As the current banking “crisis” continues to unfold, I gathered five of our investment leaders to discuss potential investment opportunities across stocks, bonds, and alternatives like private credit and real estate.
Our panel includes views on equities from Scott Glasser, Chief Investment Officer, ClearBridge Investments; a fixed income outlook from Mike Buchanan, Deputy Chief Investment Officer, Western Asset; a multi-asset perspective from Ed Perks, Chief Investment Officer, Franklin Income Investors; commercial real estate implications from Jed Belford, Chief Investment Officer, Clarion Partners; and a private credit view from Rich Byrne, President of Benefit Street Partners. Below are my key takeaways from our discussion:
This is not a repeat of the global financial crisis (GFC). Today’s banking “crisis” is far less severe than 2008, and it’s not systemic. Indeed, the quality of overall bank assets and capital ratios are dramatically better. The central banks are now coordinating globally to offer banks daily access to the dollars they need to operate smoothly.[i] The “big iceberg” hitting financial markets is the dramatic rise of interest rates, following decades of low rates and inflation. What we are seeing now are the repercussions of the rise in rates. The challenge for Federal Reserve (Fed) Chairman Jerome Powell is balancing the need to fight inflation without causing more financial instability. As banks tighten lending standards, the Fed may have more maneuverability.
We see more opportunity in bonds than stocks in the near term. The higher income that bonds now provide looks especially appealing relative to stocks. While price/earnings ratios have fallen, we still think that earnings have further to fall. Any pullback in the equity markets should offer more selective buying opportunities. Investment-grade credit and some areas in high yield offer opportunities given today’s yields. This is a dramatic and welcome turnaround from 2022, one of the worst years in history for bond markets.
Our panelists’ optimism for fixed income extends to private credit as well. To be clear, credit markets remain treacherous in places. Much of the fallout from higher rates will not happen until companies need to refinance. That pain, however, translates into investment opportunities in both private and public fixed income.
The impact on stocks is deeper than perceived. While equity market indexes—particularly in the United States—have been relatively unscathed, that’s largely due to strong performance of large capitalization technology companies that investors recently crowded into for safety. Looking under the surface, there’s been a significant selloff in small company stocks and sectors like energy, industrials and cyclicals due to markets pricing in a higher chance of a recession. On a short-term basis, these sectors may be oversold. Although the market sees rising probabilities of a meaningful recession, the panelists agree that the highest likelihood is still for a milder recission. This may present bargains for equity investors.
Commercial real estate sectors are less corelated. Before the pandemic, commercial office space, apartments, industrial warehouses and retail shopping centers largely responded to broad macro-economic forces in a similar fashion. The pandemic changed that. First, with more people shopping at home, prospects for retail shopping dropped while demand for industrial warehouses skyrocketed. Second, work-from-home flexibility has dramatically changed the outlook for commercial office space. There will be opportunities in distressed office properties, after companies figure out what to do with their half-empty offices. The outlook for other areas of commercial real estate, however, look promising including: warehouses, biotechnology and multi-family housing.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors or general market conditions.
Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.
Investing in private companies involves a number of significant risks, including that they: may have limited financial resources and may be unable to meet their obligations under their debt securities, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of realizing any guarantees that may have obtained in connection with the investment; have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and changing market conditions, as well as general economic downturns; are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on the portfolio company and, in turn, on the investment; generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position.
Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector.
Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.
Diversification does not guarantee profit or protect against the risk of loss.
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