than usual and thank you once again for your continued support.