A few weeks ago, we discussed how to characterize the economic recovery post this current COVID-19 crisis. Many experts opined on a wide range of outcomes for the rest of the year and into 2021: a “V”, a “W”, an “L” or even a “U” shape. We asserted it would look more like a ‘swoosh’.
Recently, the market has reacted positively to what would seem to be some discouraging and contextually historic economic data (i.e.: the April unemployment rate at 14.7% and the retail sales plunge of -16%). So why would the market celebrate those numbers? In a way, the market is reacting to the fact that the actual data was “better” than the expectations. Or said another way, the actual data was not as bad as what the market was pricing.
Regardless, the numbers are still painting a dire economic picture. As our economy starts to reopen, we are monitoring several aspects of consumer confidence and retail activity. The chart below is one of many such example showing the year over year change in seated dinners at restaurants across the whole OpenTable network:
Equities, or stocks, are the most obvious way to capture an economic recovery. We build diversified stock portfolios that have exposure across many sectors, market capitalization and factors. Think value versus growth or small cap versus large cap stocks. More recently, we have leaned on a higher allocation to U.S. stocks versus international stocks given our views on deglobalization and onshoring trends.
As a shareholder, you are an owner of a company and you receive a share of the profit in the form of dividends and potentially a higher price. Stocks, however, are at the bottom capital structure of a company. A bondholder conversely is a creditor to a company and buys bonds issued by that company, receiving the income consisting of interest that the company periodically pays.
What is important to know is bondholders are preferred over shareholders in terms of payments of liabilities. In case of bankruptcy or dissolution of a company’s operations, all the net assets of company are liquidated, and the stakeholders are paid according to a specific hierarchy. In such a situation, bondholders or creditors are always prioritized in their payments. Secured loans are paid before unsecured loans. After clearing all the debts of the company, shareholders are paid their investments if any money is left.
Given where we are in the recovery cycle, we believe there are opportunities abound in the bond or fixed income market. We also recommend being invested with managers that are experts at the credit work and really understand the nuances of a balance sheet and income statement. Buying a bond index means you are buying the good and the bad ratings of all the bonds that are in the index. Concentrated managers navigate the quality universe as well as the different layers of credit priorities depending on the specific industry and company.
As we expect yields on government bonds to stay low for a while, we look forward to discussing with you the outlook for distressed strategies and the liquidity and solvency opportunities in the credit space.
If you have any questions or want to have a conversation about the market or your portfolio, please contact Liz, Ed, Fred, Scott, Tyler, or myself. Your Sendero team is ready to help.
Amaury de Barros Conti