Every month that passes by brings more visibility on the economic impact of the Covid-19 virus past, present and future.
Reported economic and corporate data highlights the extent of the damage inflicted, and most governments are now rushing through measures to re-open economies whilst managing the end of the first wave of infections and preparing for a possible second wave later in the year. Most risk asset classes have seen substantial price recovery, supported by central bank and government policy stimulus.
In this uncertain environment some certainties have become apparent: the underlying quality of the companies targeted is more critical than ever. Similarly, the race for yield in a uniquely low interest rate setting is full on.
A cornerstone of J. Stern & Co.’s investment philosophy is our focus on the quality of companies in our selected investment universe. Recent performance across markets has been mostly driven by such securities. By contrast, many high yielding equities with weaker underlying business models have fallen foul of the current harsh economic realities and have had to cut their dividends, prompting sharp share price underperformance.
With central banks flooding financial markets and economies with liquidity in order to avoid a global economic collapse, a record $11 trillion of debt is currently yielding less than zero. Beside the purchases of central banks, demand from institutional investors is as strong as ever. Negative yields are forcing investors further out along the risk curve to deliver income.
Despite this, the corporate debt asset class is providing investors with a unique opportunity to generate an attractive income, with fundamental downside risks being mitigated by the liquidity support and corporate bond purchases from central banks. The months of February and March saw one of the most violent selloffs in credit markets on record, with falling bond prices leading to a rapid widening of credit spreads across both developed and emerging markets. Spreads were trading at their widest in 11 years, levels not seen since the global financial crisis. This rapid adjustment is understandable given the unprecedented nature of Covid-19 and the uncertainty which it has created. However, the massive outflows from riskier asset classes were exacerbated by a total lack of liquidity.
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