During the first few months of the year we’ve seen rising government bond yields and a value-led equity market rally. The Democratic senatorial victories in Georgia at the start of the year paved the way for further fiscal stimulus, and the successful vaccine rollout in the U.S. and the U.K. are largely to thank for the strong performance of markets YTD.
As of mid-April, over 37% of Americans and 58% of British adults have now received at least one dose of a vaccine. The vaccine rollout in the U.S. has seen the rate of hospitalizations from COVID-19 fall significantly from the beginning of the year, and for the first time in a long time, it seems that a return to some level of normalcy is almost within reach. Supported by recent data, investors are cautiously optimistic about economies reopening and such sentiment was reflected in the markets with a strong equity rally.
It’s hard to comprehend that it’s been over a year since global risk markets cratered as investors grappled with the notion of a global pandemic for the first time in over a century. Over the one-year period since bottoming out in March 2020, the MSCI world has rallied 79% and is now trending 18% above it’s pre-COVID-19 highs. U.S. Markets are up over 10% YTD, and the 10-year U.S. Treasury yield now stands at ~1.5%, vs. 0.5% at the low in August and 0.9% at the start of the year.
Investment grade and high yield corporate bond credit spreads, a measure of credit risk, are relatively flat in April, but have both tightened YTD and are approaching their tightest levels (lowest credit risk) in the last 5 years. A large swath of the market is due to release earnings over the coming weeks, and a meaningful pickup in new corporate bond issuance will likely follow. It’s the uptick in supply that could cause investors to take pause as they review the relative value of money center bank (JP Morgan Chase, Bank of America, etc.) yields to those available in other sectors.
While the outlook remains positive, some concerns exist given the potential for increases to corporate tax rates in the U.S. A corporate tax increase is feared to put significant downward pressure on corporate profits. It’s important not to forget that the impact of recent monetary and fiscal stimulus will likely be felt into 2022 and may act to lessen any negative impacts.
Inflation is also expected to continue to rise off of the low bases established during the spring of last year. Inflation is expected to normalize by late summer as the effects of recent stimulus winds down. Consumers have been excited and willing to spend, but may soon see the burden of high debt levels catch up and long-term secular headwinds, such as an aging population, will once again likely dampen growth. As such, inflation will likely settle again at levels below central bank targets.
Asset Class Summary
For a period of time during April, it was nearly impossible to have a conversation without a digression into the NFT or Non-fungible tokens market. What initially seemed to be something destined to be isolated to Gen Z made waves when Christie’s sold an NFT of the artist Beeple’s work for $69M in April. With traction growing for this form of asset, Sothebys and Phillips have now joined Christie’s to offer NFTs to the market. What this all means will likely still take time to determine, but the influence of technology into a very antiquated art auction market could lead to consolidation and M&A activity between auction houses and NFT trading platforms. From this, there will likely be downstream effects that impact the art financing space.
Another notable event in April was a recent Bank of America report that highlighted the growing divergence between real assets relative to equity markets. In summary, real asset valuations are at their lowest levels since 1925 relative to equity markets and investors are likely underexposed to them. As inflation concerns continue to lead the list of investor concerns, demand for real assets may begin to rise.
Like most institutions, COVID-19 closed court systems around the country. In recent months, court systems have gradually begun re-opening, however, cases are still materially backlogged causing law firms to look to bridge financing loans to cover their shortfall until expected settlements are received.
The COVID-19 pandemic and its subsequent strains on businesses is expected to result in the uncovering of years worth of corporate fraud. The legal finance industry is expecting a demand for capital to fund a wave of lawsuits over the coming years. We see some opportunities in COVID-19 related cases, similar to that of NY State vs. Amazon, in which the state has filed a lawsuit alleging the company failed to protect its workers during the pandemic.
Numerous cases have been filed as a result of the recent winter storms and subsequent power shortages in Texas. For example, there have been over 30 cases already filed in natural gas lawsuits. In a single week during the storm, natural gas sales were 5 times what they were in all of 2020, causing electricity bills to skyrocket. Unsurprisingly, these bills have often gone unpaid as the allegations of price gouging by utility companies have grown louder. If proven, settlements could be in the billions of dollars, but plaintiffs will need to be cautious as many of the utility companies won’t be able to afford the damages and may need to file for bankruptcy.
We predict that loan growth for big banks will continue to be soft until the end of June as PPP loans wind down and attention is turned to renewal season, which will likely consume most of their underwriting activities. We expect the second half of the year will see banks redirect their focus to heavy loan growth to continue to drive revenues. Banks, due to their capital reserve requirements, are very cautious around overextending credit, which means any increase in loan growth supports their optimism and is a positive for the rest of the market.
With intense pressure on banks to grow their loan volumes, this will likely lead to lower rates throughout the market as the largest lenders bid to win loans.
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