#WellSaid

Our investment professionals share and challenge each other’s views, creating a diverse marketplace of ideas for the Wellington Blog.

The agency credit-risk transfer (CRT) market was one of the hardest-hit credit sectors, driven by both fundamental and technical factors, when the COVID-19 pandemic battered financial markets in March 2020. At the time, we viewed the sharp sell-off in CRT tranches as a technically driven overreaction to an unprecedented crisis, with the resulting prices not reflective of the sector’s true credit risk.

Since then, the recovery in CRT prices has been nearly as…

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Daniel Kim
Daniel Kim
CFA
Fixed Income Credit Analyst
Boston

Over the years, we have done extensive on-the-ground research to understand consumer behavior across China and other emerging markets (EMs), with an emphasis on the two age demographics — millennials and Generation Z — that drive much of these countries’ total consumption.

In keeping with this tradition, we recently conducted our first post-COVID-19 survey of Chinese consumers. As everyday life begins to return to normal in China, we wanted to get a pulse on consumption and lifestyle trends in the aftermath of the pandemic. We focused on respondents in higher-tier Chinese cities, between 20 and 40 years old, with “middle” incomes of 50K – 70K renminbi per year. Here’s some of what we learned.

Spending vs savings

Unlike their predecessors, post-1980 generations in China are generally prosperous and tend to spend much of what they earn, with an eye toward enjoying life as much as possible. However, with COVID-19 affecting their lives in ways they have not experienced before, we wondered if…

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Liliana Castillo Dearth
Equity Portfolio Manager
Singapore

On 23 March 2020, the US Federal Reserve (Fed) launched the Secondary Market Corporate Credit Facility (SMCCF) — a special-purpose vehicle (SPV) designed to support the corporate-bond market in the face of the COVID-19 crisis. In late June, the Fed released an official list of its initial bond purchases made via this program.

The more I think about the Fed taking the unprecedented step of buying corporate bonds as part of its crisis-response arsenal, the more I believe it’s difficult to overstate the implications. Here are some of my latest thoughts on the matter.

Five thoughts on the program

In my view, the Fed’s corporate-bond-buying program:

  1. Minimizes tail funding risk. Many US corporate-bond issuers were distressed and deemed to be at risk of bankruptcy as recently as a few months ago. Then came the Fed’s bond-buying program, which is aimed at removing tail funding risk, primarily for corporates that “should” survive (based on their investment-grade ratings pre-COVID-19). The terms of the program have since been…
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Jeremy Forster
Fixed Income Portfolio Manager
Boston
  • The COVID-19 new case count continues to drift higher globally and has now hit a seven-day moving average of approximately 213,000/day (see Figure 1 in full post). COVID-related deaths have also increased, but more modestly — to around 4,900/day, from 4,500 at the start of July.
  • The daily new case count in emerging market (EM) countries is still trending upward, having now reached about 116,000 new cases/day.
  • New developed market (DM) cases are lower at 69,000/day, but are rising faster than in EMs. The DM new case count has now surpassed the 65,000/day peak of the first wave.
  • Notably, the acceleration in the number of new DM cases is almost entirely a US-driven phenomenon — around 62,000 new cases/day in the US, up from 51,000/day a week ago. (Continue reading full post for more on this.) 
  • There has also been a reacceleration of new-case-count numbers, from a very low base, in developed Asia. This has been driven largely by…
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Bob Deresiewicz
Bob Deresiewicz
MD
Global Industry Analyst
Boston

COVID-19 impact on US policy

Amid continued macro uncertainty and a reacceleration of infections in many states, Washington continues to forge a path forward, trying to keep the US economy afloat. In this 18-minute audiocast, we discuss fiscal policy options, take an early look at the election picture, and give a quick assessment of how foreign policy could shift in a Biden administration.

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Michael Medeiros
Michael Medeiros
CFA
Macro Strategist
Boston
Thomas Mucha
Thomas Mucha
Geopolitical Strategist
Boston

In recent months, the convertible-bond market has provided tremendous opportunity for investors looking to position their portfolios strategically for an eventual recovery from COVID-19. Convertibles have experienced a meaningful uptick in supply during the first half of 2020, including substantially elevated new-issue and secondary-market volumes. Most of this supply surge, which includes a number of notable transactions, has been driven by companies looking to boost liquidity and capital.

So what now? While the market has been engaged with the theme of a rapid recovery in economic activity post-lockdown, helped by an abundance of monetary and fiscal support, there is still potential for significant setbacks to investor confidence and for COVID-related news flow to keep volatility at relatively elevated levels. As the market’s perspective on the likelihood of a fuller, more sustained reopening of the economy continues to evolve, we believe the convertible-bond sector may offer…

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Ronan McCullough
Ronan McCullough
Director of Capital Markets
Boston

European, global, and US high-yield indices declined around 20% from the start of the year through the peak in spreads on March 23. However, extraordinary global monetary and fiscal stimulus measures in response to the COVID-19 crisis have since helped high-yield markets recoup a sizeable portion of those losses. Members of Wellington’s High Yield Strategy Group met recently to discuss their market outlook, including perceived risks and opportunities, in the wake of this extreme volatility.

Economic data buoyed by stimulus

While the worst of the economic shock is likely behind us, the question now surrounds the trajectory and timing of a recovery. Our base case is for a two-stage recovery that begins with a strong rebound from pent-up consumer demand as lockdown measures are eased, followed by a drawn-out recession.

Purchasing managers’ indices (PMIs) — economic indicators derived from surveys of private companies — remain depressed across nearly all geographies. However, we believe…

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Michael Hong headshot
Michael Hong
CFA
Fixed Income Portfolio Manager
Boston
Konstantin Leidman headshot
Konstantin Leidman
CFA
Fixed Income Portfolio Manager
London

In late May, Japanese Prime Minister Shinzō Abe’s cabinet approved a second 2020 supplementary budget of ¥31.9 trillion (US$298 billion) to further combat the bruising economic impact of the COVID-19 crisis. This latest fiscal package provides financing help to struggling companies, subsidies to help firms pay rent, funds for health care assistance and support for local economies.

The headline ”business size” of the package — including assumed private-sector activity, loans from public financial institutions and actual new spending by the government — amounts to ¥117 trillion (US$1.1 trillion), matching the size of Japan’s first package delivered in April. All told, the nation’s fiscal policy response to the crisis thus far totals ¥234 trillion, roughly equal to 40% of its GDP.

The approval of the second package follows a May 22 joint statement issued by Haruhiko Kuroda, governor of the Bank of Japan (BOJ), and Tarō Asō, minister of finance, which read:

“The Government and the Bank are committed to making every effort to facilitate corporate financing and maintain stability in financial markets through the…

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Paul Cavey
Macro Strategist
Hong Kong

COVID-19-related disruptions have impacted operating performance in the higher education sector of the US municipal market. However, we remain constructive on the sector overall, supported by balance-sheet strength across select issuers. 

Sector themes we are watching

Campus reopenings and student decisions will vary.
Campus reopenings will differ by state and the size of the institution. For example, California State University already decided to close all 23 campuses this fall, while smaller institutions such as Notre Dame and Boston College announced plans to reopen campuses.

Meanwhile, freshmen and returning students may weigh different options, such as taking online classes the first semester or staying closer to home — a benefit for public universities. Transferring to lower-cost or even “reach” schools could also be possible due to enrollment dislocations. Management teams say they are on track to meet…

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Paul Ko
Paul Ko
Fixed Income Credit Analyst
Boston

Recent global liquidity injections, a low but improving global purchasing managers’ index (PMI), and a weaker US dollar are all contributing to a supportive backdrop for emerging market (EM) equities. To the extent that these trends persist in the period ahead, I believe EM stocks can continue posting attractive relative performance. Now may be a good time to look beyond China for EM equity opportunities.

Recovery paths matter

One encouraging sign is that more cyclical sectors and regions (e.g., travel and bank stocks; Latin America, ASEAN, and Russia) have rebounded along with broader EM equities over the past several weeks, as we have seen…

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Jamie Rice
CFA
Equity Portfolio Manager
Boston
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Income is getting increasingly difficult to come by these days. Amid the severe market downturn in March, global central banks aggressively cut interest rates in an effort to lessen the damage. Meanwhile, as many large corporations effectively ceased to operate, stock dividends began to collapse.

Although the headlines focused mainly on the immediate impact of these developments, investors who rely on the equity and fixed income markets to generate regular income in the form of dividends and/or bond yields — from insurance companies to pensioners and endowment funds — will, unfortunately, likely feel the impact of this unprecedented crisis for years to come.

The crisis has also shone a bright spotlight on various strategies, across asset classes, that pay out regular income to investors, particularly the manner in which many of these strategies have been…

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Matthew Bullock
Investment Director
London

Bottom line: recovery at risk

The COVID-19 crisis has eliminated the brief window for the UK government to provide macro policy clarity and constructively move the Brexit debate forward. I fear that elevated political and economic uncertainty could delay the recovery from the crisis. These longer-term risks are not a market focus currently, but will come to the fore in the recovery.

Lockdown may last longer than in Europe

The UK health crisis is evolving broadly in line with the worst outcomes in Europe but the UK might be a week or two behind. With the Prime Minister recovering from the virus, the government has yet to set out a path to reopening the economy, as at the time of writing. The UK may follow most other European countries with a very gradual opening, but the risk is…

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Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London

Challenges increase for the eurozone

Recent data and developments have altered my view of eurozone economies and equities, increasing and significant downside risk in my view. Doubts about the path ahead have increased, reflecting fundamental uncertainty about the health crisis, the policy response and the subsequent economic recovery. A deep recession, a slow recovery and a steep earnings recession could weigh on eurozone equities. Relative to the recent IMF forecasts, the eurozone is likely to experience a bigger dip and a shallower recovery.

Medium term: policy response will shape recovery

In the medium term — six months to two years — the quantity and quality of the policy support will determine both how fast growth can bounce back and how far longer-term damage through job and firm destruction is avoided.

ECB intervention

The ECB’s intervention is extensive, providing ample liquidity and purchasing assets at a high pace. Asset purchases can be scaled up if necessary and I am confident that…

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Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London

China recently reported that its gross domestic product (GDP) shrank 6.8% year over year in the first quarter of 2020 – the first time in modern history that the nation’s economy has contracted. The contraction was sharper than our tracker had suggested, with the implication being that services (for which robust monthly data are not available) likely fared worse than other parts of China’s economy.

Headline: Bad, but expected

This outcome was largely intuitive and did not come as a surprise to markets in the wake of recent events. Indeed, it’s pretty clear that the COVID-19 outbreak delivered an unprecedented shock to China’s economy – one that hit the services sector harder than it did manufacturing.

On its own, I would have thought that such a poor headline GDP number would have been neutral for Chinese fiscal policy, in the sense that whatever the government did for the remainder of the year, it probably wouldn’t be able to…

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Paul Cavey
Macro Strategist
Hong Kong

As I argued in my March 17 post, “Technology: The future is on sale,” now may be an opportune time to “buy the future” at potentially bargain-basement prices, particularly in the technology sector. By way of a follow-up, here is my latest thinking on trends and industries that look poised to emerge as winners (and, conversely, losers) on the other side of the COVID-19 crisis:

Potential winners

  • Streaming
  • Digital advertising
  • E-commerce
  • Fintech
  • Digital goods consumption (e.g., video games)
  • Cloud collaboration tools
  • Online education
  • Direct-to-consumer business

 

Potential losers

  • Linear TV, cinema
  • Traditional advertising
  • High-end retail
  • Physical branch banking
  • Physical goods
  • Business travel
  • In-class education
  • Supply chain/middlemen

A number of quality companies in the “potential winners” column have recently been trading at attractive relative and absolute valuations. I believe equity investors should consider using this opportunity to add (or increase) exposure to some of these stocks.

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Brian Barbetta
Global Industry Analyst
Boston

Amid the impending government stimulus, the issue of stock repurchases has once again hit the headlines. Buybacks are often framed as the poster child of corporate greed or lapses in governance, designed to line executive pockets and enrich existing shareholders at the expense of broader long-term value creation. But the first critical point to remember is that buybacks should be a distribution of profits that remain after all constituents have been taken care of, and they should not be done at the expense of any stakeholder, including employees.

Let’s assume that the buybacks we have seen have been made with good intentions and examine what influenced the decision making. Stock repurchases are one of five capital allocation tools available to public companies, along with business reinvestment, acquisitions, dividends, and debt reduction. Like any other capital allocation decision, there are times when buybacks make sense, and times when they don’t. How, why, and when management teams take these actions matters greatly. Skilled capital allocation separates…

 

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Mark Whitaker
Equity Portfolio Manager
Boston

The S&P 500’s substantial market rally from recent lows has led many investors to question whether a new bull market has begun. In my view, bear market history should give pause to anyone who thinks we are off to the races again. In the US, prior to the recent crash, there have been nine bear markets of at least 20% since 1987. Figure 1 offers several lessons from these bear markets (each gray and white section), showing the meaningful lows and gauging the magnitude and quality of any rallies that were recorded as each bear market unfolded. For instance, in 1987 there were two major lows. Between the crash and the next low, the market rallied…

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David Lundgren
CMT, CFA
Director of Technical Analysis
Boston

Typically, when we think of defense and risk aversion, we think of countercyclical exposures, where the focus is on certainty on earnings, stable and strong fundamentals, and/or low price volatility. This is separate from our view on factors utilized for capital appreciation, such as growth or value factors. In Figure 1, we show the down-market capture (DMC) for commonly used factors in the US and Europe over the long term and during the market sell-off between February 18 and March 23. The numbers indicate how much of the down-market return the factor “captures.” For example, if the market was down 10% and the DMC was 60%, the factor return was…

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Gregg Thomas
CFA
Director of Investment Strategy
Boston

As the world struggles to beat back the pandemic and restart economic engines, all eyes are on the US and China. In our newest 20-minute audiocast, we explore how this crisis may affect the great-power relationship, why shifting domestic political landscapes matter, and what the re-designating of key strategic industries may mean for investors.

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Santiago Millan headshot
Santiago Millán
CFA
Macro Strategist
Hong Kong
Thomas Mucha
Thomas Mucha
Geopolitical Strategist
Boston

After its recent bounce, the S&P 500 is now wrestling with our near-term upside target in the 2,700 range. In my view, we are starting to see evidence that the market is normalizing, setting the stage for a bottoming process to begin. And even if the market sees new lows in that process, I believe it will hold above 2,000 – 2,100. From this point forward, however, I think whether or not we retest the bottom before moving higher is irrelevant. I believe it is time to ignore the market and instead focus on the factors, regions, industries, and stocks that will lead in the next bull cycle.

Will the market see new lows?

The dominant consensus view seems to be that the market will see lower lows. Investors then appear to be split between the bulls and the bears, but both camps seem to confidently expect this near-term outcome. My best-case scenario is more bullish…

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David Lundgren
CMT, CFA
Director of Technical Analysis
Boston
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