On an absolute basis, many markets and financial assets seem expensive relative to historic levels. However, as Barclays Capital notes, “Valuations may be detached from fundamentals but not reality.”1 Cash levels are enormous and numerous investors undoubtedly are sheltering in “safe” assets.
Global Cash Levels2
Where does value exist? How should one position? What is now priced in?
As always, the questions are plentiful. However, we believe one certainty remains – portfolios must reflect future expectations, not past realities.
Today, many recent uncertainties are behind us including the U.S. election, vaccine development, and the liquidity crisis. The economy is again pushing ahead. Nonetheless, countless worries remain. Moving forward, a focus on conventional risks should return and therefore key drivers will include economic growth, central bank and government policies, corporate fundamentals, and the sunset on the pandemic. In our view, financial conditions will remain supportive and we are now in an early cycle environment given the economic reset that occurred last year. Debt and deficits will remain a feature of the landscape as will fiscal and monetary support. We think inflation will probably drift higher, but will continue to be constrained by the output gap. Interest rates will struggle to go lower. The political environment remains rancorous; however, significant legislative shifts are not assured given the current composition of Congress. As in recent years, anxiety is high and we believe that investors and issuers will remain cautious. This restraint should dampen certain risk-taking tendencies, for now.
In credit land, we deem the fear is outweighed by the positive prospects. A crucial opportunity revolves around income and duration avoidance. Yield is scarce and credit still offers decent value in a world of elevated valuations. At present, we are in a “Golden Age” for income producing alternatives. The forces which brought credit spreads to current levels remain principally intact. We expect supply will be lower compared to last year. We also believe that revenues, EBITDA and cashflow, among other attributes, will continue to recover from pandemic losses. From a positioning perspective, credit selection will most likely be a driver of performance given the large amount of value recaptured through last year’s beta rally. Our research colleagues are seeking opportunities in sectors and issues that benefit from behavioral shifts caused by the pandemic, those with resilient business models, sound fundamentals and repairable balance sheets. On the other hand, challenges remain for certain traditional industries and business methods, for issuers who were over-levered prior to the arrival of the pandemic, and those who were already facing a secular decline. As always, we are seeking to exploit undervalued investments and are also wary of the elevated premiums in certain areas. We are upbeat on structured credit and CLOs, remain positive on loans, and sensibly constructive on high yield bonds. We favor long/short credit strategies, given how policy makers have pushed prices in some markets to unsustainable levels. A final observation on floating rate loans in today’s sustained low rate, low yield backdrop: they are akin to fixed rate products with a call option on rates and are competitive with many of the income alternatives available to investors.
We believe that approaching risk with emotion is flawed, and that a fact based, quantifiable examination of risk versus return is a more effective method for investing. At the end of the day, the crucial question remains: Am I being paid for the risk that I am taking?
As we begin a new year and economic cycle, valuations are stretched across many financial assets and investors seeking income are facing severe challenges. In our opinion, credit still offers decent prospects in a world of elevated prices. Downside, as well as upside, risks abound and revolve around the same elements: growth, policy, and the pandemic. However, numerous investors are still focused on downside risks only. Could upside risk surprise in 2021? Imagine a world of faster virus immunity, stronger economic growth, and lower defaults than many currently project. Could right-side tail risks potentially outweigh left-side tail risks this year? While the path will likely be bumpy, we still expect it to be supported by both positive technicals and fundamentals. As we have stated often, we are not bullish but then again, we are not as bearish as many remain. The key question persists: Am I being paid for the risk that I am taking?
As a final observation, today more than ever, investors are very watchful that their portfolios are delivering the returns they need while generating the income they require. Our view is that the credit market offers solutions to this challenge. Income alternatives available in the credit market are evolving from historically optional to indispensable here and now. At CIFC, we are proud of our people, our heritage, and the work we do to solve problems for our client partners. We look forward to continuing our performance and traditions in 2021.
1Source: Barclays Research, December 2020.
2 Source: Mitsubishi UFJ Financial Group (“MUFG”) research, data as of October, 2020. “Global Cash Levels” represent sum of: (1) “Global Money Manager Assets”: Willis Towers Watson. Thinking Ahead Institute. AUM for the world’s 500 largest asset managers; (2) “U.S. Money Market Funds”: Federal Reserve. Worldwide investment in U.S. Money Markets; (3) “Global Insurance Assets”: Financial Stability Board. Global Monitoring Report. Insurance Corporate Assets for G21 +Euro Area. National sector balance sheets, FSB calculations; (4) “Global Pension fund Assets”: Financial Stability Board. Global Monitoring Report. Pension Fund Assets for G21 +Euro Area. National sector balance sheets, FSB calculations; (5) “Global Money Market Funds”: Financial Stability Board. Global Monitoring Report. Pension Fund Assets for G21 +Euro Area. National sector balance sheets, FSB calculations; (6) “Global Sovereign Wealth Fund Assets”: Statista. IE Center for governance and Change. Sovereign Wealth Funds 2019. Sovereign Wealth Funds 2020; and (7) “Global Central Bank Assets”; Financial Stability Board. Global Monitoring Report. Central Bank Assets for G21 +Euro Area. National sector balance sheets, FSB calculations. Most recent publicly available data shown.
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