AdvisorShares: Is the Equity Rally Sustainable?

ETF Trends

The portfolio management team of the AdvisorShares Peritus High Yield ETF (HYLD) shares their perspective on an overlooked benefit in debt investing as new equity market highs cause signs of concern.

Record levels on the Dow and S&P 500 seemed to have finally raised some questions: is this equity rally sustainable?  Looking at the broad picture, it hasn’t made a ton of sense to us for a while.  Yes, we have seen the economy recover and corporate profits improve off the lows, but the reality is that this recovery has been relatively muted, with periods of stalling along the way.

Corporate profits have improved, but on the back of cost cutting rather than rapid revenue/demand growth.  Unemployment remains elevated.  The Fed has had to hold our hand the entire way with their various rounds of monetary easing, and seems to be hesitant to take their finger off the trigger of the most recent easing out of concern as to whether the economy can stand on its own.

And the U.S. is the economy that looks good.  Europe has been in a much bleaker situation for years.  While we get signs now and then that a recovery might be on the horizon there, the most recent data showed that the driver of any recovery so far, Germany, has slowed, and other previously stable countries, like France, are also starting to contract.

Europe faces record unemployment, in the double digits, and no clear path for improvement.   Japan’s growth is slowing and emerging markets have also been struggling to sustain growth.  This will continue to have an impact on multinational here in the U.S. that have exposure to worldwide markets.

In this environment, an often overlooked benefit in debt investing is that you aren’t reliant on growth and market multiples to get paid.  You  need to make sure the company can pay its bills (i.e., the interest payment) and you have risks that must be managed, such as default and interest rate risk, but at the end of the day, a bond has a maturity date at which you get paid back your principal investment, all the while you are clipping coupon payments.

In looking at these risks, we are in a low default environment and expect to remain there for the next couple years.  On the interest rate front, while we will likely continue to see some volatility due to the tapering talk, this lack of real economic growth worldwide will be a massive hindrance to a substantial rise in rates.

As we look forward, we expect that the reality of persistently slow global growth to be a significant headwind for the equity markets and multiple expansion.  After being up over 32% over the last year and 57% over the last two years (S&P 500 returns), we don’t see a continue rise as substantiated.

On the other hand, we believe that the high yield bond and leveraged loan market are in a sweet spot, as investors here can benefit from a maturity date (and often even an earlier call or tender at a price above par) instead of relying on market movements and psychology for your final pay date, all the while clipping a healthy coupon income.

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