Stocks' Season of Discontent Could Linger Well Past Winter. Plus, Picks Among BDCs. — Barrons.com
By Randall W. Forsyth
This truly is the winter of our discontent, not just in the present but in our thoughts about a dystopian future.
As the Northeast was hit this past week with a blizzard the likes of which it hadn't seen in a decade, a "financial history, from the future" dropped on the internet with even greater force. By now, you've no doubt read of this "scenario" from June 2028 in which Citrini Research posited a world where artificial intelligence was so successful that large swaths of white-collar jobs were eliminated, decimating incomes and thus spending.
With investors already fearful about the more proximate risks posed by the hundreds of billions being spent on AI, this vision of the future spooked the markets further. After the snow stopped falling, stocks continued declining. Even Nvidia's latest boffo earnings report failed to provide a meaningful lift.
Also lower were bond yields, with the Treasury 10-year note trading under 4% for the first time since late last year. One of the few things moving up was oil, which hit a 52-week high amid fears of another U.S. strike against Iran.
Despair or worse describes the mood in another AI-afflicted sector: business development companies. BDCs lend to small-to-medium-size firms that banks tend to avoid, usually at relatively high interest rates. Many of those borrowers are private software companies, smaller brethren of the public victims of the Saas-pocalypse that has taken the iShares Expanded Tech-Software Sector exchange-traded fund to a negative 21.85% total return from the beginning of the year through Thursday, per Morningstar data.
Over the same span, the VanEck BDC Income ETF posted a minus-7.19% year-to-date return, and an even-worse minus-7.39% in the past month. And the ETF's 12-month total return was negative 15.20% — even with the double-digit yields that are BDCs' main attraction.
Simplistic investing in a sector ETF is based on the assumption that the component stocks accurately discount all their risks and future returns. Maybe that is true for the 500 biggest U.S. stocks but less so for a relatively arcane and less-researched sector such as BDCs. Which leaves opportunities for those who do the old-fashioned fundamental research.
Less-sophisticated investors have been selling first and asking questions later, according to Charles Lieberman, chief investment officer at Advisors Capital Management. Lieberman sees a significant variance in the quality of the management teams in the sector. "Some BDCs are poorly managed, more for the benefit of the managers than the shareholders," he said in an interview.
Most BDCs trade at significant discounts to their published net asset value, but that doesn't make them bargains, Lieberman says. And that presumes the published NAVs represent current reality; most NAVs are as of Dec. 31, and much has happened since then.
Lieberman's picks are sector leaders Ares Capital, Golub Capital BDC, Hercules Capital, and Sixth Street Specialty Lending. "The main issue is the quality of the loans being made and the risk that a lot of the loans go bad. You rely on the caliber of management to handle the situation," he said.
Yields range from 9.96% for Ares to 12.23% for Golub.
"BDCs are ground zero for value opportunity," says Stephen O'Neill, portfolio manager at RiverNorth, a specialist in closed-end fund and BDC investments.
He also looks for managers who deliver higher returns on equity rather than shopping in the bargain basement for the biggest discounts.
On that score, he agrees with Lieberman on Golub for its reasonable fee structure and diversified portfolio. That said, the BDC has a 30% exposure to software, but O'Neill says everyone has to make a prognostication about the risk of default and the recovery rate in that event.
More controversial is his pick of Blue Owl Capital Inc., whose ticker is OBDC, the main publicly traded BDC from Blue Owl Capital Corp., ticker OWL. O'Neill sees the sale of $1.4 billion of loans from Blue Owl's private BDCs at 99.7% of face value as a positive for the publicly traded BDC.
"That's a huge benefit to OBDC shareholders," given that there is considerable overlap between the assets in the public and private BDCs. OBDC traded Friday at a 23.6% discount to its Dec. 31 NAV of $14.81, as posted by BDCinvestor.com. The current annual dividend of $1.48 would yield 13.09%.
Private credit has been a worry for the markets since last year, with the busts of First Brands and Tricolor prompting JPMorgan Chase CEO Jamie Dimon to warn about "cockroaches" emerging in the sector. But what worries Mizuho Americas Chief Economist Steven Ricchiuto is that the big banks have become lenders to the so-called shadow banks.
His other worry is that inflation is accelerating, not slowing as touted. With the benchmark 10-year Treasury under 4% — which has pulled the 30-year fixed mortgage rate under 6% for the first time since 2022 — that leaves little real return, with the personal consumption deflator, the Federal Reserve's main inflation gauge, running at a 2.9% year-over-year rate. Morgan Stanley economists project that January core PCE (excluding food and energy) was up 3.2% from a year earlier.
After a blizzard, the markets could face the perfect storm of deflating asset prices as inflation in consumer prices remains sticky. While worries about AI and credit may have driven the flight to safety in the Treasury market, the Fed may be constrained from providing relief in the form of rate cuts while the PCE remains well above its 2% target. The discontent may continue after winter's end.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
No comments:
Post a Comment