Amid the panic and uncertainty lies solid reasons for optimism, says portfolio manager
Yes, the world is in a state of panic as COVID-19 ruthlessly cuts through cities and communities. Yes, the democracy of the most powerful western country is being challenged by the prospect of prolonged post-election legal battles.
But, according to Geoff Castle, of PenderFund Capital Management, under the surface of an abundance of headline risks are many positive factors that he believes will support credit and other risk assets going forward.
1, Risks are known
He said many of the unknowns surrounding COVID-19 have come into much clearer focus. Masks and distancing create inconvenience, but these practices, when adhered to, seem to work.
“We know much more about who is vulnerable to the virus and how to protect them. Hospital outcomes have improved. And a vaccine, howsoever imperfect, appears likely to arrive sometime in 2021. Whether further recovery comes by leaps, or by grindingly slow progress, the uncertainties of recovery from COVID-19 become smaller every day.”
2, The hedges are on
Given the risks associated with the U.S. election and the uptick in measures such as the CBOE put-to-call ratio, PenderFund suggested that some of the recent volatility has resulted from hedging activity. But for every hedge put on, Castle said, eventually a hedge must be taken off.
He explained: “There is really no central record of temporary de-risking and position hedging on at any one moment, but we can attest that in the last six weeks we have personally observed much more risk-off behaviour than usual. Given the hedgers have to cover, we are buyers of this wall of worry.”
3, Our bogey is zero
“Well it’s not exactly zero, but a five-year Government of Canada bond, for instance, yields about 0.4%,” Castle said, adding that as he looks to other markets that have ended up with risk-free rates below the zero-lower-bound, he sees a history of fairly striking spread compression.
“Given high-yield credit spreads around their historic 5% range, there does appear to be continued scope for tighter spreads. And tighter spreads are good news for credit and other risk capital markets.”
4, The Fed is engaged
The Fed has the tools to manage a spike in risk premia with its unlimited firepower. There are indeed problems that a central bank can’t fix, but PenderFund beleives a nominal price collapse in domestic markets is not one of them.
Castle said: “We could list other factors that give us optimism amidst the current gloom. The rise of modern monetary theory as a boost to fiscal spending expectations is one. Another is the almost inevitably favorable comparative results that will arrive once we begin annualizing Q2 2020 numbers. There are many factors that encourage us to take sensibly considered credit risks in this environment. Will you light this single candle of optimism or will you choose to curse the darkness? The choice is yours.”
