Market Commentary | November 16, 2022

Positioning for a return to normal

Last Thursday, October’s CPI stormed in at 7.7% which would normally be cause for panic, but because the figure was lower than September’s, stocks soared and interest rates fell. On Tuesday PPI came in lower than estimates, furthering the perception that inflation may be on the wane. Anticipating that the Fed may soon be done with their rate hiking campaign, funds have poured into the bond markets bringing the yield on the 10-year Treasury to 3.679% at today’s close, down from 4.22% on November 7th.

We are not yet calling an end to inflation or ruling out a recession, but it seems that some institutional investors are.  The Financial Times last week reported that many big European and US hedge funds believe markets are severely oversold and they have begun buying discounted corporate debt. The high coupons and price appreciation as markets recover combine to produce compelling, risk-adjusted returns. We see similar opportunities in today’s REIT market.

Despite a majority of REITs reporting and forecasting strong earnings growth, and this year’s more than 90 dividend increases, overriding investor anxiety has pushed share prices of many good companies down by as much as 50 percent. Beyond common equities, the prices of many preferred stocks have suffered a lack of liquidity that makes them available for prices that offer going in yields of 6 to 9% and 20 to 40% upside to par. The high dividend yield and capital appreciation as markets normalize can combine to produce 13 to 16% annual returns over the next few years.

We may have been here before

Every economic cycle is different, but what we are seeing today bears strong resemblance to the environments post-2008 financial crisis or the late summer of 2020 after the COVID outbreak. During those markets, we examined the entire capital stack of our portfolio companies and repositioned to optimize returns. The results were very strong, and we are attempting to seize the opportunity again. You will likely see names you recognize, but they might be a new more advantageously priced issue within the company’s capital structure.

Our aim, as always, is to contain risk while optimizing returns.

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