2021 Outlook: Three Questions for the Mortgage and Structured Finance Sector Team
- The securitized credit sector has lagged the recent broad rally in risk assets. How do you expect the sector to perform in 2021?
In general, securitized credit sectors lagged the broader rally in risk assets. Unlike agency MBS and corporate credit, securitized credit sectors did not benefit from direct Federal support during the pandemic. While fundamentals remained favorable, technical pressures weighed on prices.
Consumers and housing—major drivers of underlying risk in securitized credit markets—did hold up well during 2020 given fiscal stimulus and increased housing demand. In our view, this dynamic coupled with relatively lagging spread tightening have left the sectors positioned to potentially outperform in a continued credit rally. In addition, the sectors’ high carry (income) and short duration could provide downside protection amid potential volatility in an uneven economic recovery.
The securitized credit market currently appears bifurcated. On one hand, you have benchmark risk assets that rallied sharply on news of an effective vaccine in the last few months of 2020. Despite the rally, these assets may still offer compelling value in terms of risk (duration) and quality (rating) relative to corporates. In a tight spread environment, this carry (for the rating and risk) can be attractive. On the other hand, pockets of dislocation remain in areas more deeply impacted by pandemic-related shutdowns, such as transportation-related ABS and commercial real estate (CMBS). Investors able to navigate the complexities of these markets can potentially realize significant upside as the economy reopens and recovers. We believe that pricing pressure in these securities is largely contained, especially if we continue to see sustained improvement in the medical treatment of COVID-19 and the impact of increasing vaccination, which should allow for a return to travel (business and leisure) and other commercial activity.
We acknowledge, however, that there are near-term risks that could give rise to bouts of volatility. Specifically, as COVID-19 cases continue to rise at an alarming pace throughout the country we could see (and in fact have seen in some areas) additional lockdowns, some of which could be protracted. In such instances, additional stimulus beyond what has been extended thus far may be needed to help support consumers and other sectors. Nevertheless, we believe the overall scarcity of risk assets in the securitized credit sectors, favorable carry and attractive valuations relative to other sectors may dampen the impact of any near-term volatility.