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Nasdaq moves higher, 'every positive point on the economy is well received by the markets'

Yahoo Finance's Alexis Christoforous and Brian Sozzi talk to Gibson Smith, founder and CIO at Smith Capital Investors, about overall markets, jobless claims for the week ending May 23rd, the economic impact of reopening plans and more.

Video Transcript

BRIAN SOZZI: Let's welcome in here Gibson Smith, founder and CIO at Smith Capital Investors. Gibson, good to see you here. Also joined by our-- my co-anchor Alexis Christoforous. Gibson, what do you make of the market's rally here? Are you getting slightly concerned on the valuation of the market here? And I don't know what takes it down, but this market continues to be pretty resilient.

GIBSON SMITH: Yeah, it's very interesting to watch the recovery of the markets after the very sharp and quick down-trade that we saw both in equities and credit. Now, our focus at Smith Capital Investors is on the fixed income side of the business, so we're paying very close attention to what's happening in credit markets, because they actually correlate quite well with the equity market. I think there are some-- some that are skeptical about this recovery in markets. But the markets are a discounting mechanism, and they're looking forward to the economy reopening, a more robust growth outlook, and hopefully a return to some normalcy.

ALEXIS CHRISTOFOROUS: But Gibson, should the market be discounting what we're seeing unfolding now with China? I mean, heightened tensions there, more tariffs could be on the way. This could have far-reaching repercussions, especially now when you put Hong Kong into the mix. How are you handling that when you're looking at portfolios?

GIBSON SMITH: Well, in fixed income portfolios, you have to have a balance of risk and then treasuries to really provide insurance against the volatility to try and provide a ballast in the portfolio. But you've highlighted in terms of what's happening in Hong Kong, the China-US relationship probably experiencing a lot of tension on the horizon, as well as the uncertainty related to the economic outlook, there are a wide range of outcomes here that we have to kind of monitor.

If you think back to just four weeks ago, it was really Armageddon, in many ways, as it related to the economic outlook. And here we are four weeks later, corporate bond spreads have tightened, equities have rallied. It almost feels, again, like we're in a fear of missing out market, where investors are running back into the market.

We did a call yesterday with a group of investors, and we were talking about the massive amount of money sitting in money market funds today, about-- almost $5 trillion of money that exited the markets back in March, and now it's kind of finding its way back. I think every positive validating point we get about the economy recovering, both domestically and globally, probably going to be very well-received.

BRIAN SOZZI: Gibson, realist-- realistically of that $5 trillion that has been parked in money market accounts, is there a number-- how much comes back going into the end of the year?

GIBSON SMITH: You know, it could be $1, $2, $3 trillion. I think it all really depends on the volatility in the market. If we see a lot-- you know, low volatility-- you look at the VIX index, which has collapsed from 48 down to about 25, 26 this morning-- if volatility remains low, I think that money will find its way back in. But if we have a series of shocks where we get increased volatility, that money is probably going to stay put, just on the fear that we go back into the lows on equities or the wides in corporate bond spreads, so I think it really depends on volatility.

ALEXIS CHRISTOFOROUS: What do you think would take us there if we were to retest the lows again? Is it-- is it a second flare-up of the virus? Is it no more stimulus coming out of Congress? Or might it just be something else entirely?

GIBSON SMITH: Well, we don't know exactly what it is on the horizon. I think the risk of a large flare-up, a really large flare-up that is kind of nationwide or even on a global basis, would probably spook the markets. As it relates to fiscal stimulus, we're-- we're in a sweetheart period of time where monetary policy and fiscal policy are working hand in hand.

And I think the government, as well as our Federal Reserve, recognizes that they need to keep liquidity in the markets, and they need to provide that Keynesian backstop for the economy. I think the odds of that kind of falling off are very, very low. So I think your flare-up risk is big.

The other issue that could play out is that the markets are, in many ways, discounting a V-shaped recovery. And as we go through these earnings, we hear more from companies, it's going to probably take longer than expected. And I think there is a time horizon risk that if the economy doesn't start to show that it's improving in short order, we may see equities actually give up a little bit and actually corporate bond spreads widen a little.

BRIAN SOZZI: Gibson, just looking at your fixed income portfolios, where is some of your-- where are you swinging for home runs? Because to be perfectly frank, I'm worried about bankruptcies. I'm worried about the credit structures of many companies here, as we still have bankruptcies rising, and I don't see them stopping into year end. What are you playing?

GIBSON SMITH: Well, first off, we're-- we're not really home run hitters. We're kind of consistent, just singles and doubles hitter, and so we're focusing on the credit market. In our portfolio back in-- in February, January and February, had a lot of exposure to US treasuries. Today, we have a lot of exposure to corporate bonds and credit.

We think credit offers some of the best risk-adjusted returns in the fixed income markets, and there's room for significant tightening. We do share your view, though, that corporate bankruptcies are going to increase. There's going to be a spike in defaults. We're going to continue to see a wide range of downgrades across various sectors, and that could, obviously, create a little volatility.

You know, one of the perverse outcomes of this environment where companies are actually concerned about liquidity and concerned about solvency is that we could see an environment where over the next 12 months, a lot of companies file for bankruptcy, and they fall out of the Index. Triple-C companies go bankrupt. Double-- triple-B companies end up falling to double-B, the fallen angels we've all talked so much about.

Ultimately, it ends up with a higher quality high-yield market than we have today, somewhat of a perverse outcome based on downgrades, defaults, and ultimately how this plays out. But to answer your question directly, we think there are some phenomenal opportunities with the credit markets. It's all about security selection, finding those companies that are addressing their liquidity quickly, have the ability to generate free cash flow as the economy improves, and are really managing their capital structures somewhat defensively in this type of environment.

ALEXIS CHRISTOFOROUS: What would you say to investors, Gibson, who are looking for those opportunities, that have a little cash on hand, they're going, yeah, I want a little more exposure to fixed income? Are you looking at corporate debt? Muni bonds? Treasuries? I mean, give us sort of an idea of where you see the most opportunity right now.

GIBSON SMITH: Well, I think-- I think the most opportunity, again, reigns in the credit markets. And it's interesting you asked the question about the liquidity. A lot of investors sitting on cash, not sure where to go after this significant rally in the equity markets and the tightening we've seen in the corporate bond markets. And the Muni markets actually recovered quite nicely here over the last four weeks.

There's a real interesting phenomena playing out with those large cash balances that we described in the money market mutual funds. The yields on those funds have collapsed from about 40 basis points to low single-digit, you know, one, two, three basis points. So you're not earning anything to stay liquid in the money market fund today because of zero rate interest-rate policy.

There is an interesting trade to move out of money markets into short-duration strategies, where you can pick up triple-digit type yield and have the opportunity for some potential total return based on corporate bond spread type. So we think there's some good opportunities there. It's a low-risk way of getting a little additional yield and a little additional return in the portfolio. And I think smart investors are going to find their way working their way out the-- out in front of the curve.

BRIAN SOZZI: All right, let's leave it there. Gibson Smith, founder and CIO at Smith Capital Investors. Good to see you this morning. Thanks for taking some time.

GIBSON SMITH: Yeah, thanks for having me. It's great to be with you guys.

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