HB’s CIO Stephanie Lang , on behalf of CFA Society Atlanta, spoke with Rupal J. Bhansali of Ariel Investments about stocks and investing today. To watch the full interview click here.
The Fed’s actions are a combination of lessons learned from the 2008 financial crisis and new measures created for today’s unique situation in their attempt to prevent the health and economic crisis from becoming a financial system crisis. Combined stimulus from the Fed, Congress, and the U.S. Treasury currently equals more than 25% of real U.S. GDP this year. It’s becoming easier to understand the concern about the current disconnect between the economic pain on Main Street and the resilience of Wall Street as the economic news continues to be rather devastating for Main Street, including U.S. deaths crossing over one hundred thousand and 40 million Americans filing for unemployment benefits.
Unprecedented Stimulus Has Helped Fuel Stock Rally
One reason for that resilience is that the growth rate in money supply that has gone parabolic (the blue line below) as the government has pumped liquidity into financial markets to keep the economy afloat. However, the velocity of money continues to decline (the yellow line below), which is why inflation in the “real economy” has not been an issue. “Money printing” by the Fed only becomes inflationary if the liquidity pumped into the financial system comes out via the lending channels and flows through the economy. Without increasing velocity, inflation may be absent in the real economy, but can become quite evident in financial assets, such as stocks, where prices can become inflated as a result.
M2 Money Supply Has Gone Parabolic As Velocity As Declined
Source: Charles Schwab, Bloomberg, Federal Reserve as of 4/30/20
The government-mandated shutdown and resulting recession have broadly devastated earnings across companies and industries. FactSet recently reported that Q2 earnings estimates have come down 35% since March 31. To put in context for the full year, the current year 2020 earnings per share estimate for the S&P 500 has declined by 28% to $128 from $178. At the same time, stocks have broadly risen off the March lows based on the hope that the economy’s reopening will be successful, and also on expectation that we’ll develop therapeutics and eventually a vaccine for the virus itself. As an example, since mid-April, the four best-performing days for the Dow Jones Industrial Average, came on days there was a significant medical announcement:
- April 17: Gilead’s drug Remdesivir showed effectiveness in treating COVID-19 (+705 points)
- April 29: Positive data about Remdesivir’s trials (+532 points)
- May 18: Moderna announces early-stage human trials for its COVID-19 vaccine (+912 points)
- May 26: Novavax announces phase one clinical trial for vaccine; Merck announces plan to work on vaccine alongside IAVI (+530 points)
Stock Rally Has Left Us With Elevated Stock Valuations
With the recent stock market rally and declining corporate earnings continuing to filter through, stock valuations have increased significantly in just a matter of weeks. This has led us to become cautious on U.S. stocks and their return potential over the short term until we see improving economic data. It’s certainly true, fiscal and monetary support has been unprecedented and could ultimately overcome the damage to the economy, but getting 40 million Americans back to work and understanding what the recovery of several large industries, including travel & leisure, retail, and entertainment will look like are still largely unknown.
The below chart shows the S&P 500 Price to Earnings Ratios based on the Last Twelve Months (red line) and also Next Twelve Months (brown line). There is still much uncertainty to future earnings as many companies have pulled their guidance, but both show the rapid rise in valuations. Valuations have rebounded much faster than the economy. In focusing on the Next Twelve Months P/E ratio, it appears that investors are pricing in a ‘V’-shape recovery not only for the economy but also for earnings. However, we believe earnings estimates will continue to come down through the second quarter. We believe much of this rally has been fueled by the unprecedented stimulus provided by the Fed and Congress, which gives us reason for our short-term cautionary view on stocks until the economic data catches up.
S&P 500 P/E Ratios Have Significantly Risen In Recent Weeks
Source: Bloomberg, as of June 3, 2020 for trailing 3 years
Our strategy to navigate these uncertain times continues to be based on principles such as diversification across, and within, asset classes, and rebalancing that trims exposure into strength and adds exposure into weakness. We believe successful investing does not rely on the precise timing of market tops and bottoms, but is about a consistent process over time that reduces risks and keeps investors on track within their financial plans. Please contact a member of your client service team if you have any questions.
Disclosures: This is a general discussion of current investment themes, asset classes, and specific investment segments. The discussion includes our opinions and forward looking thoughts and analysis as of June 7, 2020 and is not a guarantee of future investment results. Actual client portfolios are often customized and do not necessarily represent an exact replication of, if any, allocation discussed. This commentary focuses on a wide range of economics and finance issues in order to educate you on the linkages between these topics and their impact on the overall economy and investment markets. The content of this presentation represents the opinions of Homrich Berg regarding these educational topics and should not be interpreted as direct investment advice or marketing of HB services. Information included is from sources believed to be reliable, but which have not been independently verified. Investing involves risks including loss of principal. This document does not constitute legal, tax accounting or investment advice.
While much of our communication to date has focused on the impact of the COVID-19 virus on markets, we have also tried to highlight financial planning strategies that are more attractive when interest rates are low and equity markets have experienced a significant pull-back. Now that the S&P 500 is well off the March lows, some of those strategies dependent on depressed asset values are less compelling. However, with respect to interest rates, you may recall that the Federal Reserve had been gradually raising the Fed Funds Rate to reach a “new normal” before the virus hit. Rates have since retrenched (see chart) and the 10-year Treasury yield hit an all-time low in March of 0.54% before rebounding, slightly. The 10-year Treasury yield is now 1.26% lower than at the start of this year which a significant move given that rates were already low. It now appears that very low interest rates will be with us for the foreseeable future and this presents some opportunities to consider.
As always, please consult with your client service team to determine whether these concepts apply to your personal situation.
Certain wealth transfer strategies are relevant in all environments (such as annual exclusion gifting; $15,000 limit per beneficiary) and others may make the most sense in high rate environments (Qualified Personal Residence Trust or QPRTs and Charitable Remainder Annuity Trust or CRTs). Below we highlight strategies that we believe work best in today’s low interest rate environment.
First, it is worth noting that these estate planning strategies make the most sense for those who feel they will have a taxable estate. Currently, the estate tax exemption is $11.58 million per spouse ($23.16 million per couple). That may seem like a very high number but the limit is set to revert to $5 million (inflation adjusted from 2018) in 2026, and estate tax exemptions are notoriously volatile and may be subject to higher scrutiny if we end up with a change of control in Congress. It’s a guess as to whether or not this may occur but suffice it to say that the current limits may decline at some point making these strategies applicable to a wider audience.
- Intra-family Loans. The simplest strategy entails lending to a family member at a permissible, low rate with the expectation that the assets purchased by that family member will grow at a higher rate than the loan interest. The spread between the investment return and interest rate amount to a wealth transfer free of gift tax. The minimum allowable rate is a function of the loan term and the rates are published by the IRS as the Applicable Federal Rates (AFRs). The June 2020 AFR features a 9-year rate at just 0.43% and a long term rate of 1.01% (e.g. use this for a 30-year mortgage). Loans can be structured as interest-only notes with a balloon payment on maturity.
- Grantor Retained Annuity Trust (GRAT). An irrevocable trust into which you make a one-time transfer of property, and from which you receive a fixed amount annually (annuity) for a specified number of years. If any property remains in the GRAT after the final annuity payment is made, the property will pass to beneficiaries named in the trust document free of any gift tax. Here, too, this sets up a horse race between the return earned on the investments placed in the GRAT and the interest rate used to compute the annuity but a different minimum rate applies—something referred to as the §7520 rate which is just 0.60% for June GRATS. Because these vehicles are easy and cost-effective to set-up, many choose to establish a new GRAT each year.
- Installment sale to an Intentionally Defective Grantor Trust (IDGT). This strategy builds upon both the intra-family loan and GRAT concepts presented above to provide enhanced benefits but with more technical hurdles and complexity. We will not cover the details, here, so we present this strategy as an illustration that there are options with even greater complexity and associated increased benefits available to those willing to invest the time and capital to pursue them. We can certainly help you navigate these choices.
- Charitable Lead Annuity Trust (CLAT). Similar to a GRAT, but with the annual annuity payments going to a charity of your choice. This strategy is appealing to those with both philanthropic and estate transfer goals. The §7520 rate is used to determine the annual annuity payments to charity that would be needed to assure that no gift tax is due when the annuity term is reached, and the remaining value is transferred to the ultimate beneficiaries. Like the two strategies presented above, if the investment assets grow at a rate higher than the required minimum interest rate (currently 0.60%) used for the annuity calculation, then there will be some benefit.
Rates are up slightly from record lows but remain an opportunity to for those that have not yet acted. Here’s an update regarding rates, recent loan processing delays and tightening credit standards:
- Low, but not lowest. Mortgage rates reflect the trends in the mortgage bond market more than the Fed’s rate setting and those rates have declined less dramatically than, say, the 10-year Treasury Bond. Even so, rates remain highly attractive.
- Improved processing capabilities. Some borrowers were deterred from refinancing earlier this year by loan processing delays. Loan processors were initially overwhelmed and struggled to deal with a coincidental surge in applications when rates dropped as they were also suddenly forced to work from home. In addition, many third-party partners utilized by lenders (appraisers and title officers, for example) were also negatively impacted by COVID-19 because they were considered non-essential businesses in some areas of the country. This situation has generally stabilized. Some lenders have innovated to provide all-electronic loan processing, drive-by closings and no-entry home appraisals.
- Tighter lending standards. Credit conditions have tightened as lenders worry that a borrower’s financial picture may have changed in a way that is not evident on their 2019 tax return. Expect delays and requests for supplemental data to prove creditworthiness. Borrowers should be organized by having W-2’s, tax returns, and recent pay stubs accessible.
The ideas presented above highlight opportunities for achieving your financial goals that are enhanced in a low-rate environment. Because we expect low rates to be with us for some time, there may be little urgency to address these matters immediately and many of them will require further analysis to fully evaluate and deploy anyway. However, we encourage you to discuss the ideas presented above that appear to apply to your unique circumstances with your client service team.
Disclosures: This is a general discussion of current investment themes, asset classes, and specific investment segments. The discussion includes our opinions and forward looking thoughts and analysis as of May 31, 2020 and is not a guarantee of future investment results. Actual client portfolios are often customized and do not necessarily represent an exact replication of, if any, allocation discussed. This commentary focuses on a wide range of economics and finance issues in order to educate you on the linkages between these topics and their impact on the overall economy and investment markets. The content of this presentation represents the opinions of Homrich Berg regarding these educational topics and should not be interpreted as direct investment advice or marketing of HB services. Information included is from sources believed to be reliable, but which have not been independently verified. Investing involves risks including loss of principal. This document does not constitute legal, tax accounting or investment advice.
Andy Berg spoke with the Atlanta Business Chronicle about some of the issues high-net-worth clients are concerned about, and offered advice for readers in various stages of the retirement and estate planning process. Read the full article here.
Last week, we commented on some of the differences between Wall Street and Main Street with a primary emphasis on the scale benefits enjoyed by some larger companies. This week we’ll pivot our focus to cover the pandemic’s impact on Main Street and specifically the real estate sector. As you may know, our firm has extensive experience investing in real estate which puts us in a good position to provide some perspective and convey what we have heard from real estate operators managing properties across the commercial real estate spectrum including multifamily, office, industrial, retail and hospitality.
Except for the well-known challenges in retail, real estate entered this year with solid fundamentals. Vacancy rates were low and there has been more disciplined construction spending than was the case entering prior recessions. For several sectors, April and May rent collections have exceeded expectations. This has been an encouraging sign for many of our operators within the multifamily, office, and industrial sectors. Other areas such as retail and hospitality have been most negatively impacted. Below we present a few high level comments and additional commentary on each sector if you would like to read more.
- Multifamily. Rent collections have remained above 90% and exceeded expectations so far. Consumer financial health is key for the summer months and the likelihood of further stimulus plays a significant role in the outlook for multifamily. We expect delinquencies to increase as unemployment remains high, but the lack of new construction for a time and the likelihood that first-time home buying slows may help support occupancy levels.
- Office. Rent collections have also been higher than expected in April and May. In the short-term, the length of the economic “shut down” will impact bankruptcy rates and presents the biggest risk, but long-term risks to office space requirements due to greater work-from-home preferences will battle with higher space-per-employee desires to define demand.
- Industrial. Recent trends that were already in place are accelerating due to the pandemic. Logistics-dependent businesses like Amazon and Wal-Mart have benefited which increases the need for warehouse and distribution space. Bankruptcies will be disruptive for suppliers and declining global trade is a concern, but overall we believe industrial investments will remain attractive and will be well-positioned during the recovery and beyond.
- Retail. Challenging trends for malls and other retail sectors due to shifting consumer preference toward online retailers have only been accelerated by the pandemic. This is not limited to small operators as national retailers are already starting to announce bankruptcy filings. Restaurants have also been hard hit and new experiential concepts in retailing have been shut-down. The outlook for retail remains challenging.
- Hospitality. Hotels were the hardest hit due to the pandemic. Occupancy has plummeted and the name of the game is survival. Currently, most hotels have been given flexibility from lenders, but the recovery will vary greatly based on the location and their revenue drivers. Whether a hotel is located by a university, corporate business center, airport, hospital, tourist attraction will directly impact the timing and extent of recovery.
Our current perspective is being formed fairly early in the process and much uncertainty remains. Over 30 million workers are unemployed, and vacancy tends to follow unemployment. Many of these workers believe they will be rehired within 3-6 months, but some jobs will not be coming back. There are many chapters ahead and the timing and shape of the recovery are large unknowns. Generally, we have been encouraged that collections have outperformed expectations. We certainly hope that the phased reopening of the states goes well. June and July will be important months that will indicate whether the economy can regain its footing without significant additional extraordinary stimulus measures. We will continue to communicate what we are seeing as developments unfold later this summer. If you have further questions, please contact a member of your service team.
Keep Reading to See the Full Detailed Update
- Rent collections. We have been encouraged with rent collections for multiple operators that have said that May collections are ahead of April collections to date. Most operators have collected or expect to collect more than 90% of rents in April and May. In fact, for some properties, occupancy has increased as moving out has become harder.
- Leasing. Leasing activity has slowed somewhat, but many managers have been able to quickly adapt to virtual leasing and tours and electronic paperwork.
- Future. We believe that higher-than-anticipated collections were partly due to the significant stimulus passed by Congress including individual checks and also increased unemployment benefits. Looking ahead, if the recovery is prolonged and more stimulus or extended benefits are needed but Congress becomes gridlocked, tenants may then be unable to choose not to pay rent. Multifamily has a headwind with the lack of 2020 graduates that will be moving to accept first-time jobs. However, a deep recession will also make first-time home buying more difficult and that should support multifamily occupancy over the short term.
- Rent collections. Similar to multifamily, broadly speaking tenants and landlords are working together to manage the current situation. The vast majority of April and May rents have been collected to date. Typically, rents are due by the 7th-10th of each month. By the initial due date in April, rents were collected in the 80-85% range, but by month-end landlords had generally passed 90% which was higher than anticipated. For May, we’re hearing that collection rates have so far exceeded April’s, which is an encouraging sign. Requests for rent assistance have typically come from smaller tenants, especially those that depend upon clients, customers, or patients accessing the office.
- Leasing. There is a definite slowdown in leasing activity as touring activity has been halted and we believe this will likely lead to a decline in asking rents.
- Construction. For projects in progress, construction has been mixed as many projects have continued without issues, especially in states where construction was deemed an essential activity. Others, however, have experienced disruptions either due to local lockdowns, supply chain issues, or issues with permits or inspections as many local governments have closed.
- Future. We foresee the risks and impact on office proceeding in stages. Initially, the risk is that some tenants will go bankrupt or may decide not to come back to the office at all. However, the long-term challenge is that unexpected and unwelcome work-from-home test has taught many that they can reduce their overall office footprint. Yet a desire for more space per employee to allow for proper social distancing will counter this trend. In general, we see this outlook for this particular segment as complex and we will need to cover this in a few months as we learn more.
- The flip side of retail. Industrial is benefiting from retail’s woes (discussed below) as the demand for industrial and warehouse space continues to grow. This includes cold storage as online groceries become more convenient. Industrial most likely comes out of the pandemic in a stronger position.
- Current state. The sector has held up fairly well in early innings of the pandemic, but we expect pockets of distress to materialize as corporate and small business bankruptcies disrupt supply chains. However, there will also be growing sectors of the economy due to the pandemic and industrial is a space that is likely benefit.
- Future. New construction will probably slow over the short-term but demand should remain robust. We believe industrial will continue to be an attractive sector for institutional buyers. However, industrial real estate that is dependent on global trade will probably see a slowdown. Self-storage should also hold up well as it has in prior recessions. The low-cost nature of self-storage coupled with the fact that it is not greatly impacted by social distancing should help protect margins. Also, some areas have seen increased demand as college students or other individuals that have moved back home have needed additional storage.
- Exacerbated trends. Retail hasn’t caught a break in a long time, and this pandemic is only accentuating trends regarding ecommerce that have been in the works for years. One recent trend that has been hurt is experiential entertainment concepts such as ‘retailainment’.
- Opposite results. It has been a story of the haves and have-nots in retail. Malls and consumer power centers with big box clothing or sporting goods stores have been mostly closed or limited to only online purchasers or pickup orders. Large home improvement centers such as Home Depot or Lowe’s or necessary retails such as grocery stores have been able to stay open and have even seen higher demand over the last two months.
- Rent collections . . . and bankruptcies. Generally, smaller tenants and local shops throughout retail have been unable to pay rent in April or May. However, it’s not just the small stores suffering as several public retail companies have announced plans for possible bankruptcies.
- Future. Restaurants, which are low margin business to begin with, have tried to stay afloat with take-out and delivery options, but many will not survive under the current conditions. This will only accelerate the struggles for class C centers or malls that will probably not survive the crisis.
- Scale wins. Bigger is proving to be better in retail as large companies such as Amazon, Walmart and Target that are able to complement online merchandising with delivery and logistics strengths will continue to increase their market share leaving smaller retailers behind in their wake. Retail is becoming more of a warehouse and logistics business as the pandemic accelerates consumer behaviors that were already shifting.
- Occupancy. This sector has probably been the hardest hit during the pandemic. After several years of record profits, rates, and occupancy levels, hotels have been devastated for no fault of their own. Occupancy levels which were typically 75-80% have crashed to 20-25% for many hotels.
- Financing. Currently, most hotels are able to obtain flexibility form their lenders for up to 90 days. However, future distress in hotels is likely as a recovery may be more prolonged for certain parts of the hotel industry.
- Future. The path to recovery will look different whether the hotel is next to a hospital, university, corporate business center, airport, beach, or an amusement park. Conference center hotels that depend on business or other large events for revenue may lose that revenue for an extended time. The recovery will depend on the submarket and typical reason for a nightly stay. Hotels will likely experience a slower recovery.
In closing, we want to acknowledge that this information we are sharing, and our perspectives are being formed fairly early in the process of dealing with the pandemic. Much uncertainty remains. Over 30 million workers are unemployed, and vacancy tends to follow unemployment. Many of these workers believe they will be rehired within 3-6 months, but some jobs will not be coming back. There are many chapters ahead and the timing and shape of the recovery are large unknowns. Generally, with respect to real estate, we have been encouraged that collections have outperformed expectations to this point and pockets of opportunity remain.
We certainly hope that the phased reopening of the states goes well. June and July are important months that will indicate whether the economy can regain its footing without significant additional extraordinary stimulus measures or not. For that reason, we’ll continue to communicate what we’re seeing as developments unfold later this summer.
Disclosures: This is a general discussion of current investment themes, asset classes, and specific investment segments. The discussion includes our opinions and forward looking thoughts and analysis as of May 17, 2020 and is not a guarantee of future investment results. Actual client portfolios are often customized and do not necessarily represent an exact replication of, if any, allocation discussed. This commentary focuses on a wide range of economics and finance issues in order to educate you on the linkages between these topics and their impact on the overall economy and investment markets. The content of this presentation represents the opinions of Homrich Berg regarding these educational topics and should not be interpreted as direct investment advice or marketing of HB services. Information included is from sources believed to be reliable, but which have not been independently verified. Investing involves risks including loss of principal. This document does not constitute legal, tax accounting or investment advice.
As a majority of states have now begun a phased reopening, we continue to hope that you and your family are well and healthy. We often hear about the differences between Wall Street and Main Street when it comes to the economy. Wall Street represents the financial markets and big business. Main Street is represented by small businesses, individuals, and the economy at the local level. During the pandemic, the contrast between the two economies has become quite evident. Even though over 30 million Americans have filed for unemployment, the S&P 500 is only down 10.3% year to date as of May 7. Wall Street and Main Street appear to have two different views of the economy, and likely their respective paths to recovery will be different as well. National attention was drawn to this contrast, recently, when some public companies made headlines as they were able to access Paycheck Protection Program loans first while many small businesses were left waiting in line when the initial funding ran out.
As mentioned, the Wall Street economy is that of larger firms, which have outperformed their smaller peers in the stock market this year. The theme – that bigger is better and biggest is best – is becoming more apparent in the stock market and economic recovery. Larger firms simply have more resources and levers to pull to sustain themselves through recent events and many are striving to gain market share through the pandemic. While the corner pizzeria, dentist or local hardware store has had to close up or has limited ability to serve customers, companies such as Amazon have had historic demand for their products and deliveries, which is reflected in their stock price.
This is even evident within the large company universe, itself. As of May 4, the top five stock weightings in the S&P 500 were Microsoft (5.2%), Apple (4.9%), Amazon (3.4%), Google (3.2%) and Facebook (1.9%). Although Apple, Google and Facebook are slightly positive at 3.7%, 3.4% and 2.9%, respectively, they are outperforming the broader market considerably, and Microsoft is up 16.7% while Amazon is up 28.1%. In fact, a cap-weighted portfolio of these top five companies is outperforming the S&P 500 by 21.8%. It’s up 11.5%, while the S&P 500 is down 10.3%.
We also see this trend with other top firms in their sectors including Walmart, Adobe, Netflix, and Home Depot as just a few examples which were up 3.5%, 11.2%, 34.9%, and 5.8% year to date, respectively. Even though the entire retail sector has been hit hard, larger companies are generally outperforming their smaller peers. As of May 4, there were 40 companies that had year-to-date returns above 10%. However, there were 331 companies that had stock prices down more than 10%, including 197 companies that were down more than 25%. Those large companies we singled out are real outliers.
The chart below on the left shows that Technology is the largest weighting and the best performing sector in 2020. Healthcare, the second largest weighting and the second-best performer, is also comprised of large companies that have scale and staying power.
The chart on the right shows the subsectors in Technology and how the returns have been driven by a few companies within the Software sector which include of course Microsoft, but also Oracle, Intuit, Citrix, Salesforce, to name a few large ones that have also outperformed the broader market during the pandemic. To be sure, the recent challenges seem to be accelerating some broad economic trends that were already underway—particularly in retail, entertainment and technology.
We believe the different economic realities between Wall Street and Main Street may exist for some time, and even as the economy gradually recovers. This phenomenon reminds us of the need to try to capitalize on these Wall Street advantages in a diversified investment plan to benefit our clients on Main Street. That plan is customized to fit each client’s unique situation, goals and risk tolerance. If you have any further questions on this topic, please contact a member of your service team.
Disclosures: The information reflects Homrich Berg’s views, opinions and analyses as of May 10, 2020. The information is provided for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any investment product. The information does not represent legal, tax, accounting or investment advice; recipients should consult their respective advisors regarding such matters. Certain of the information herein is based on third party sources believed to be reliable but which have not been independently verified. Past performance is not a guarantee or indicator of future results; inherent in any investment is the risk of loss.
First and foremost, we hope you and your family are safe and well during this health crisis. After seven weeks of successfully working from home, we are making plans to reopen our offices. We plan to share details of our plan later this week.
In our continued effort to communicate through these challenging times, we want to focus today upon recent developments in the bond market. Although stock market movements tend to dominate headlines, the bond market is actually quite larger in size and represents an important allocation for nearly every investor. Debt is really what keeps the engine of corporate America running smoothly and when there are disruptions, as we have recently observed during the pandemic, it has wider implications for the financial system.
In the bond market, Treasuries are considered a “safer” investment as they are backed by the full faith and credit of the U.S. government, and therefore Treasuries typically feature lower yields (interest rates). When there is turmoil brewing in the economy, investors tend to sell riskier investments and buy Treasuries as a “safe-haven” investment. Like the stock market, the bond market is comprised of many sectors and each features unique risks and return trade-offs. Examples include: Treasuries, mortgage-backed securities, municipal, investment grade corporate, asset-backed securities, high-yield (junk bonds), and emerging market debt, among others. The level of perceived risk in a given category is measured by its “spread”. The spread is the difference between a bond yield of a given maturity, credit rating, issuer, or risk level as compared to a similar Treasury bond—the higher the perceived risk, the higher the spread.
During periods of economic stress, spreads can increase significantly as the value of riskier bonds decrease causing yields to rise. As the economic damage began to unfold in March, spreads widened dramatically across many sectors including those shown in the chart below. Redemptions from mutual funds and margin calls for hedge funds and mortgage REITs created an environment with the forced-selling of bonds in order to raise cash with very few buyers.
Although stock market volatility dominated headlines, the volatility and illiquidity in the bond market may have been more surprising and—in some cases—was just as severe. We can see that High Yield and Emerging Market debt had a higher spread to begin the year to reflect their riskier nature, but those spreads increased even more than the typically safer sectors of investment grade corporate, mortgage-backed, and asset-backed bonds over the rest of the month. Spreads increased through much of March as there continued to be more sellers than buyers until the Fed began to purchase bonds in late March. The Fed began with $700 billion in bond purchases, and it then followed with an unlimited and open-ended plan to purchase corporate and municipal bonds. This was later revised to encompass some high yield bonds in April. The Fed was willing to buy almost anything just short of equities. Their goal was to keep financial systems functioning, intact, and able to extend credit both through the crisis and also after the recovery begins. Its goal was largely achieved as markets began to settle down in early April.
Given the Fed’s action to cut interest rates to practically zero and the slower expected economic growth, it is likely that yields will remain low for an extended period. Still, we believe bonds remain an essential part of a diversified portfolio for liquidity and capital preservation. During the early moments of this crisis we reduced bond risk and focused on cash and Treasury backed money-market funds to allow time for the liquidity crisis to pass, but we have now moved back into ultra-short duration bond funds and traditional money market funds to improve yield income while keeping interest rate risk lower. In times of low rates we will continue to emphasize shorter maturity bonds to reduce the risk of future yield increases that may hurt bonds down the road. We do not believe investors are getting paid enough extra yield to go into longer maturities today. Even though we believe yields will likely remain less attractive for some time, it is our view that there are sectors of the bond market where there are still good fundamentals such as mortgage- or asset-backed bonds that can provide a higher yield and price appreciation opportunities. We will continue to look for investment opportunities within the bond markets while also continuing to recognize the liquidity and capital preservation role they play in client portfolios. If you would like to discuss further please contact a member of your service team.
Disclosures: The information reflects Homrich Berg’s views, opinions and analyses as of May 3, 2020. The information is provided for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any investment product. The information does not represent legal, tax, accounting or investment advice; recipients should consult their respective advisors regarding such matters. Certain of the information herein is based on third party sources believed to be reliable but which have not been independently verified. Past performance is not a guarantee or indicator of future results; inherent in any investment is the risk of loss.
Homrich Berg is pleased to announce it has been named to the 2020 InvestmentNews Best Places to Work for Financial Advisers. The third annual InvestmentNews Best Places to Work for Financial Advisers highlights 75 firms that recognize the importance of a strong workplace culture and stand as role models for the industry.