As you will have read, we have had one of the most dramatic (in speed and magnitude) three weeks of sell-offs in global markets, as Covid-19 fear spread globally and literally drove the world economy to a standstill. As people panicked, markets did too, hitting the sell button on absolutely anything that looked like it could possibly be liquidated. The carnage was so brutal and indiscriminate in bond markets, that often what is the most liquid part of the market – bonds with 1-2 years to maturity, not only sold off to wider spreads than its longer dated equivalent, but were also simply impossible to sell, in any size or package.
USD mid-March Credit Spreads (bps)
|1-3 yr||3-5 yr||5-7 yr||7-10 yr||All|
Source: BofAML, data as at 19 March 2020
Systemic stress became so elevated at one point that even rock solid, risk free instruments such as US Treasuries, sold off (doubled in spread) in less than two days. Liquidity simply evaporated and there was no safe asset to hold, none. Credit markets were just too stretched by large fund outflows, making many market participants forced sellers. Perversely, this also resulted in bonds that were more liquid underperforming, as investors sold what they could leading to the inversion of the credit curves shown above.
It seems that initially the policymakers’ response was neither very swift nor coordinated, which escalated the market panic at the beginning of the month; but given the speed of market falls and spread of Covid 19 this is not really a surprise. It took several attempts from Global Central Banks and G7 try to put a lid on the carnage. In the end, however, we have seen a very broad based mix of policy response, which we think puts a floor under credit spreads here. Direct fiscal stimulus is underway in almost every part of the developed (as well as Emerging) world now. Even in Germany. This will have a much-needed real world tangible impact on people and businesses.
To that end, we believe fixed income markets have emphatic systemic support to valuations. We see investment grade corporate bonds in particular as an area when investors can improve the quality of their portfolios AND pick up a significant amount of extra compensation for it along the way.
To us, investment grade asset prices simply do not reflect true fundamental value or macroeconomic reality at the moment. In the ongoing hard and sharp economic impact that is spreading across the world due to the Covid-19 situation, investment grade markets have valuations that mirror the peak of the 2008-9 GFC and post the TMT bubble burst. Assuming Covid 19 can be contained we believe valuations are as cheap as anytime over the last decade and possibly future decades. There is no doubt that many businesses may not survive, as the impact that we are seeing today will fundamentally change people’s habits going forward. This is the beginning of a new secular shift that will permanently change industries such as healthcare, cash payments, travel or hospitality, to name a few. Being alive to these seismic shifts should prove a very fertile ground for active managers and outperformance.