A greener, more digital future sets the scene for 2021, yet investors have to be clever in executing views on the biggest investment themes of our time.
This month, our wealth management experts argue that those calling a US recession may have spoken too soon and that tailwinds still exist for equities at a time when cash may be too expensive to hold and opportunities also abound in the high yield credit market.
Where good value opportunities exist in the high yield credit market
Why the US labour market remains healthy, auguring well for equities
How cash may be too expensive to hold in current conditions and the case for leverage
Given the record levels of negative yielding debt – $17trn at last count – it might seem strange to be looking to the fixed income markets for an area of opportunity. However, we believe that certain parts of the high yield market; particularly the shorter-dated end of the spectrum are well priced and represent good value in a yield starved world.
We believe that certain parts of the high yield market; particularly the shorter-dated end of the spectrum are well priced and represent good value in a yield starved world
Taking the fixed income markets in general, we’re very much of the belief that risk has got to extreme levels. Generally speaking, duration has been pushed to all-time-highs, yields to all-time-lows and duration as a multiple of yields is at all-time-highs. The reason for this is quite simple. Companies and governments have opted to take on more debt for longer terms (often to buy back equity in the case of the former). It makes sense to the issuer but represents a poor deal for the investor; less (negative in some cases!) cushion from the coupon payment should market yields rise off their record lows. However, the high yield markets have been anomalous and herein lies the opportunity.
Unlike other markets, high yield benchmark durations have actually decreased this year; by about one year in the case of US high yield (where investment grade credit duration has increased by over half a year). This is reflective of a lack of issuance and a lack of late cycle characteristics in this market: an absence of aggressive M&A, lack of levered buy backs and credit ratings that are tending to, at the margin, improve. With credit spreads having pushed out to fair levels the opportunity looks decent. Furthermore, for us sterling investors, currency hedging costs are lower (and set to decrease) as too are leveraging costs should we look to gear up the higher quality parts of the market; something we think makes sense for clients with higher risk appetites.
Head of Investment Strategy at Psigma Investment Management
Some commentators have suggested in recent weeks that the probabilities of a US recession and a pick-up in the unemployment rate in 2020 are rising. A deterioration in the US labour market matters for investors, as equity performance tends to beat bonds, provided the unemployment rate is falling, and vice versa. However, we have a different view.
Our data indicates that the US labour market still remains healthy, so we remain constructive on equities over bonds. Arguably, it is therefore too soon to talk about a US recession.
The Manpower survey, which measures the hiring intentions of 11,500+ U.S. employers, hit a 13-year high in the third quarter of 2019
Here are six indicators underpinning our rationale.
First, US employment opportunities remain. Hiring is running close to cyclical highs, while job separations (e.g. workers who quit jobs and those that are laid-off or fired) have largely flat-lined over the past year. The difference between job hires and job separations is more or less equal to the monthly non-farm payrolls, which is a net figure. The bottom line is that there are employment opportunities in the US.
Second, hiring intentions are at record levels.The Manpower survey, which measures the hiring intentions of 11,500+ U.S. employers, hit a 13-year high in the third quarter of 2019. This shows that concerns over trade protectionism or the economy have not hurt optimism amongst US companies.
Third, job growth is higher than normal. The latest non-manufacturing ISM survey employment sub-component, which correlates closely with job growth, is elevated.
Fourth, small businesses are confident to employ.The National Federation of Independent Businesses small business plans to hire survey is not far off cyclical highs and points to faster payroll growth.
Fifth, consumers are confident about lower unemployment.The consumer confidence labour market differential, which looks at the difference between jobs plentiful less jobs that are hard-to-get, tends to lead the unemployment rate. In August this differential rose to a 19-year high and indicates that consumers expect the unemployment rate to fall further.
And sixth, labour is cheap.The share of compensation to GDP at 53.6% is below its long-term average and previous cyclical peaks. The low share of compensation in the economy is likely structural and reflects globalisation and the assimilation of China into the global economy. Given that it is not too costly to hire, firms are likely to continue to expand their workforce.
Chief Investment Strategist at Smith & Williamson
We are seeing great geopolitical turmoil but that doesn’t mean that staying on the investment side-lines is your wisest move. Wealth managers are adept at drip feeding money into the markets to obviate the need to to time it correctly. Cash certainly isn’t king and, as our experts argue, there are lots of attractive investment opportunities out there. Why not have a free, no obligation discussion of your objectives with an investment professional through our 3-minute search?
Any portfolio of assets will invariably contain a cash position. The question is of course: how much? Before the credit crisis, there was a free lunch and we were earning 5% in our checking accounts, whilst inflation was comfortably at 2%. Nowadays, this situation is very different. Inflation hasn’t gone away and we are not making anything on our cash, which means we are losing money in real terms, and even more so if we hold euros or Swiss francs.
So, what to do? Clearly, we need to reduce our (idle) cash positions and the way we do that is by borrowing against our assets. Here are the numbers: let’s say we keep 25% of our money in cash. Not unusual, and according to one study (by This is Money), that’s what more than half of wealthy individuals in the UK do for a rainy day. According to another study, these same wealthy individuals put the rest of the money into equities (55%) and bonds (20%). Bonds are currently yielding around 1% and equities have averaged about 7% for the last 100 years, giving us return expectations (before costs) of about 4%. Nice, but could we have done better if we didn’t leave so much of our money on the side-lines doing nothing?
Bonds are currently yielding around 1% and equities have averaged about 7% for the last 100 years, giving us return expectations (before costs) of about 4%. Nice, but could we have done better if we didn’t leave so much of our money on the side-lines doing nothing?
Absolutely, and if you can’t get anything for your cash, then why not heed the words of Dire Straits and get Money for Nothing instead. It’s called buying on margin and here is how it works: Back to our example, we want to buy equities and bonds, which give us a yield of 4% on our portfolio (including cash). If we borrow money from our broker and put up our assets as security, we could easily increase our exposure by 50%. That means we could have 112.5% (75% * 150%) of our money earning 6.075%. Of course there is a cost, but money is cheap and last I checked the cost of borrowing is about 1.5%. That means we would only have to pay 0.55% for the money we borrow, giving us a net return of 5.5%.
Ah, but what happens if the markets fall and our margins get called? That’s where the cash kicks in. Remember we are still keeping 25% of our money in cash, and we also have 30% (20% * 150%) of our money invested in bonds (which go up when markets crash). All of which gives us plenty of cushion to withstand any shocks to the system. Why doesn’t everybody do this? Because leverage is evil, cash is king and people think a hard Brexit is a good idea. The point is, rather than paying an opportunity cost on our cash, we can take advantage of the low interest rates and use our money much more productively. There are always two sides to every trade, and if one of those isn’t working, it means the other is there for the taking.
Chief Investment Officer at Blu Family Office
The investment strategy explanations contained in this piece are for informational purposes only, represent the views of individual institutions, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.