As the U.S. economy snapped back to life after the worst of the pandemic lockdowns, it was apparent some industries were hit harder than others. Restaurants, airlines, in-person retail and leisure suffered most as society grew more comfortable meeting virtually, shopping online and getting food delivered. While these industries were tagged as “social distance losers,” not all companies in this category are falling in a downward spiral into nonexistence. Some of these companies will rebound and thrive, while others will struggle.
We believe the U.S. airline industry, for example, remains an attractive re-opening investment trade. The airlines have strong support from the U.S. government while also doing whatever it takes to raise liquidity, including issuing debt backed by airline mileage and loyalty programs, routes, slots, and gates. Airline bonds rallied last year, reflecting investor enthusiasm for the coming end to the pandemic and the subsequent expected rise in airline travel. However, the Delta COVID variant resulted in airline traffic stabilizing at 75-80% of 2019 levels. We expect this holding pattern to continue over the near term until travel ramps back up to pre-pandemic levels.
Demand for residential real estate skyrocketed during the pandemic, although would-be-buyers discovered a market devoid of supply. Low rates, limited supply and high demand have led to all-out bidding wars.
At the root of the overheated housing market is a chronic lack of new home supply, which pre-dates the pandemic. The home building industry never fully recovered from the 2008 crash, causing a massive under-supply of new homes across the country (Figure 1). The U.S is about 4 million homes short of meeting current demand, according to Freddie Mac.
The supply shortage is estimated to last another decade or so. Like most industries, homebuilders are having trouble hiring workers. In the meantime, we believe the favorable supply/ demand imbalance creates opportunities for investors in several asset categories, including credit risk-transfer securities, legacy, non-agency mortgages and mortgage loan originators that issue unsecured credit.
Figure 1: New Housing Starts Never Recovered From the Last Bust | As of May 31, 2021
The first wave of the pandemic – the second quarter of 2020 – will always be remembered for the lockdowns, school closures and the social distancing that changed everyday life for millions of people. Trapped at home with little else to do, Americans stashed more cash into their savings accounts than ever, and the personal savings rate skyrocketed to 33.8% in April 2020, an all-time high (Figure 2). Although it has fallen since last year, the savings rate remains elevated versus the long-term average and the consumer is in better financial shape today than before the pandemic.
In this environment, we favor securitized credit and asset-backed securities, in addition to certain consumeroriented financial companies. With robust savings and a strong employment market, American consumers are in great fiscal shape.
Figure 2: Personal Savings Rate Skyrocketed During the Pandemic | As of June 30, 2021
We think preferred subordinated securities, such as preferred stock, offer relatively attractive yields in today’s low-rate macro environment. As shown in Figure 3, preferred equity yields are similar to those of high-yield bonds. But not all issuers are created equal. We seek out high-quality preferred issuers to help manage potential risks such as bankruptcy to seek to take advantage of these attractive yields.
While preferred debt provides income opportunities, they also feature less sensitivity to interest rate changes. Preferred income may also be tax advantageous as qualified dividends are taxed at a lower rate than ordinary income.1 Preferreds also have characteristics that make them less correlated with other asset classes giving them a place in investors’ portfolios. These securities are generally issued by banks, insurance companies, REITs and other diversified financials as well as utility, energy, pipeline and telecommunications companies.
Figure 3: Preferred Securities Offered Compelling Yield Opportunities | As of September 30, 2021
The Fed has set its key policy rate near zero while simultaneously purchasing billions in Treasuries and Mortgage Backed Securities (MBS) each month. But today’s central bank worries are much different from prior periods when rising rates were most concerning to investors. The Fed’s biggest worries today are rising inflation and maintaining price stability (Figure 4). Given these headlines, investors are nervously anticipating the potential taper of the Fed’s current bond purchase program, which includes about $120 billion combined in Treasuries and MBS per month.
Regardless of what happens with rates, we think the conditions for high coupon, premium MBS will remain attractive for some time. We believe some borrowers will not refinance. We look for borrowers who previously fit this pattern while also targeting areas of the country with a higher threshold to refinance.
Our theme regarding the housing market also applies here. We see demand for homes remaining solid for years to come, as the supply shortage will persist. Rates should stabilize at an acceptable level for many home buyers and borrowers, offering support to MBS investors.
Figure 4: 10-Year Treasury Yield and Federal Funds Policy Rate | As of September 30, 2021
Conclusion: An uneven recovery suited for active managers
We expect economies and markets to continue recovering for the foreseeable future. While it’s impossible to say when we will put COVID in the rearview mirror, we expect the more challenged industries to bounce back gradually. However, not all will enjoy the same degree of recovery, which is why an active, risk-managed approach is critically important in today’s market. That’s why the MacKay Shields Global Fixed Income team invests in high conviction ideas, which employ a top-down, bottom-up approach. In today’s challenging markets, we focus on strong risk controls and seek diversified sources of return and income potential. Our team has demonstrated how a broad investment approach that considers an expansive multi-asset universe can surface compelling investment opportunities, including in low-yield and volatile times like these.
Footnotes and references
1. Not to be construed as tax advice. Consult your professional tax advisors for specific guidance.
The ICE BofA US BB High Yield Index, a subset of the ICE BofA US High Yield Master II Index tracking the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market. This subset includes all securities with a given investment grade rating BB. The ICE BofA Core Plus Fixed Rate Preferred Securities Index tracks the performance of fixed-rate US dollar denominated preferred securities issued in the US domestic market. This index is comprised of 100% retail securities and does not require securities to be investment-grade rated. The Bloomberg US Intermediate Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market whose maturity ranges between 1 to below 10 years. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers. The Bloomberg US Treasury Intermediate Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with maturities of 1 to below 10 years to maturity.
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