Credit investors are perhaps bearish by nature – always looking for threats. But even CIFC veteran Stan Sokolowski wonders whether investors are being overly pessimistic about the market. Here he offers a balanced assessment of the threats and opportunities, evaluates why investors may need to recalibrate their return expectations and explains why fears about debt covenants are perhaps overplayed.
What’s your view on the economy today?
It is our view that we are in a world of moderating growth – but growth nonetheless. There are a number of flashing yellow lights – geopolitical flashpoints around the globe, trade tensions, below-trend growth, and bouts of elevated volatility. At the same time, we also have ultra-supportive global central bank policy and low inflation. These are all conditions that have been with us for the past decade and will continue to be around going forward. In the U.S., we are seeing a deep inversion at the front end of the yield curve. Is the yield curve indicating recession and signaling the official end of the credit cycle? There are many opinions on both sides of this argument. For us it is certainly a signal to be cautious. However, we do not foresee an imminent recession. One way to monitor the health of the economy is to monitor credit spreads. Credit investors have historically been credited with foreseeing economic deterioration. If a recession were close, we would expect to see credit spreads materially wider than they are today.
What threats do you see ahead?
We mentioned those flashing yellow lights. As credit managers, our job is always to be on our toes trying to spot risk. There are plenty of threats to consider – a contentious U.S. election cycle, the ongoing headlines of political discord out of Europe, Brexit, and now an increasingly belligerent Iran. The potential risks can be endless. However, avoiding investment risk altogether is not an answer. We have to be alert to the upside potential as well. What happens when Brexit concludes or if a deal is agreed with China and all that money pours in from the side lines? What happens if the pockets of mixed signals from the U.S. economy come in stronger than expected, as we saw with GDP numbers for the first quarter of the year? If you look back through history, periods of slowdown are far more common than periods of recession. As the investment guru Peter Lynch once said: “More money has been lost by investors preparing for corrections, or trying to anticipate corrections, than in corrections themselves.”
But we’re now in the longest bull market since World War II. How much longer can it go on for?
Show me an economist who says that market cycles have to be determined by calendar turns. How long a bull market has endured has absolutely nothing to do with why it might end. Look at Australia as an example – they have not seen a recession in 28 years. Now, it may be that the longer a bull market goes on, the more likely it is that there will be some kind of dramatic jolt to investor confidence – as they say, bull markets always climb a wall of worry.
When people are out with their friends, they aren’t talking about how great their portfolios are performing. They’re all generally nervous. This is actually perfect for credit investors, because it means that everyone is behaving a lot more sensibly and taking on risk they can service. If “complacency” is the word that best describes the pre-crisis days then “paranoia” best describes this post-crisis period.
So why all the gloom, do you think?
The truth is that investing is always worrisome. There is an eagerness to identify the top of the cycle, in all likelihood due to how few people actually accurately predicted the last financial crisis. It is certainly keeping euphoria in check, which is healthy, but on the negative side, there is always the potential for prophecy to be self-fulfilling. People can fall into the trap of convincing themselves that things are very bad and that it’s only going to get worse. The media is not always helpful here either. We so often observe pundits substituting emotion and opinion for facts and analysis, thereby perpetuating a negative feedback loop. The fourth quarter of 2018 was the perfect case study.
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