America’s Consumer, Today’s Fixed Income Hero?
When the going gets tough, look to the U.S. consumer.
The U.S.-China trade war, lingering Brexit uncertainty and geopolitical tensions are among the hurdles that the world’s major economies face. Easing by the U.S. Federal Reserve has helped prop up U.S. stock and bond valuations but stimulus from the world’s central banks has failed to boost meaningful global economic growth while keeping bond yields at historic lows. Where can fixed income investors find compelling opportunities in this market environment?
For now, look to fixed income securities that are linked to the U.S. consumer. For example, automotive asset-backed securities (ABS), enhanced equipment trust certificates and consumer-themed corporate bonds can offer attractive fundamentals and relative value in today’s sluggish global economy.
The resilient U.S. consumer leading the way
The consumer continues to shine in the U.S. where personal consumption accounts for roughly two-thirds of total GDP. The University of Michigan’s consumer sentiment gauge just hit a seven-month high, the unemployment rate stands at a low 3.5% (as of December 2019) and household balance sheets are relatively solid.1 America’s household debt as a percentage of overall GDP has been falling since the Great Financial Crisis, yet nonfinancial corporate debt has increased sharply (see Chart below). With global growth slowing and the surge in corporate debt raising red flags, one might be concerned about the U.S. economy. The resilient U.S. consumer is a reason for optimism.
Household vs. Nonfinancial Corporate Debt as a Percentage of GDP (through 9/30/19)
Investing in the U.S. consumer: Opportunities across sectors
- Auto ABS – Consider shorter duration bonds that amortize rapidly but also have attractive spreads. These bonds are often mispriced due to negative media reports or issues with specific lenders that create credit risk concerns about the sector generally.
- Telecom corporate bonds – Telecom corporate bonds can be a good way to access consumer strength and can offer meaningful value in today’s rapidly advancing wireless landscape. Although competition in the telecommunications industry can be intense, companies can potentially benefit from stable revenues and cashflow as long as consumers stay glued to their smartphones.
- Enhanced Equipment Trust Certificates (EETCs) – There is a secular shift by the consumer toward experiences, with travel being one of them. Commercial airlines may issue EETCs to help finance their fleets. EETCs are secured by the airplanes, making them strategically important assets. The issues are enhanced through over-collateralization and/or issued in multiple tranches, making senior tranches less risky. These characteristics can boost the relative value of EETCs versus buying the carriers’ corporate bonds.
Unlocking relative value
A fixed income portfolio manager needs to be able to pinpoint which U.S. consumer-related securities have the most attractive relative value versus other kinds of securities.
Siloed investment teams that research individual sectors or asset classes in isolation often lack a 360-degree understanding of the potential merits and risks of an investment relative to other securities. These siloed teams run the risk of missing out on today’s compelling fixed income investment opportunities.
Successfully exploiting attractive relative value in fixed income investments requires the ability to think outside the confines of boxed research criteria. An investment team that employs a collaborative, cross-sector research approach compares securities across sectors and asset classes. Individuals with diverse fixed income experience and skill sets can work together to analyze fundamentals from the bottom-up and assess risk and reward across the full spectrum of available opportunities.
- Source: U.S. Federal Reserve: Chart – U.S. Consumer: Assets, Liabilities and Net Worth – https://www.federalreserve.gov/releases/z1/dataviz/z1/balance_sheet/chart/