Much fear has been spread already on the health of banks, recession likelihood, and the scissor effect of high rates and high inflation. Let’s not over-darken the picture, but also be conscious about what comes next.
First a recap on where we are in the cycle. The tech valuations brutally deflated in 2022. ARKK fund plunged 75% from Dec21 to now. There has been some repricing in fixed income, culminating with SVB and other banks failure. The weaker banks are still under the cosh, Deutsche Bank and First Republic have been the latest under attack. Now everybody and her sister is either short bank stocks, or is squaring her books from any over-exposure to lower tier 1 banking paper. You know, these infamous contingent-convertible debts that transform into equity when banking ratios hit the fan.
Despite all the hou-ha of the investor community, it is not unjust that these papers go to zero, it is simply a sign that the system is working and getting risk takers their penny worth.
Commercial real estate seems to be the next area of concern. Commercial spaces struggle to fill up. To be convinced, just walk into a Wework office or down main street to look at empty commercial property spaces. Higher rates and low foot traffic continue to squeeze developers, and lessors.
According to Marathon Asset Management, a credit fund manager, $1tn of commercial property loans are coming due this year. As per Goldman Sachs, over half of $5.6tn of outstanding commercial loans sitting on bank balance sheets. Blackstone’s BREIT and other REITs have already been gating investors to limit the outflow. Listed REITs are already down 30% from Dec21 peak (as per FREL US). How long this credit crunch can be contained in the absence of an economic pick-up?
Well, enough of the doom mongering. In short, it means that we are entering the end game when credit contraction finishes to push economies into recession. We don’t aim to resolve all the world’s problems, but we may guess what happens next. Governments and central banks step up their intervention to save the day. This includes lowering rates. We end up more indebted as nations, and live happily ever after until the next crisis.
So what do you do?
First, you make sure that your banking relationship is diversified, and you get a direct market access through a managed brokerage account. No intermediation risk, higher return. Do it now. I can help.
Second, it pays off to be exposed to short-duration high quality paper, and also longer duration investment grade that would benefit from the rate curve further crashing down. On equity, the under-weight US is playing out in favour of an overweight on EM markets. Extreme credit risk remains unattractive neither in high yield US or Asia, nor in deeply discounted financial paper, nor in consumer debt, where we expect higher default rates. Overall, liquid assets have priced in a lot of what’s coming and I’ll add to those, as opposed to private assets that haven’t been marked down yet.
Again, stressful situations offer market repricing opportunities. Just make sure you’re not catching a falling knife.
360 Advisory LLC is a Boston-based RIA managing investments