Monthly commentary discusses recent developments across both the Diversified Bond and Credit Income Opportunities Funds.
After months of relentless rallying, we finally saw some volatility in equities and credit. Prices have fluctuated wildly, mostly on US fiscal stimulus headlines. We remain of the opinion that additional fiscal stimulus ahead of the Presidential election is somewhat unlikely, as the gap between what Democrats and Republicans want is still too wide. What happens in the lame duck session remains to be seen, but depending on the result of the election, we might have to wait for January 2021 for a new fiscal package to be approved. Already, some of the economic data from August such as retail sales are showing signs of weakness (late July is when the last enhanced unemployment benefits were disbursed). With the Covid pandemic entering its second wave and social distancing measures remaining in effect, the lapse of fiscal support might expose the true damage of the recession.
Another important development is the increased odds of a Democratic sweep in November (i.e. Democrats winning the White House and control of both houses). As of the time of writing, Trump is lagging in the polls (Figure 1) in most swing states and several Republican senate races are also very close. From the market’s perspective, the best-case scenario would be one where Biden wins the White House, but the senate remains Republican. This would bring back some sort of normalcy to the Oval Office, but prevent Democrats from enacting their full agenda, particularly on the fiscal side (i.e. more spending, coupled with higher taxes on corporations and the wealthy). One way or another, if Joe Biden wins the presidency, the deregulation that took place during the Trump presidency will be mostly reversed. In the event of a sweep, higher taxes and re-regulation is a clear negative for US companies, but for now market participants do not seem overly concerned with the policy implications of the election, focusing instead on the immediate concern of whether Trump will vacate the White House peacefully.
The pandemic and civil unrest in the US has made 2020 a truly unusual year, and with about three weeks to election day, a lot can still change. With Trump lagging in the polls, we expect his behaviour to become increasingly erratic (e.g. the First Debate and his comments about white supremacists). Our biggest concern heading into November is how disruptive Trump and his supporters could be, even if the election result are a clear defeat.
Across the pond, Brexit is making the headlines again. By the end of 2020, unless there is a trade agreement, the UK and the rest of the EU will revert to WTO trading rules. Negotiations have lagged, bogged down by two issues: fishing rights and state aid to companies. We know from experience that Boris Johnson likes playing games of chicken with the EU, but that he has typically been the one that flinches. With the pandemic already hitting the UK and EU economies, it seems like the logical thing to do would be to find a compromise on those issues and move on. Unfortunately, Johnson seems intent on playing yet another game of chicken into the end of the year.
While US equities sold off by about 10% in September, the reaction of credit markets was initially more muted. To be fair, credit didn’t witness the same extravagance as stocks in the previous month (Figure 2). Investment grade spreads have widened modestly, but mostly in the second half of the month, as equities bottomed. We continue to see new issues being extremely oversubscribed and secondary markets conditions are characterized by better buying. In other words, investors are flush with cash and so far, the buy the dip mentality is alive and well. Although we did take profits on some of our investment grade positions there has been no change in stance at our end. We continue to add to our liquidity, keeping some powder dry to deploy at more attractive spreads. Until then, we continue to buy short dated corporate bonds, commercial paper and called securities.
September was a more modest month for the DBF, returning 34bps; while credit spreads widened modestly, our various hedges provided us a positive return. We did not make any material changes to the portfolio in September, but astute readers will notice our government bond and high yield weights going up slightly. This increase doesn’t reflect a big change in positioning bias, its more of a cash management strategy. We have been buying short-term called high yield bonds as a cash replacement strategy (often with yields around 3%) along with 2-year government bonds for increased liquidity.
With credit spreads widening in September, we are happy with the Credit Opps staying flat (+1 bps to be exact). Since August, we have been steadily reducing risk in the portfolio, harvesting profits, selling down credit and taking a more cautious stance. As of month-end, leverage is now 1.15x (from 1.33x in August and 1.67x in June).
Our defensive stance going into September paid off, and we remain well positioned to weather more volatility, should it arise. Unfortunately, credit has not got cheap enough to entice us to start putting more money to work. Until then, we will continue to look for idiosyncratic opportunities and wait for the volatility.
Until next month,
Mark & Etienne
1 All Ninepoint Diversified Bond Fund/Class returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at September 30, 2020 1 All Ninepoint Credit Income Opportunities Fund returns and fund details are a) based on Class F units (closed to subscriptions); b) net of fees; c) annualized if period is greater than one year; d) as at September 30, 2020.
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