Analysis

Whether credit signals tell us to be concerned about the market moves, and thoughts for those working with individual investors

March 13, 2020

We ran a piece in our Altimetry Daily Authority today, a daily report that we write for our individual investor clients today. For those interested, you can see what we normally write there, by clicking here to register.

Some of the report is more asset-allocation focused for individual investors, but the broader points of the article, around understanding the current credit environment and realized versus unrealized losses, we felt were relevant enough to repeat here too, in lieu of our normal Friday Portfolio Report.

This is slightly adjusted from that report, and some more thoughts on investor sentiment are in that report, so feel free to read the full report at Altimetry.

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We have repeatedly highlighted our credit analysis and what it means for the macroeconomic picture over the past few months. We summarized all our thinking in the Altimetry Daily Authority on February 26, when the current turbulence was just starting to escalate… and again earlier this week. We also sent a note out to Investor Essentials Daily readers on February 25th.

Over the past two weeks, we’ve received many questions about credit signals. U.S. Treasury yields have collapsed, and because of this, bond spreads have widened. Also, the rout in oil led to significant concerns about credit issues for exploration and production (E&P) companies and other energy firms.

We saw a surge in people checking in with us after Wednesday, when reports came out about Boeing (BA), Wynn Resorts (WYNN), and Hilton Worldwide (HLT) drawing down their revolving credit lines and about private-equity firms directing their portfolio companies to do the same.

To many investors, that sounds an awful lot like 2008—when people were concerned about liquidity drying up because the banks didn’t have that liquidity.

But the data says something different…

Boeing has been a mess for a year, with its recurring problems over the 737 MAX, among other issues. The company’s drawdown isn’t a sign of credit markets seizing—it’s a sign that it has made some bad decisions.

Similarly, the reason why Wynn, Hilton, and private-equity firms are drawing down isn’t because of seizures in the credit market…

It’s a demand-side issue, not a supply-of-credit issue. These companies are thoughtfully preparing for the potential that with reduced travel for a short period of time (due to global quarantine barriers rising), they may need liquidity.

This is actually a good thing for the economy and market. These companies drawing down this cash before they need it means they’re less likely to run out of it, if and when there’s any disruption.

None of our other credit signals have massively changed. What about the entire conversation about credit spreads rising? Take a look at the chart below in that context—it shows the total cost to borrow for corporate high-yield and investment-grade credits.

As you can see, even if credit spreads widen, the actual cost to borrow for high yield bonds would be right in line with where it was for most of 2015 through 2017. And the cost to borrow for investment-grade bonds would still be below 2017 levels. Take a look…

It’s easy to panic about the headlines. But we’re not actually seeing credit collapse—the type of signal that would tell us “we’re on our way to this getting much worse.” It isn’t fun to live through… but this will pass.

Putting the moves into perspective for individual investors and clients

‘The value of my home just fell 20%. I’d better sell it right now!’

Home prices fluctuate. However, it’s hard to imagine a homeowner speaking like this. The long-term focus on the value of the home makes him ignore such temporary changes in valuation.

And yet, this panic selling is exactly the same thinking as investors today who sell as the market officially enters bear market territory—down more than 20%—simply because stock prices have fallen.

When an investor owns the broad market index through a mutual fund or exchange-traded fund (“ETF”), he is a business owner of the greatest, most profitable, and innovative companies on the planet. That’s why these firms were added to the index in the first place.

If you have a long-term horizon on business ownership, as you do with your home, why would you sell your ownership based on near-term fluctuations?

And over the long haul – studying decades and decades of data – stocks prove to be far more valuable than real estate and all other readily available asset classes. After all, the business not only increases in value… it also provides regular profitability and cash flows. A home doesn’t do these things.

Feel good that you ignore the temporary fluctuations of the stock market. Don’t get caught up in the market having “a down day” – just as you shouldn’t get too excited when the market has a big “up day.”

This should be as true for most institutional investors as it should be for individual investors. If you have a strategy and are looking to own businesses, as opposed to our clients that are more trading-focused, a long-term perspective is valuable.

Assuming you or your clients and investors don’t need the money you have in the stock market in the near term, the long-term orientation of the business owner—you, the investor—allows you to focus on your family and your work, and let the market experience its own mad emotionality without you.

As always, your health is your first wealth. And as always, listen to the data and not the noise when making any of your investment decisions.

All the best, as always,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research