Governments around the world continue to propose new ideas to soften the economic blow of the coronavirus and put people back to work. Making headlines this week: The European Union has proposed a massive recovery plan that would include 750 billion euros of commonly issued debt to fund grants and loans to the EU’s hardest-hit members. And the Trump administration is examining the idea of a temporary “back-to-work bonus” that could replace the $600-a-week unemployment payment that the US government is currently providing in addition to state unemployment benefits.
If implemented, such programs would be the latest in a long list of government pandemic-response initiatives. In this piece, Invesco Fixed Income takes a closer look at another such program that’s scheduled to launch in the US on June 17 — the 2020 Term Asset Backed Securities Loan Facility (TALF) — and how it’s already impacting the structured debt market. We also hear from a global equities manager who’s taking a long-term, perhaps contrarian view, as well as a US value equity manager who sees positive signs emerging in several sectors.
- Glenn Bowling, Head of Asset-Backed Securities Credit, Invesco Fixed Income
- Kevin Collins, Head of Commercial Credit, Invesco Fixed Income
- John Delano, Senior Portfolio Manager, Global Equities
- Kevin Holt, Chief Investment Officer, US Value Equities, and Senior Portfolio Manager
Structured debt: TALF financing expected to provide stability
Kevin Collins and Glenn Bowling: The 2020 Term Asset Backed Securities Loan Facility (TALF), announced by the Federal Reserve on March 23, is a repeat of an effective government/private program implemented after the 2008 global financial crisis. The 2020 program is intended to help meet the credit needs of consumers and small businesses by facilitating the issuance of asset-backed securities (ABS) and improving market conditions for ABS generally. After initially being open to AAA rated new issue ABS and static collateralized loan obligation (CLO) AAA assets, the program was extended a few weeks later to include secondary market AAA commercial mortgage-backed securities (CMBS). Importantly, the three-year loans offered by the New York Federal Reserve provide especially attractive financing to support new issuance and very high-quality assets in the secondary markets.
Since the announcement of the program, TALF-eligible AAA ABS spreads have tightened significantly. In some of the larger, more generic ABS sectors like prime auto loans and credit cards, spreads have tightened inside of levels where the New York Federal Reserve will provide funding for TALF leverage, making them unattractive assets to finance with TALF leverage. Other ABS sectors, like subprime auto loans, auto dealer floorplan loans and corporate fleet leases, remain wider than TALF funding levels. While it remains to be seen how much new TALF-eligible ABS issuance will occur over the next three months, Federal Reserve support has clearly helped the functioning of this market. New issues are have picked up and are expected to continue through the June 17 TALF launch date and beyond.
We expect TALF financing to help provide stability to the CMBS market and assist in increasing investor demand for bonds. We believe AAA rated eligible investments will benefit directly from favorable financing made available by the Federal Reserve via the TALF. Indeed, since their inclusion, AAA rated CMBS have posted some retracement of the credit spread widening seen in March. While the TALF does not directly support bonds rated below AAA, we believe CMBS bonds just below AAA in the capital structure (i.e., AA and A) — which can withstand various downside scenarios — may also benefit as tightening spreads in AAA assets cause investors to look just below very high-quality AAA assets for alternatives also at wide absolute and relative spread levels.
Global equities: Long-term investing can look like contrarian investing
John Delano: Recently I’ve been asked why, in the current environment, I still see an opportunity in the aircraft manufacturing industry. The answer is simple: I’m not investing for today but for two and three years from now and beyond. I’m investing in the structural trend of growing air travel, particularly in emerging markets Clearly, I expect people to resume flying. There are two reasons for my optimism: Our problem-solving ability and our basic nature. People are good at solving problems. It’s what we do. There is a tremendous problem-solving effort aimed at this coronavirus and I’ll be surprised if it doesn’t yield increasingly effective solutions. We are also highly adaptive, as I learned near the beginning of my career.
As a young analyst covering the cruise industry, I recommended buying a major cruise company right before going on vacation to get married in September 2001. As I was landing in Bali on my honeymoon, I learned of the 9/11 attack. Along with my other feelings, I had a very bad feeling about my recommendation. At the time, the idea that people would be willing to travel for leisure — let alone get on an airplane to go to a boat to take a cruise — seemed … unlikely. But in our subsequent discussions, that company’s CFO said something I’ve never forgotten. She told me that in their first post-attack cruise ticket sale, they discounted the tickets steeply and saw an immediate response. She said to me, “We priced fear that day.“ We’re seeing the same thing today, with various reports of high demand for tickets to amusement parks and other recreational activities.
My point here is that people adapt. In my view, this coronavirus event will not change basic trends. It may delay some of them, such as the growth in air travel that we’ve just discussed. It may accelerate others in which we were and are invested. For instance, I expect a higher portion of the workforce to work “remotely,” a higher percentage of retail purchases to be done online, and contactless payment to grow at a faster rate now. The rising use of data in medical diagnostics and treatment development has just gotten a push. All of this drives the need for more data center capacity and semi-conductor chips. These are just a few examples. To me, the direction the world is moving remains clear.
COVID-19 is one of the “black swan,” “once-in-a-century” events that have happened every 10 to 12 years in my career. They convulse the market, converge correlations, and focus attention on the very short term. For an operating manager, or a short-term trader, that is appropriate. But for an investor, I believe the focus should remain on fundamental structural trends, which remain the same. The key questions remain the same as well: Which companies can most profitably and sustainably monetize the world’s long-term structural trends, and do they have the financial strength to withstand the shocks that are inevitable?
US value stocks: Positive signs are emerging in several sectors
Kevin Holt: Value’s decade-long underperformance versus growth1 has become even more pronounced after experiencing a multitude of exogenous events. Since the fourth quarter of 2018, we have dealt with China trade war tensions, a shutdown of our global economies due to an unprecedented pandemic, and the second oil price war in five years. The result has been an economic shock that rivals only two other time periods in the past 100 years – the Global Financial Crisis of 2008 and the Great Depression in 1929. The question now is whether this massive dislocation and aggressive response by central banks has reshuffled the deck in favor of value investing. We believe so.
Our team’s opportunity set has greatly expanded beyond the cyclical industries that are typically favored by value strategies and has allowed us to buy higher-quality companies at fire-sale prices. And on a sector basis, we’re seeing some positive signs emerge:
- Financials: We still believe financials will be part of the solution to this crisis rather than the source of the problem (as they were in 2008). Even with low rates into the foreseeable future, we believe the group is very inexpensive.
- Energy: We believe the historic drop in spending by energy companies will benefit investors once demand improves. Prior to COVID-19, many analysts were already projecting a slowdown in output from US shale wells in 2020 due to spending cuts and production declines. When today’s depressed demand rebounds and approaches normalized levels, we believe we will experience a typical energy cycle of higher prices fueled by underinvestment. Until such time, balance sheet strength is key.
- Health Care: We’ve become increasing positive on select health care companies as they have been forced to temporarily stop performing elective surgeries due to COVID-19.
- Industrials: Opportunities have opened in the industrials space as specialty chemicals and global manufacturing companies have seen their stock prices disproportionately punished, in our view.
In closing, we are cognizant of the fact that the trajectory of the recovery is a significant unknown. In past downturns, the bottom was reached once investors felt the government had provided enough stimulus to stabilize the economy and thus stock market valuations. Today, we believe the US federal government and the US Federal Reserve have acted swiftly and aggressively to infuse enough capital into the system to hopefully set the foundation for a recovery. However, the difference in this crisis is that it’s not caused by a financial breakdown but by a health care pandemic, so it’s tough to determine when it will be safe for the economy to fully reopen — and when people will feel comfortable resuming their normal activities. In uncertain environments such as these, we act out of an abundance of caution, lean hard on valuation, and take a long-term time horizon.
Read other blogs in this series
1 From April 30, 2010, to April 30, 2020, the Russell 1000 Growth Index had an annualized total return of 14.41%, compared to 8.54% for the Russell 1000 Value Index.
Blog header image: Joe + Kathrina / Stocksy
The Russell 1000® Growth Index is an unmanaged index considered representative of large-cap growth stocks. The Russell 1000® Value Index is an unmanaged index considered representative of large-cap value stocks. Both are trademarks/service marks of the Frank Russell Co. Russell® is a trademark of the Frank Russell Co.
Asset-backed securities are securities backed by financial assets, such as credit card receivables, auto loans and home equity loans.
Commercial mortgage-backed securities are securities backed by commercial mortgages (not residential mortgages).
Collateralized loan obligations are securities that are backed by a pool of debt, often company loans.
Spreads measure the difference in yield between two types of bonds (for example, corporate bonds and Treasuries).
Mortgage- and asset-backed securities are subject to prepayment or call risk, which is the risk that the borrower’s payments may be received earlier or later than expected due to changes in prepayment rates on underlying loans. Securities may be prepaid at a price less than the original purchase value.
Credit ratings are assigned by Nationally Recognized Statistical Rating Organizations based on assessment of the credit worthiness of the underlying bond issuers. The ratings range from AAA (highest) to D (lowest) and are subject to change. Not rated indicates the debtor was not rated, and should not be interpreted as indicating low quality. Futures and other derivatives are not eligible for assigned credit ratings by any NRSRO and are excluded from quality allocations. For more information on rating methodologies, please visit the following NRSRO websites: standardandpoors.com and select “Understanding Ratings” under Rating Resources and moodys.com and select “Rating Methodologies” under Research and Ratings.
Risks of collateralized loan obligations include the possibility that distributions from collateral securities will not be adequate to make interest or other payments, the quality of the collateral may decline in value or default, the collateralized loan obligations may be subordinate to other classes, values may be volatile, and disputes with the issuer may produce unexpected investment results.
The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.
The profitability of businesses in the financial services sector depends on the availability and cost of money and may fluctuate significantly in response to changes in government regulation, interest rates and general economic conditions. These businesses often operate with substantial financial leverage.
Businesses in the energy sector may be adversely affected by foreign, federal or state regulations governing energy production, distribution and sale as well as supply-and-demand for energy resources. Short-term volatility in energy prices may cause share price fluctuations.
The health care industry is subject to risks relating to government regulation, obsolescence caused by scientific advances and technological innovations.
The opinions referenced above are those of the authors as of May 28, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.