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The credit markets are tied to what the fed is doing and what’s going to happen with the economic picture: Sr. Fund Manager

Lale Topcuoglu, J O Hambro Senior Fund Manager joins the On the Move panel to discuss the latest stock market news.

Video Transcript

ADAM SHAPIRO: And we got to talk about what President Trump tweeted within the last few minutes. He says stimulus talks are moving along, and to quote, "go big." We're going to break this down over the next 30 minutes definitely, but we want to talk about how that, along with the volatility of this election are impacting markets, especially the credit markets and fixed income.

One of the people we like to do that with is Lale Topcuoglu from JO Hambro, Senior Fund Manager. She is joining us now. And I did want to start with you, Lale, to talk about the credit markets and what's going to happen as we see the spreads tightening, but then perhaps capping. Got to ask you, the president's tweet though about do something big when it comes to fiscal policy, is this volatility that upsets the credit markets or do they ignore it?

LALE TOPCUOGLU: Well, first of all, thanks for having me on again. It's always very nice to talk to you guys. I think there is going to be a stimulus whoever wins the election. The biggest delta is how big it's going to be. So there's two impacts for this on the credit market. One is if the Democrats come through, how big is going to be the fiscal spending. What has that done to the deficit, and what that does to the 10-year curve, the long-term yields. That's what's critical for the credit markets.

If the spending is small, then maybe there will be less of an issue. I think the Democrats clearly want to move on on the spending. They can see the 10 years just really moving if there's news one way or another. But I think the credit market can be capped in terms of spreads here, because the fortunes are not always, what the credit markets fortunes are tied is, not always, not the only yield curve. It's what the Fed is doing, and what's going to happen with the overall economic picture.

JULIE HYMAN: And Lale, so we've talked to a lot of equity investors about what they are doing ahead of the election and as they contemplate stimulus, et cetera, et cetera. We've had fewer conversations about the credit markets and what people are doing. So what are you doing? Because as you talk about the economy, obviously the economic recovery is going to depend on stimulus, the size of the stimulus, et cetera. So how do you then position yourself as we get towards the election and maybe stimulus of some kind?

LALE TOPCUOGLU: Sure. So the first obvious one is what's going to happen with the rate. So obviously, managing your duration exposure is incredibly important. And so if you'll look at the investment grade markets on a spread poor duration basis, it actually screens very expensive. That tilts us a little bit more to the high yield market, and combining that rate perspective along with the Fed-induced extra liquidity in the market. Front and high yield paper that are yield to call that offers you anywhere from 2% to 4% Is a very sweet spot for us to be in.

The second leg is really the recovery plays. And the way I think of this from a credit perspective is, credit market, there is about, if you look at the unemployment numbers, where it's really sticky is those industries that are just beaten down because of the coronavirus. So as a result, if the stimulus comes in and these folks get a little bit more help, where you would see the high yield spreads rally is sort of what I would call probably a junkiest of the junk in terms of the ratings category. And really being at the epicenter of the shutdown.

For us, the best way to play that is actually through the equity. Because the equities will certainly have the more upside, whereas in high yield, you get into this game of, where do I get primed and who comes in ahead of me. It's a lot more difficult decision to make. But the equity piece, it's certainly a lot clearer story.

DAN HOWLEY: Lale, this is Dan Howley. I want to ask where you think this stimulus then, if one is coming, we still don't know, what would best help the economy? And do you think they need to target certain areas? I know we talked a lot about airlines, but there's things like local cities and states need to have their budgets shored up. Because what do you think they, if they can't get a larger deal and they can do a more targeted one, what do you think they should really hit?

LALE TOPCUOGLU: I mean, it becomes a lot more so where they should target versus politically what's palatable are two different answers. So where they should target is what I'm going to try to answer. And where they should really target is the municipalities. there are a number of municipalities and towns where they desperately need the grants. Not even loans. People get confused. They actually just need grants to basically help the people.

The second leg, and from an industry perspective, obviously, airlines, transportation are hit very heavily. There are also public companies. So you have to find the right thread, and how do you give them loans while they do have a public currency? If you look at the equity markets, the equity market's already figured out the easiest part of the trade, which is the infrastructure spending. And look at what's happening in the infrastructure names. They just keep rallying. So the most difficult part to see is going to be what did they do on the health care policy, what did they do infrastructure, and how big the spending happens.

ADAM SHAPIRO: When we look at almost zero interest rate environment, I'm curious, when you tell your client's investment grade companies could look at shareholder-friendly activities, are we talking about financing share buybacks? What else is in that?

LALE TOPCUOGLU: Well, it's M&A. I mean, look at the M&A headlines. When your financing cost is effectively 0%, and even, let's just say even the rates rise. Let's just put this into perspective. Let's go from 0% to 1% or 1 and 1/2%, because it's unclear to me whether they can break through 2% or 3%, it's still cheap. And why wouldn't you do M&A?

And look, and this is the other piece that people I think are overlooking. Look at all the M&A that's happening. You know what's going to happen in the next stage? It's going to be cost cuts, it's going to be synergies. That's how you drive earnings. That still struggles, that still spells trouble for the economy if there is not a lot of government help that's coming through.

JULIE HYMAN: Lale, I'm also curious as we see this continued low rate environment, if companies are borrowing to do deals, to do share buybacks. Even with these very low rates, are there any implications from that down the road or things that we should be watching for?

LALE TOPCUOGLU: I mean, we always watch what the leverage statistics in the balance sheets are. But companies can manage that, because once your financing cost is so low, and the next thing you're going to do, if the economic recovery doesn't happen, as I mentioned, the easiest things you do is cost cut. Again, I encourage everyone to go and read 2Q earnings. Q3 is coming up, and screen for the word, cost savings.

A lot of the companies are saying these are not permanent. Nobody is going back and saying, yes, that was a temporary coronavirus-related cut we did. We're going to definitely inflate our cost base again. It's out of the system. And that, I think that just gets forgotten. So the companies are clearly moving towards equity shareholder activity here from a credit perspective. I think this is part of the reason why the equity markets keep going up.

ADAM SHAPIRO: Lale Topcuoglu is JO Hambro Senior Fund Manager. We always appreciate your being here and all the best to you.