Once upon a time, families would gather together on Thanksgiving, eat turkey and discuss the potential for a Goldilocks economy . . . but this year it’s all about the bears. Globally, cautious sentiment abounds, but we get tactically bullish on China which should recover while other areas slow. While higher rates spell bad news for CFOs (Chief Financial Officers) faced with refinancing debt, it’s good news for reinsurance companies.
Investor sentiment remained uber-bearish according to BofA Global Research’s November Global Fund Manager Survey. Investors kept cash levels high at 6.2%, just below last month’s 21-year peak of 6.3%. Additionally, net 77% are calling for a global recession. “Stagflation” (below trend growth, above trend inflation) is the overwhelming consensus view, at 92% of fund managers we surveyed. Moreover, they don’t expect the Federal Reserve Bank (better known as the Fed) to “pivot” “pivot” – or change course on rate hikes – until U.S. Personal Consumption Expenditures (PCE) inflation falls below 4%. Relative to the past 10 years, investors are long cash, defensives (Utilities, Consumer Staples & Healthcare), bonds and underweight U.S. Equities (Tech), Eurozone equities, and cyclicals. BofA Global Research Chief Investment Strategist Michael Hartnett suggests investors should “rent the pivot”. Given recent market action could just be a bear market rally.
Reversing two years of caution on China equities, Asia and Global Emerging Markets Equity Strategist Ajay Kapur finally turns tactically bullish. While long-term concerns on China remain, early signs of reversal along various vectors of uncertainty, most notably the relaxation of COVID-19 rules, should help China equities in the near-term. In addition to a pivotal change in the zero-COVID policy, Ajay highlights improvements in property, regulatory and monetary policies; but also reminds investors that geopolitical risks remain challenging. Sectors in the region that should benefit include Energy, Materials, Industrials, and Consumer Discretionary. BofA Global Research Chief China Equity Strategist, Winnie Wu expects large, liquid, index-heavy and high-beta stocks are likely to lead the performance. Helen Qiao, BofA Global Research Chief China Economist, expects a gradual Chinese-style reopening but warns that things will get worse before they get better. Helen expects many in China will stay at home initially, not due to official lockdowns, but rather to avoid the peak of infections.
In the new world order of higher interest rates, CFOs looking to refinance debt coming due in the near-term face a materially higher cost of capital. Although many companies were wise to lock in low rates on their corporate debt over the last few years, some have upcoming maturities that management teams need to address, something that could lead to reduced buybacks or lower spend. Credit analyst Larry Bland and our Credit Research team examined recent changes to capital allocation strategies for about 800 companies across both High Yield (HY) and Investment Grade (IG) bonds. Across a wide spectrum of sectors, we lay out near-term maturities from 2023-2025. HY issuer balance sheets are in reasonably good shape, considering the challenging macro environment. Maturity profiles have been pushed out, with 85% of bonds maturing 3yrs out and beyond. As for IG, despite higher corporate bond maturities next year, we expect lower issuances driven by high borrowing costs, less M&A (Mergers & Acquisitions) funding needs and a slowdown in bank supply.
There is a corner of the market where higher rates and tighter money is actually welcome. Reinsurance has suffered through years of low rates and depressing investment income, which forced companies to compete with a deluge of capital from fixed-income investors rotating into catastrophe risk as they sought higher yields. But as mentioned, the rate picture has changed, and these stocks are now breaking out and Insurance analyst Josh Shanker believes that strength will continue. Josh believes reinsurance is a better business with superior long-term book value per share growth owing to thinner expense structures, increased capital diversification, tax arbitrage and lower regulatory oversight.
We give thanks to all of our regular readers. Must Reads returns December 4th.
