Navigating Short-Term Dislocation Through Long-Term Thinking
In the face of what was the largest first half decline in the S&P 500 since 1970 and the worst ever start to a year for high yield bonds, short duration credit was not immune. Furthermore, a general concern for shorter-term bonds and a fear of recession has caused a significant shift in the term structure of yields in the short duration credit investment universe. In other words, shorter duration securities are often yielding more than longer duration securities, an observation not lost on several Wall Street strategists who have been pointing out the opportunities in the shorter end of the credit markets.
Within the high yield universe, gravitating toward those companies whose price declines can be explained not by a deterioration in fundamentals but rather because the bonds are getting cheaper in the face of stable, and in many cases improving, businesses, can be a more consistent approach than betting on unpredictable catalysts for price appreciation. While we have seen bond prices go lower with the market, we have seen the issuers of certain bonds post year-over-year revenue growth, increases in demand, strengthening liquidity and general long-term resilience. While the short-term moves driven by global economic impacts are real, such as lower margins from supply chain disruptions and inflation, such impacts are more transient than the very real gains of winning market share and demonstrating countercyclicality in a challenged economic environment.
In these times of ongoing market dislocation, it is worth highlighting a few fundamental points to give some insight into the opportunity we are seeing in the markets right now. Investor misunderstandings and ill-advised market timing can result in mispricings which present opportunities in the types of bonds that can be attractive for portfolios.
As an example, our long-standing observation from years of experience with the Michaels Stores credit profile warranted our observation that some babies get thrown out with the bathwater. Michaels released Q1 earnings which may have surprised some in the markets but not those in the know. If one spent enough time understanding the underlying business, customers, and dynamics of this company they would have had a good sense of the resilience Michaels demonstrated in past market declines and understood that it was repeatable. The Fresh Market is another example where the delayed IPO due to the tough equity issuance environment was misinterpreted by the market as not being able or willing to pay off debt. But they did redeem their bonds at the beginning of July, albeit a bit too late for some investors who sold the bonds at an inexplicable discount.