The Birdseye View – September 2022

Currently, there is plenty of drama in financial markets with heightened sensitivity as we continue to rely on Fed Chair Powell to hand hold us into what should be another well telegraphed POMO reduction attempt commencing November. Mixed August data and a growing divergence of opinions around the stickiness of inflation amongst central bankers muddies the messages, something Powell will have to shed light on this week during the FOMC meeting. Other risks still remain with the debt ceiling vote (legislation currently sits in the senate) coming due the 1st week of October, China on the brink of a real estate crisis, capital gains tax increases, additional regulatory scrutiny and lest we forget the ongoing pandemic still raging across the globe.

Oh yes, and if you think cashing out is a good idea, real yields in the US are in subzero territory once again, making cash holding a negative carry trade. We do however, expect “Cash to be King” in the coming months and into next year with one important caveat – the money needs to be spent.

A low rate environment and massive capital injections into risk assets facilitated public companies to raise copious amounts of cash in the last 2 years. Increased savings rates and adjusted spending patterns during the pandemic are still supportive of strong corporate earnings which continue to fuel equity markets. This additional amount of cash on corporate balance sheets will lead to 3 important adjustments in the markets:

I. Dividend yields will begin to increase and remain the premise of capital allocation into risk assets (vol will eventually recede and normalize)
II. Debt paydowns and stock buyback programs will and have already begun to re-emerge in sectors where reinvestment is not warranted (e.g Occidental Petroleum and Diamondback Energy Inc).
III. Cash holders (the Kings) will be targeting acquisitions and we will see increased consolidation across sectors.

Outlook: This last point is of interest because premiums will be paid for these acquisition targets. If 2021 was a stock pickers market, 2022 will be a sector specialists market and we should be on the prowl for low leveraged, fundamentally sound companies with steady revenues and competitive advantages in their industries. With valuations historically high, the value space will contain the bulk of these candidates. Aside, we maintain our long bias on commodities but are cognizant of increased short term volatility driven by risks of a Chinese credit bubble burst. We have substituted single name exposure for broader sector indexes. In rates, we believe ranges will continue to be respected, and favor buying dips in the belly of the curve until risks events pass and more capital re-enters the marketplace. We remain active with micro-flatteners within the ED strip and have re-added steepeners further out on the curve as we trade 20y+ duration short into year end.