First Quarter 2024

It has been the tale of two economies. On one hand, high borrowing costs have curbed credit demand, curtailing spending and investment. On the other, strong earnings growth and the step up in interest income has boosted spending. Taken together, the net impact has skewed positively. Areas that had been of concern are showing signs of stabilization without a trade off in incremental weakness from sectors that withstood tighter policy. On balance, the backdrop is constructive and that has positive implications for the outlook for risk assets.

The continued upside surprises have reset market expectations for the number of Fed cuts in 2024, aligning the market to Fed guidance. The transition to fewer forecast cuts, along with questions about U.S. fiscal health still percolating, caused rates to drift higher across the curve. With 10-year yields sitting in the upper end of our range of 3.25% – 4.5%, we seek to benefit from an expected move lower over the course of the year. We believe the anticipation of looser policy, should ultimately exert the strongest influence on rates this year.

Yields across fixed income sectors are attractive and continue to draw investors into the asset class. Across investment grade index sectors, yields are about 2% – 4% higher than they were ten years ago. We acknowledge that Corporate option adjusted spreads are at the lower end of historical ranges, particularly for long bonds. While rich, spreads are tolerable in the context of our outlook and valuations found in early expansion periods. Further support comes from the technical benefit of the supply of investment grade credit not keeping pace with demand, a dynamic more pronounced at the longer end of the curve. The projected net supply of investment grade credit for the remainder of 2024, after accounting for maturities and coupon payments, is expected to be negative.

Corporate fundamentals, broadly speaking, are stabilizing. Within the sector, higher rated companies have exhibited more willingness to make decisions that result in less favorable credit metrics. In contrast, BBB-rated companies have been more judicious, possibly because this is what is required to preserve their investment grade ratings. We believe that the incremental spread these issuers’ securities provide, enhanced by their relative discipline in an improving macro environment, should translate to better return profiles. The output of our bottoms up work with a strong focus on security selection affirms that tilt and we remain overweight BBB-rated companies.

The rise in rates pressured MBS index returns last quarter yet we expect rate volatility will moderate over the remainder of the year. On a relative value basis, the MBS sector is attractive. Option adjusted spreads compressed over 40 basis points for Non-Agency CMBS in the first quarter, driving the highest excess returns in the index. The continued evolution of the future of work in the office sector will likely keep anxiety around CMBS investing high. This creates opportunities for us to selectively add exposure to CMBS where our underwriting identifies desirable characteristics that we believe are not fairly valued.


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Information presented is for informational purposes only. It is not intended as investment advice nor an opinion or a recommendation as to the appropriateness of investing in any particular security, asset class, strategy, or product. Nothing in this publication is intended to be relied upon as a forecast or research; legal, tax, securities, or investment advice. Nothing in this publication is a solicitation of any type.

This commentary contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions, outlook, and strategies are subject to change without notice. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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Source: Pugh Capital, Bloomberg, and Bloomberg Indices.

As of March 31, 2024.