Nearly all investors have felt the effects the COVID-19 pandemic has had on the equity and credit markets over the past several months. Today, CFN’s Dennis Jablonoski hosts and is joined by Eric Green, Certified Financial Analyst and Senior Managing Partner at Penn Capital. They look ahead to the long-term impact of federal stimulus dollars on our economy and what the Federal Reserve’s recent moves have done to effect the markets. Also, with the November elections just a few months away, they discuss what role political results might have on economic conditions in the months ahead.
Program Length: 18 minutes
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Welcome to the your life, your well network, helping you find clarity and comfort for your life.
And, well, welcome to the Your Life Your Wealth show. I’m finished, Yablonsky and I’m sitting in for Steve Cordasco today. Today, we’re going to talk about the equity and credit markets where we’ve been in the last six months and more importantly, where we’re going. There’s a lot of volatility going on around us in the markets every day.
Market fluctuations in swings. And we’re going to get into some of that today and we’re gonna get into some of the topics that are driving the headlines when it comes to the markets and investing. Joining me today is Eric Green. And Eric is a certified financial analyst. Deputy chief investment officer, senior portfolio manager and senior managing partner at PEN Capital. Penny Capital is a local registered investment firm, specializes in the leveraged finance market. Eric, thanks a lot for joining us today. How are you? I’m great, thank you, Dennis. I can’t believe it. It seems like a lifetime ago, but the last time we talked and last time we interviewed you, we were sitting at a local conference in Center City, Philadelphia, in the middle of February. And we were talking about what was going to happen in 2020. We were reviewing 2019 and we were talking about what to expect in 2020. Boy, has the world changed since then.
Yes, it has.
Unbelievable. Unbelievable. So, Eric, there are some indicators right in your world in the leverage finance market. There’s some indicators both good and bad. Right. When when we get into times of volatility and markets decline and markets increase, there are some lagging and leading indicators that cannot only drag us down, but also take us out of times of volatility and times of appreciated markets. Can you reverse a little bit and go back from where we were about six months ago to where we’re at now and where you see the world kind of moving forward from here at this point with all of this debt and everything that’s going on around us?
Sure, yeah. So we were part of what we do is we talk to companies all the time getting update on their businesses. We were seeing early this year extremely strong numbers from most of our companies. The consumer was in the best shape that we’ve ever seen in some cases. Unemployment was historically low. Things look very good. Of course, most people didn’t expect the virus side to spread the way it did around the world, as well as in the United States, particularly starting on the East Coast. And that changed everything very quickly. I remember talking to a casino company who went from 99 percent occupancy at the end of February to three days later, having zero percent occupancy because everything was shut down. So everything just changed on a dime.
And clearly, nobody anticipated shutting down the entire economy the way the way that happened, the week we saw many companies sides, stock prices were were crushed, particularly the ones of companies that I had to close their businesses and had essentially zero revenue starting in early early March, late February. So I also what happened is one of things that you just mentioned, the credit market froze up for a short period of time, high yield spreads, which is a difference between what you get paid on a non investment grade company and a U.S. Treasury. So it’s the the credit risk that you take by buying a high yield bond. Those spreads went from about 400 over treasuries, four percent over treasuries to about 11 percent. Eleven hundred over Treasuries. That is usually very negative, at least in the short term, for for equities. And it essentially made it very, very difficult for companies to borrow money as a cost of borrowing money went up considerably, started as things started to ease. In late March, early early April, the high yield market started to improve, the credit market improved, and we saw spreads move from over 11 hundred eleven percent over Treasuries to now below 600, below the Treasury about treasuries. And so now companies can borrow money at a much lower rate. What’s also happened is that companies have been able to issue new debt to survive the downturn. So a lot of these companies, if their businesses were closed for a prolonged period or inside the economy, was weak for a prolonged period. There is a real threat of them going bankrupt. And that’s why you saw violent moves in a lot of companies in the leisure industries, in particular distressed consumer industries where they had their businesses close. But what was nice is that money. Went into the high yield market in high yield managers were buying new deals, deals in industries that you would be very surprised to see.
Cruise companies, Caribbean region cruise lines. Companies like that. Theaters, airlines. Live entertainment venues. Retail companies. Amusement parks, restaurants, hotels and casinos. All did. New high yield deals during the months of April and May. And so far in June, those deals allowed a lot of the companies that only had three to six months of life before they would end up running out of money, essentially to extend the runway for 12 to 18 months or even longer in some cases. Some of the cruise lines, if there were no cruise ships sailing for the next six months, they might not have made it. But by doing those those high yield deals where there was strong demand for those deals, they’re able to extend their runway for two years, even if the Renault ship sailing for two years. Year to date, there’s been 212 billion dollars of new high yield deals among the 310 new deals. That’s versus only 183 deals at this time last year and only 120 billion dollars of proceeds. Last time this year. So these these proceeds have been used to fortify the liquidity of these companies.
When the market when their business has been closed or negatively impacted by the virus, how are these spreads relatable to the investor that’s going in and looking at is for one care, looking at his investments on a daily basis, is it just giving these companies a longer lifeline that hopefully they can stay in business a bit longer if if at all?
Sure. The improvement in credit has historically been very positive for equities, particularly small cap stocks, smaller companies, as those companies have more debt as a percentage of their their market value. The lower cost of borrowing money and the ability to borrow that money is very positive for them. And historically, the small cap market in particular does extremely well as spreads are declining. And that’s what’s happened over the last six weeks. And it also is a leading indicator for forward performance where small cap stocks have generally done extremely well for the next three years. Post spread tightening spreads of reach, a thousand basis points over treasuries. The next three years have historically been very good for small cap stocks.
There’s been a an argument out there to some or debate about the amount of stimulus that the Fed has done to to backstop the economy. Right. So they’ve stepped in and unprecedented levels and they’ve gone to the to the window and just backloaded as much as they could into all types of credit for companies. Can you give us just an overview? Has the Fed done too much? Are these inflated levels now in the markets because of the Fed? Is this just a temporary fix? And with the Fed coming out and saying interest rates are going to be held historically low for a good two and a half years now, how do you foresee that? What’s going to interact with equity markets and with rates staying where they’re at for the foreseeable future?
We believe the Fed’s one of the most important jobs at the Fed is to to create confidence in the financial system. And with the Fed keeping rates low, committing to lower rates, with the Fed supporting the corporate credit market by buying not only the exchange traded high yield funds, but also individual corporate bonds, both investment grade and non investment grade helps to stabilize the financial markets, helps it, helps banks, helps companies the ability to pay back when as things start to improve again, that the Fed right now is they still have plenty of ammunition. They’ve just started buying high yield bonds and high yield exchange traded funds. And we expect them to continue, especially if there’s any second wave for the virus or any bad economic news over the next six to 12 months. We expect them to be very active, but we believe the Fed is doing the right thing. It’s creating a more confidence in the system. It’s creating stronger banks, stronger credit and stronger housing market as well. The housing market’s been particularly strong here as opposed to in 2008 2009, banks were in a weak position. Housing was was failing. And there was zero confidence in the financial system during the depths of the financial crisis in 2008. This is not happen. It’s been almost the opposite this time.
Eric, I’m going to give you two scenarios. We kind of know where we’re at here. We’re not really sure how we’ve gotten here. Right. We know what’s happened to the economy and the small business owners in the Fed. But I guess what’s as important, if not more important, is where do we go from here? I’m going to give you two scenarios. I sat in on a webinar the other day and there was two different scenarios and they gave the bull the bull scenario. The markets continuing their climb. Their rapid ascension and then the bear scenario. And I’d like you to just comment on both of the bull case was number one and give three reasons. The bull case. Number one, he can’t fight the Fed. Number two, the reopening of the economy is going to go well. We closed the economy, so the reopen is going to go well. And number three, the vaccine and pandemic data that we have is all been very positive. The bear case stretched valuations in markets where we’ve come too quick, too soon. A second wave of this virus taking this out at the knees again, bending the curve and having shut down the economy again and then economic data. We have unemployment numbers that are a multi decade highs. I know I gave you both scenarios. Can you just give me a little bit of insight for both the bull versus the bear shirt commenting on on the bull side.
And this is the side that I lean on. The liquidity that the Fed is putting into the market is extraordinary, unprecedented. The amount of money that’s out there, the cash on the sidelines, the with the fiscal stimulus that is going in to the. The six hundred dollars additional in the unemployment benefits. All those things should help the economy reopen the on the on the vaccine side. There are dozens, if not more than eight companies working on a vaccine, working on a treatment for the drugs. I feel pretty strongly that some there will be a medical breakthrough. We’ve seen some very encouraging things so far. We do some of the data that we’ve seen. The early economic data, although on an absolute basis, is very bad. The unemployment numbers and so forth. But we’ve seen some. We’ve seen data that’s improving. It continues to improve. And that’s what’s important. If the investors start to see improving economic data to the point, we’re not going to get back to where we were in February real soon. But as things start to show more and more improvement, that’s that’s very positive.
We’ve got the housing market has been unbelievably strong. You’re seeing year over year gains in housing starts, which is pretty shocking this quickly. I’m on the better side. Valuations are high. I can’t argue that. But they’re high in particular areas of the market. The growth stocks, growth stocks have worked over the years because there’s been little economic growth. And we’ve been very slow and it’s scarce. So all the dollars have flowed into the fang stocks and the growth stocks and growth is trading at the highest premium. I have my career and it’s been over 20 years. I value stocks as cyclicals are trading at a big discount. Cyclicals, companies that do well as the economy does well. Those are trading at historic discounts to defensive stocks. Companies that are less impacted by the economy. So I think that there the market may trade water, but there are pockets that are very interesting.
I mentioned SmallCap. Why does extremely well coming out of a recession, coming out of when spreads got out I cyclical stocks value stocks should do better as the economy starts to get better. So I would agree that the overall market looks expensive, but we have to look beyond the last few months and look forward to the economic recovery. And typically that’s led by more cyclical value, smaller type companies. Regarding the second wave, certainly a risk. I think that’s a risk that almost everybody believes is going to happen. So if everybody believes it’s going to happen and it happens, maybe it’s already priced into the market, maybe it’s not. But if if it’s not as severe as people think, then that would be a net positive to the market. I don’t believe even if we do have a second, we think. I do not believe there is. There is a desire to shut down the economy the way we did the last time. And we’re just gonna have to, I think, will slow down. But they won’t be where we were in April and May with a completely shut down economy. Economic data, as you mentioned, it’s bad now, but it’s improving.
I think Washington and the government is going to try not to shut the economy down again. And I think if they’re owed this is just me personally, if there is a second wave. The fact that there would be a therapeutic or some sort of a vaccine might mitigate a lot of that fear, because going through this on the first, then we really didn’t have any that right there was the fear of the unknown. So if, God forbid, somebody were to get the virus, we didn’t know what to do. So was more of a panic. Right. And so we didn’t know what to do. And I read the other day, once again, there’s hundreds of companies that are out there working on this. So hopefully we hope that something comes through sooner than later. It’s already June and. Before we know it, everybody’s going to be wrapped up in the summer, it’s a completely different kind of a year, but November is right around the corner and I have to bring it up. Let’s talk about a couple of scenarios there now. Number one, Mr. Trump regains his second term. And then, as importantly, if the Democrats take over the White House and or the House and the Senate, what will that do economically? Eric, in your opinion with those two scenarios, please?
Sure. First, I want to say that last time we talked, Trump was favored to win by betting odds of over 90 percent back in February. Today, Biden is favored to win 55 percent to 25 percent. So I should say that nobody knows. Things can swing. We did. We.
There’s an eternity between now and the election. And things can swing in both directions multiple times between now and then. We also learn that polls can be very inaccurate from the last election. But in this scenario, where were Biden wins and the Senate becomes it becomes Democratic and all the houses are on the Democrat side. I would expect higher taxes. They’re done absolutely on the higher tax brackets. That would increase the corporate taxes. Biden has not given a lot of details on what his plan would be, but the corporate taxes would go up not to where they were before they went down. But I would expect it would be somewhere in the middle between where they were before the last tax cut for corporations and where they are right now on the. It would also depend somewhat on the Senate in terms of the composition if it was very, very close. You would. It would be difficult to get the real controversial bills through the Senate unless one House had one party had more than 60 votes. And we don’t see that happening.
These are things that are not only shaping our economy today, but also moving forward. These are the things that we need to be considering when we’re looking at our four one KS, when we’re looking at our investments. It’s not just listening to Jim Cramer and CNBC and going with the hot stock of the week. Right. There’s more things that drive the markets and there’s economic factors that we should all be aware of. And this is great insight from Eric Green at Pen Capital, who’s a great partner of ours. Harry, thank you again very much for joining us today.
Thank you very much for having me.
If you have any specific questions on what you heard today or if there’s anything else that we can help you with as relates to your life and your wealth, please give us a call.
Thank you for joining us today. For Steve Cordasco and Eric Green, I’m Dennis Yablonsky. Stay safe and have a great week.
If you’re interested in learning more about applying the principles we discussed to your personal financial circumstances, please visit Cordasco Financial Network at CNN Plans dot com or call our office at two one five five five eight thirty five hundred. We hope you’ll join us again next time on the Your Life Your Wealth network.