Credit Market & Stocks – Post Mortem
By Julien B. Booth
February 11, 2018
I hope this note finds you doing well.
After difficult week(s) in the financial markets we find it insightful to judge our underlying performance vs. our stated objective: Risk-Adjusted Total Return.
This past week the stock market was down -5.3%, high yield bonds -1.4%, and high-grade bonds -1.20%. No one likes drawdowns, but they are a part of the investing process.
For some time now (trailing 3-4 months) we have favored floating rate, hybrid securities, and selected high yield bonds, all securities that are senior in the capital structure.
Senior loans and other floating-rate securities generally reset to prevailing interest rates (3 month Libor). In the past few months Libor has been trending strongly upward. See chart at bottom. We found 6-7% yields downright attractive vs. the alternatives.
We often look stupid as we fade euphoric stock markets. This time was no different…equity asset prices (stocks) continued unabated, screaming into 2018. Fortunately, we were not fired as we under performed stocks.
As is often the case, Expectation is the root of all Heartache.
Interest rates are the gravity in the financial markets. Every asset is sensitive to the time value of money (discount rate). Fixed income securities are especially sensitive to rates – subject to credit quality and the duration/maturity of the asset. Additionally, in an age of massive leverage (borrowed money), interest rates become extraordinarily important for the level of all asset prices. Do we dare reflect on all the borrowed money during the 2007 housing bubble.
Stocks are long duration assets; they trade on a multiple of annual earnings (http://www.multpl.com/shiller-pe/). While a ten year U.S. Treasury bond yields 2.85%, the direction of rates, and velocity, can force owners to check their expectations.
This past week was no different, but in addition we have so many other elements of excess, crypto-currency speculation, massive bets on volatility, extreme bullishness, etc.
After fully reviewing this past week’s affect we are pleasantly surprised. Generally, NAV performance in our closed-end fund positions included modest declines (-2%), high yield bonds (-1.5%) and mortgage bonds (-2%). Our preference for income does not prevent portfolio declines, but it sure looks better than Dow -1050 pts.
The past week will be forgotten in the narrative of the longer-term story of the markets. It is part of the process. As always, understand what you own, the cash flow associated, and what the intrinsic value should be over time. Research is not an exciting story to tell…until it is.
As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at email@example.com.