weekly relative value - alloya corp · where do we go from here? last thursday was week five of the...

Weekly Relative Value

www.alloyacorp.org/invest

WEEK OF APRIL 27, 2020

Tom Slefinger SVP, Director of

Institutional Fixed Income Sales

Where Do We Go From Here?

Last Thursday was week five of the collapse of the labor market with an additional 4.42 million employment claims reported. That brings the five-week total to 26.5 million, which is over 10 times the prior worst five-week period in the last 50-plus years. Amazingly, COVID-19 has wiped out five million more jobs than were created over the past decade.

Source: Bloomberg

And layoffs are still happening in large numbers. This coming week an additional 3+ million new claims are likely to be reported. In addition, contract workers, self-employed and gig workers will show up in larger numbers in the claims going forward. So, the gut-wrenching tally will continue to balloon for a few weeks.

Source: Hedgeye

THIS WEEK

• UNINTENDED CONSEQUENCES

• “HOMEBODY” ECONOMY

• HOMESICK

• OVER 6% OF ALL MORTGAGES IN FORBEARANCE

• THE GOOD NEWS

• DID YOU KNOW?

• BONDS HAVE MORE FUN

PORTFOLIO STRATEGY

“We are looking at a world with parameters bounded by pure imagination; where we go from here is anyone's guess.” – Will Thomson and Chip Russell, Massif Capital

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ALLOYA INVESTMENT SERVICES WEEKLY RELATIVE VALUE | 2


The number of the “insured unemployed” – often called “continued claims” – skyrocketed to 15.98 million, by far the highest in the history. The high before this COVID-19 era was 6.63 million in May of 2009.

Source: Bloomberg

The insured unemployment rate – the share of the labor force claiming jobless benefits as a percentage of the labor force (total number of employed plus unemployed) – jumped to 11.0% from 8.2% in the prior week. Assuming all who filed for benefits are counted as unemployed, the latest figures suggest an April unemployment rate potentially as high as 20%. That is double the rate reached during the Great Financial Crisis in 2009. That is just ugly.

Source: Bloomberg

And there is simply nowhere to hide. The wave of losses, which began with restaurant, hotel and factory workers, is now hitting office and support workers. As shown below, layoffs are hitting every industry and income group.

Source: Oxford Economics

In addition to job cuts, many companies have reduced pay and/or hours. A Gallup poll shows that 25% of American workers now say it is either “very likely” or “fairly likely” that they will lose their job in the coming year (survey conducted from April 1-14). We have not seen anything like this in at least 40 years.



UNINTENDED CONSEQUENCES

The additional $600/week bonus is in addition to state unemployment benefits, which vary widely, from a maximum of $235 per week in Mississippi to $795 per week in Massachusetts. This means that for the next several months, unemployed workers will be bringing home at least the equivalent of $15 an hour based on a 40-hour work week.

According to a report by the Georgetown Center on Poverty and Inequality, 42.4% of people working in the U.S. in 2015 earned less than $15 an hour.

In many cases it is financially rewarding not to work, and millions upon millions of Americans are going to be more than happy to take advantage of that opportunity for as long as it lasts.

So how is the economy supposed to “get back to normal” if more than 40% of our workers would be better off unemployed?

Without workers, we do not have an economy, and right now we are incentivizing people not to work.

“HOMEBODY” ECONOMY

The pandemic has impacted spending patterns in a significant way. Check out Virus Outbreak Alters American Shopping Lists in the Wall Street Journal.

The article starts with: “Consumers are cooking and cleaning more while spending less time and money on grooming and makeup, consumer-products companies say, as a picture emerges of how the coronavirus is reshaping lifestyles.”

This speaks to a rising personal savings rate ahead — which will prevent the government stimulus from having a full impact on growth. And this is backed up by the incoming economic information, which suggests that consumers are pulling back. For example: The Redbook weekly data show that U.S. retail sales plunged 10% in April. (This would be unprecedented. The prior record plunge was in March, down 8.7%.)

Barring a vaccine, which according to experts, is at least a year away, spending patterns are going to keep shifting away from consumer discretionary goods to essentials. Most likely we will witness rising savings rates as well as more and more Americans pinching their pennies. But it is safe to say people will not be sacrificing soap, detergent and tissue paper for the trip to the theme parks (even if they do re-open). And pizza is something that nobody sacrifices under any circumstances. To wit: Domino’s just reported a 7.1% year-over-year sales increase (from March 23 to April 19).

“History suggests consumers’ preferences for home-cooked meals might persist well after the initial shock.”

The CARES Act includes a $600-a-week bonus until July 31 for those registered as unemployed. The $600 is issued in addition to the standard unemployment benefit, which varies by state and by individuals’ record of previous earnings.



The question now is which behaviors will stick and which will fade when restrictions to fight the pandemic are lifted. There are other surveys with different timelines and activities, but they all point in the same general direction: This is not going to be like turning on a light switch.

Source: CBS News

HOMESICK

New home sales crashed by 15.4% month-over-month – the biggest drop since July 2013 – smashing the year-over-year comparison down 9.5%. This is the biggest decline for March... ever! March was the first month when U.S. state closures of restaurants, retailers and other non-essential businesses became more widespread. The data underscore how the pandemic and broader uncertainty about the economy is thwarting potential homebuyers.

Source: Bloomberg

Likewise, mortgage applications to purchase a home in the U.S. during the week ended April 17 plunged by 31% from a year ago, and by 41% from the peak in January. It was the fifth week in a row of year-over-year plunges and the third week in a row in the minus 31-35%. The purchase mortgage application data are an early indication of demand by regular people trying to buy a home.

But it is likely much worse.

Again, when looking at the mortgage application data, it is important to understand that none of potential buyers – nonresident foreign investors, large U.S. investors, and instant buyers (iBuyers) – are included. And demand from those three sources has evaporated. So, the drop in housing demand is likely larger than the 31-35% drop depicted by mortgage applications, which reflects mostly regular folks trying to buy a home.



OVER 6% OF ALL MORTGAGES IN FORBEARANCE

According to the Black Knight as of April 23, 2020, more than 3.4 million homeowners – or 6.4% of all mortgages – have entered into COVID-19 mortgage forbearance plans.

This population represents $754 billion in unpaid principal and includes 5.6% of all GSE-backed loans and 8.9% of all FHA/VA loans

At today’s level, mortgage servicers are bound to advance $2.8 billion of principal and interest payments per month to holders of government-backed securities on COVID-19-related forbearances. Another $1.3 billion per month in lost funds is faced by those with portfolio-held or privately securitized mortgages.

FHFA very recently announced that principal and interest (P&I) advance payments will be capped at four months for servicers of GSE-backed mortgages. Even still, servicers of GSE-backed mortgages could still face more than $7 billion in advances based on the number of forbearance plans thus far. Regardless of a borrower’s forbearance status, servicers of loans in government-backed securities must make advance P&I payments each month for these loans.

Meanwhile, refi applications have skyrocketed. Prepayment activity jumped by nearly 40% in March, driven by record-low 30-year mortgage rates. Refi applications in the week ended April 17 nearly tripled from a year ago, and now account for 75% of all mortgage applications.

Source: Bloomberg

Likewise, in jumbo-land, 5.5% of “jumbo mortgages” (> $510,400), about 131,000 borrowers, have asked to postpone payments due to a loss of income. Thus, credit standards are now tightening across the board, as lenders are getting



cold feet in the era of forbearance, and the availability of jumbo mortgages has plunged in states such as California, New York and Washington. For the survey week ended April 17, purchase mortgage applications in California and Washington plunged by 48% year-over-year, and in New York by 58%. In many of these markets, a home with a median price would have to be funded with a jumbo mortgage, which banks have to deal with on their own.

THE GOOD NEWS

It is not all bad news. The really good news is that the World Health Organization (WHO) reported 83 vaccines are in development globally, with six of them at the human trials stage.

Vaccine production capacity will be key. We will need millions per week and eventually billions per year. This is a global crisis and must be treated globally.

The first vaccinations should go to healthcare workers, then those providing necessary services like food, power, and so forth. Then those who are most at risk, and finally everyone else.

DID YOU KNOW?

The Fed is purchasing $41 billion of assets on a daily basis (expanding 50% in just the past six weeks) to $6.4 trillion or 30% of GDP, the European Central Bank (ECB) is at 39% of GDP and the Bank of Japan’s (BoJ) balance sheet is more than 100% of GDP.

Source: Bloomberg

How are markets supposed to function with central banks owning so much paper? Just because the BoJ owns 5% of Japan’s corporate bond market and 5% of the stock market (via exchange-traded funds) does not guarantee investors a one-way ticket to prosperity, because that largesse did not exactly prevent Mr. Market from ripping everybody’s face off during this bear market phase.

The Fed is surely going to continue to fight the “negative wealth effect” really hard. But in the end, when you are buying an equity, you are de facto buying an earnings stream. The bulls tell you to “normalize” earnings with no regard that the future profits stream for airlines, financials, theme parks, restaurants, movie theaters, retail, commercial and mall real estate, and energy have been permanently impaired. As for Q2 earnings estimates, since the end of March, the consensus has been pared to -25% year-over-year from -10% (this comes atop a 15% drop for Q1).

“Look, think of it like 71 shots on goal. The more we try the more likely we are to score… Of those, probably 10 or so will look promising enough to draw funding.” – Dr. Kim



Also, we have to keep in mind what the “market” really represents. There are five mega-caps (Microsoft, Apple, Amazon, Alphabet and Facebook) that account for 20% of the total market capitalization of the S&P 500. You have to go back to the Nifty Fifty bubble five decades ago to have seen such a lopsided market... and that period did not end well.

The one thing the central banks have not been able to do is change the extremely poor shape that business balance sheets are in. The S&P has made 125 upgrades and 1,270 downgrades so far this year. That is more than a 10-to-1 ratio. So, the Fed can distort market pricing but cannot change the reality of ever-eroding credit quality.

And it cannot be denied who the losers are as we see J.C. Penney in advanced bankruptcy funding talks, Sears continuing on its course of shuttering stores and dumping assets, Macy’s planning to close 125 locations in the next three years and the Neiman Marcus Group planning to file for bankruptcy. Did you know that Gap has warned that it has burned through half its cash holdings, even after drawing down its entire credit line —and skipped its April rent payments!

BONDS HAVE MORE FUN

I do not think this is universally recognized, but in the past 10 years, the total return for the S&P 500 has been +10.7% at an annual rate and +9.8% for the long bond. In the past 20 years, stocks have returned 4.7% annually; and +8.1% for the long bond. And in the past 30 years, the S&P has delivered investors a net +8.2% average annual return and that comparable is +9.0% for the long bond. And so, which of the two really did, over time, produce the superior “risk-adjusted” returns?

Source: Hedgeye

Imagine that — all of the Fed’s quantitative easing in support of the “wealth effect” on spending, relentless fiscal stimulus, including huge corporate tax cuts to stimulate “animal spirits,” the various bailouts, all the 401(k) cheerleading from the Oval Office, and this is the best the stock market can do?



No doubt, there are risks in Treasury bonds, mostly from inflation and Fed cycles. There always is duration risk. But unlike stocks, you have no capital risk — you know exactly what you are getting paid upon maturity. That is surely not the case with equities as an asset class. So, when your advisor tells you about “stocks for the long run,” ask him why “bonds have more fun”— with a far smaller risk profile and far less volatility.

MARKET OUTLOOK AND PORTFOLIO STRATEGY

The pandemic’s impact on economic growth and inflation is gaining traction, but is yet to be fully incorporated in financial markets. With the entire U.S. economy shut down, 15-20% unemployment, and -20% GDP and with global demand cratering, the Fed’s preferred measure of inflation will likely fall to 1% or even lower by the end of the year — well below its target of 2%. And in the absence of a COVID-19 vaccine, the malaise will likely persist well into 2021.

A rising personal savings rate ahead will prevent the government stimulus from having a full impact on economic growth. This will make the demand-driven organic inflation the Fed has been seeking extremely elusive in the coming months.

And, as shown below, inflation expectations continue to decline. In fact, according to the Cleveland Fed, inflation expectations over the next decade have reached an all-time low.

Source: Bloomberg

Recall that the Fed was already struggling with inflation creation long before COVID-19 redefined the global economy. If an environment with nearly full employment is unable to trigger the needed wage-gains, then how do the layoffs of millions of workers solve the problem? In a vacuum, it will simply exaggerate the issue.

Source: Bloomberg

“So, the Fed is left no good argument against going negative. Terrifyingly high unemployment and potentially rapid disinflation are powerful arguments in favor. Next week, the Fed should take interest rates at least a quarter

percentage point below zero.” – Narayana Kocherlakota, former President of the Federal Reserve Bank of Minneapolis



The Fed officials hold their Federal Open Market Committee (FOMC) meeting this week, and all the lights on their dashboard will be flashing red.

Unprecedented situations require unprecedented actions. That is why some believe the Fed will go NEGATIVE! In fact, last week former Fed Minneapolis President Narayana Kocherlakota wrote a Bloomberg article encouraging the Fed to go negative!

Source: Bloomberg

The one thing that continues to be dismissed is the extent of the economic damage already incurred and how long the carnage will last. The National Association of Business Economists (NABE) just released its latest forecast (conducted from April 13-16) and 86% of the respondents expect the U.S. economy to shrink right through to the first quarter of 2021 (another 8% see any rebound by then being little more than a 1% annual rate of growth in real GDP).

Bloomberg Economics has sliced its forecast for 2020 global GDP to -4% from -0.2% in the latest projection — a huge swing from +3.3% at the start of the year. To put -4% global GDP growth into perspective, the contraction during the Great Financial Crisis over a decade ago was -0.1%.

Source: Wall Street Journal

The one thing I am certain of is that the recession that is in full swing now will outlast the pandemic itself. Unless the federal government comes to the aid of state and local governments, rest assured services will have to be curbed. Businesses who are operating at less than full capacity will not be able to hang on to the staffing levels they had prior to the crisis. Many at the low end of the income scale will continue to be dependent on jobless benefits, food assistance and other financial help. And it is still not apparent as to how much lasting damage to the economy has already been incurred.

With this backdrop, the 10-year yield downward trend remains entrenched as interest rates continue to converge with yields in Japan and Europe while heading toward ZERO.



As such we continue to advocate that credit unions continue to invest excess cash reserves in a high quality, diversified risk appropriate ladder strategy

Source: Bloomberg

PREMIER PORTFOLIO

Alloya Investment Services’ online trading platform, Premier Portfolio, has been making a positive impact at credit unions across the corporate’s membership since its launch in 2018.

Visit www.alloyacorp.org/premierportfolio to learn more about Premier Portfolio and how it can benefit your credit union!

MORE INFORMATION

For more information about credit union investment strategy, portfolio allocation and security selection, please contact the author at [email protected] or (800) 782-2431, ext. 2753.

Tom Slefinger, Senior Vice President, Director of Institutional Fixed Income Sales, and Registered Representative of ISI has more than 30 years of fixed income portfolio management experience. He has developed and successfully managed

“Premier Portfolio is user-friendly and modern. It allows us to browse current offerings and make immediate purchases at any point throughout the day. The tracking mechanism in Premier Portfolio is very hand. Since the system knows what dollar amount is currently owned in a financial institution, there is no room for error. We love the ability to check term and rate on a single summary. Premier Portfolio takes the guessing out of the equation. It is a highly useful tool and would recommend to anyone using Balance Sheet Solutions (now Alloya Investment Services).” – Darin Higgins, President of Western Illinois Credit Union

“While it’s always great to connect with our Balance Sheet Solutions, (now Alloya Investment Services), Account Executive one-on-one, Premier Portfolio is an amazing and easy tool to use in purchasing investments. We have access to statements, online trading and the ability to look at all of the offering in one place. I highly recommend trying this out!” – Shawn Nikkel, Finance Director of Denver Fire Department FCU

“Premier Portfolio’s online services allows me to access statements and overall market analyses, review a list of available security offerings, as well as purchase SimpliCD’s and Alloya’s certificates. Premier Portfolio is convenient, easy, secure, and has become my go-to place for investing!” – Rhonda Schroeder, CEO of Blackhawk Area Credit Union

http://www.alloyacorp.org/premierportfolio

mailto:[email protected]



various high profile domestic and global fixed income mutual funds. Tom has extensive expertise in trading and managing virtually all types of domestic and foreign fixed income securities, foreign exchange and derivatives in institutional environments.

At Alloya Investment Services, Tom is responsible for developing and managing operations associated with institutional fixed income sales. In addition to providing strategic direction, Tom is heavily involved in analyzing portfolios, developing investment portfolio strategies and identifying appropriate sectors and securities with the goal of optimizing investment portfolio performance at the credit union level.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alloya Corporate Federal Credit Union, Alloya Investment Services (a division of Alloya Solutions, LLC), its affiliates, or its employees. The information set forth herein has been obtained or derived from sources believed by the author to be reliable. However, the author does not make any representation or warranty, express or implied, as to the information's accuracy or completeness, nor does the author recommend that the attached information serve as the basis of any investment decision and it has been provided to you solely for informational purposes only and does not constitute an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such.

Information is prepared by ISI Registered Representatives for general circulation and is distributed for general information only. This information does not consider the specific investment objectives, financial situations or needs of any specific individual or organization that may receive this report. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities. All opinions, prices, and yields contained herein are subject to change without notice. Investors should understand that statements regarding prospects might not be realized. Please contact Alloya Investment Services* to discuss your specific situation and objectives.

*Alloya Investment Services is division of Alloya Solutions, LLC.

weekly relative value - alloya corp · where do we go from here? last thursday was week five of the...

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