Category Archives: Newsletters

The Market: May 2020

The stock market is caught in a tug-of-war between very bad economic data and the tremendous amount of fiscal and monetary stimulus. At his recent press conference Federal Reserve Chairman Powell reiterated his “whatever it takes” position. What that ultimately means is unknown but for now the Fed is buying government and corporate debt to keep interest rates low and maintain functioning debt markets in order to make it easier for companies to obtain financing to keep them going during the pandemic. This may mean that stocks could be stuck in a trading range until there is a vaccine or an effective therapy against COVID-19. The very low interest rates engineered by the Fed is making debt issuance affordable for companies. However, more debt on already heavily indebted companies is not a great situation for stockholders. Less cash flow available for shareholders should translate to lower equity values. This is not a universal case but it does mean investors need to be more careful than ever. Similarly, bond investors are facing more indebted companies with which to invest. Even worse, many troubled companies are issuing new debt that is secured by company assets (it may be the only way to attract buyers), shrinking the pool of assets available for subordinated debt (and equity) from which to make a claim. The term for this is known as”cramming down”. Not every investment case is destined for disaster. With the Fed supporting the corporate debt market, ideally companies can replace near term debt maturities with longer-dated bonds giving the enterprises time for a COVID solution to appear. With the Fed propping up bond prices, it’s hard to discern the health of a business from the company’s bond price. Company debt may well be over-priced vs the true underlying fundamentals and business risk. Investors should always examine each opportunity on its own merits. In the current environment, this rule is even more important. — Ian Green, Pendragon Capital Management

The Market: April 2020

From its high on February 19 to its recent low on March 23rd the S&P500 dropped 35.6%. Not only was the decline of significant magnitude, the speed of the fall was the fastest since the 1987 Crash. The deep and quick drop in stocks was accompanied by disruptions in most asset classes. Corporate bonds declined as investors feared defaults. This was especially true in the High Yield market. All this was in anticipation of what will likely be a signifiant recession brought on by Coronavirus and the intentional shutting down of economies around the world to save lives. In the US, to mitigate the economic impact of the virus, there has been a massive monetary and fiscal response. In all likelihood, there will be more stimulus to come. The Federal Reserve has essentially said it will do whatever it takes to keep liquidity in the various markets and buy most classes of debt instruments to allow companies to continue to fund themselves. The Congress, through the Treasury, will send out money to individuals and whole industries in an attempt to make up for lost income. It is truly a massive effort to meet the crisis head on. After the moves by the Fed and Treasury, the high yield and corporate bond markets stabilized and stocks rallied, bouncing 20-25% off the lows. The rally has been led by the mega-cap companies. Small stocks have lagged. On Friday, however, small-cap stocks, led by banks joined the relief party. With much of the stimulus flowing through the banks, there will be fee income to be had and money for borrowers to repay existing debts. The relief rally has given the market a shot of optimism. I remain cautious. No matter how much the government throws into the economy, it will not create a cure or vaccine to neutralize the Coronavirus. It will take at least a year, maybe two, for a vaccine to be available. No medicine has yet been shown to work. Until then, the economy will continue to be fragile. Even when the economy emerges from lockdown, will people in large numbers return so quickly to restaurants, airplanes, and workplaces? I can easily see stocks and bonds slipping lower from current levels. Could stocks to fall below the March 23rd low? Possibly. However, that would likely be a short-term phenomenon. As time moves forward, the vaccine and/or an effective treatment will be closer at hand. As the recovery process continues, investors should selectively add quality stocks to their portfolio, keep to their long-term strategies and maintain appropriate asset allocations. After the crisis has abated, there will be massive amounts of liquidity in the system. It will take time before the Fed can or will drain the pool of liquidity. Money finds its way everywhere and financial assets could rally significantly. — Ian Green, Pendragon Capital Management