Alpha Strategies: Three Questions on What's Changed Since the March Madness

Back in March, you were stressing company balance sheets and examining free cash flow to determine corporate health. What’s your current assessment of corporate health and are you seeing any areas of potential opportunity?

Many companies took advantage of Federal Reserve and European Central Bank policy actions to add a significant amount of liquidity to their balance sheets. This added liquidity should help companies survive in a slow-growth world. As you can imagine, conditions really depend on the industry. The technology, communications, and consumer non-cyclical industries have seen record cash flow due to COVID-19. However, the situation remains extremely challenging for airlines, hotels, casinos, cruise lines and certain retailers. In addition, we are seeing a significant amount of defaults in the energy space at very low recovery rates.

Credit spreads have significantly tightened since April. We see a number of risks on the horizon, but central banks and fiscal responses are swamping the market with liquidity. Based on the number of companies pursuing a vaccine and preliminary results, the market is expecting anti-viral medication or vaccine approval in 2020, with pre-COVID consumer behavior resuming by the third quarter of 2021. On top of the vaccine development uncertainty, we have China/US tensions, a US election where the senate race is arguably more important than the presidential race, and UK/EU negotiations.

Lower-quality credits have significantly lagged the overall market. Near term, we may see a rally in more idiosyncratic lower-quality credits versus high quality and overall market beta. Over the long term, we believe significant volatility will return once central banks and fiscal measures are dialed back. The liquidity injection has likely left a lot of zombies in the credit market. It should be fun operating in these markets as we try to navigate the next 24 months in our view.