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The Armageddonists have cost many investors money over the years and we suspect 2019 was another example. As a good reminder for us all, Zach Stanton, an editor and writer for Politico recently observed, “pundits lack steady reliability, scientific methodology, or real-life consequences for their forecasts.”
That said, 2019 was spectacular for financial markets equities ended at all-time highs as a “Santa Claus rally” pushed stock prices up into year end. In contrast to 2018, when approximately 90% of financial assets delivered negative returns, 90% of financial assets delivered positive returns in 2019. The ongoing predictions of doom were proven wrong once again as the economy did not enter recession, rates did not rise, markets did not crash, and the world did not end.
As we welcome a new decade, we also enter the 11th year of the U.S. economic cycle. Again, the risk list is long and, as usual, there are many questions. Predictions are impossible to make with consistent accuracy. That said, we believe the conditions of past years are set to continue.
Nevertheless, 2020 is especially difficult to forecast given the variability of potential outcomes. In our view, moderate growth will endure, sympathetic do-no-harm policy makers are prepared to lend a hand and bouts of headline driven volatility will linger. In contrast, trade wars are front and center, economic growth has struggled to achieve pre-crisis levels and geo-political risks are elevated. For obvious reasons, business caution will linger; however, the consumer appears set to keep spending given that unemployment is close to 50-year lows and household balance sheets and the savings rate remain healthy.
Although politics are unpredictable, the coming election year should be supportive as President Trump will undoubtably manage policy and markets to best realize his reelection. We do not expect a material change in sentiment and the abundance of concerns will endure. At this point, we are, by definition, late(er) cycle, so anxiety and skepticism will persist. We expect positive returns but are hesitant to guess levels.
The past decade brought many trials and tribulations to financial markets, including a U.S. sovereign downgrade, Fed taper tantrums, BREXIT and trade wars, among others. It has been a difficult period.
Given the omnipresent risks and opening valuation levels, it is a challenge today to see a year that is anything other than limited in upside potential. However, in a world where traditional equity and fixed income products may be restrained by a pause in policy that buoyed markets in the past year, higher carry credit instruments and products such as U.S. senior secured loans and hand-picked high yield bonds provide a compelling risk reward opportunity for investors concerned about negative convexity and for those seeking income and reduced volatility.
Our base case for credit includes a completed trade deal and ongoing moderate economic growth alongside diminished new debt issuance. Defaults will likely occur in secularly challenged and over-leveraged sectors and issues but will remain below long-term averages. It will take a recession to push defaults materially higher. Credit concerns will not abate which should keep overly bullish impulses in check. However, we believe that credit will continue to generate meaningful returns and can outperform traditional fixed income markets in the coming year.
Markets are inherently forward looking. In the coming year, certain things will go right, and certain things will go less right. Anxiety will ebb and flow from investor psyche. Nevertheless, we maintain our no recession call and, as highlighted above, remain constructive on credit. No matter the validity of predictions, the CIFC team remains highly focused on constructing durable, resilient and risk-controlled portfolios that avoid exposures where we are not being compensated for the risks assumed.
