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20 July 2021

The Reopening Trade Still Has Legs

By Robert O. Abad

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Market nervousness around another global COVID-19 flareup has brought into question the sustainability of the economic reopening trade, and rightly so. Over the last 12 months, sectors such as airlines, cruise lines, hospitality and some segments of retail—all were initially written off during the peak pessimism period of 1Q20—have stormed back, producing handsome gains for those fixed-income investors who saw the deep value potential of those sectors. Now these hard-fought gains appear to be at risk.

In our view, we don’t think a material pullback is likely in these reopening sectors, but should we experience another market panic similar to that of March 2020, we would view it as another compelling buying opportunity. This conviction is premised upon the fact that global vaccination rates are markedly higher versus a year ago (which goes a long way to mitigating material spikes in hospitalization and mortality rates) as well as upon the resolve of policymakers and central bankers globally who have yet to remove the aggressive accommodation currently in place. If anything, their rhetoric suggests they will remain highly vigilant to prevent downside growth risks. Both of these macro-level factors temper our concern that we might see widespread lockdowns that threaten to derail the pace of the global economic reopening.

At a micro-level, it bears repeating that with the help of emergency response programs, such as the Federal Reserve’s Primary and Secondary Market Corporate Credit Facilities, companies (in many cases) have adjusted their business models to compete and survive in a post-pandemic reality. Many have significantly fortified their balance sheets by refinancing and extending near-term debt. This helps to explain the continued resilience of corporate credit fundamentals, specifically the sharp decline in default expectations and the uptick in the upgrades-to-downgrades ratio observed in the US high-yield complex. Delta Airlines is an example of one such issuer whose bonds experienced a significant amount of stress during the height of the pandemic, but have since bounced back sharply due to a rebound in business travel and customer acquisition, but also in large part due to active liquidity management. Case in point, after reporting strong Q2 earnings, the airline announced that it would use $1 billion of its accumulated $15.2 billion cash balance to tender for high coupon debt that was issued in 2020.

After Covid‘s asteroid-like impact on global financial markets last year, we’ve been wary of the possibility that one of the many Covid variants making the rounds globally might take hold and rekindle the market panic we experienced in 2020. The possibility of such a risk-off scenario is one key reason why we maintained an overweight to US duration in portfolios throughout the first quarter and added to our position as yields rose and the curve steepened (on the back of the market’s singular and euphoric focus on growth and inflation). The behavior of the US rate market year to date continues to reaffirm our long-held view that US Treasuries remain the best diversifying hedge against spread risk in broad market and multi-asset credit portfolios.

For now, we maintain our constructive stance on corporate credit due to favorable fundamentals and supply-demand technicals, and continue to position for a reopening trade. We remain overweight certain cyclical sectors including airlines, cruise lines and select retail segments complemented by a higher quality bias in less cyclical subsectors that provide ballast in portfolios. Should we see a resurgence of market fear that leads to a material widening in credit spreads, we would view that as an opportunity to add exposure to issuers offering solid income and total return potential.

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