Monday Musings: June 8, 2020

Jun 08, 2020

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Public Trust Credit Team
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Economic fundamentals and investor sentiment

The Bureau of Labor Statistics (BLS) surprised most economists and investors last Friday when it announced that the unemployment rate fell from 14.7% in April to 13.3% in May. However, the BLS mentioned there had been a misclassification error and that without the error, the unemployment rate would have actually fallen from 19.7% to 16.3%. In any case, the government’s Paycheck Protection Program created a strong incentive for many small businesses to rehire employees, appearing to limit the damage. The latest ISM non-manufacturing index showed that the sector remained in contraction territory in May with a print of 45.4, still below the 50 threshold that marks expansion but slightly higher than the 41.8 level recorded the prior month. These glimmers of hope continue to prop investor sentiment; in the past few weeks, the stock market has seen an impressive rebound as the economy has begun slowly reopening, the Fed and the various government stimulus programs have been a tremendous help, and more than 120 COVID-19 vaccine candidates are at various stages of testing according to the World Health Organization.

The OPEC+ alliance agrees to extend historic production cuts through the end of July

Over the weekend, the consortium agreed to extend its supply cut of 9.6 million barrels a day (roughly 10% of global supply) through the end of July, a reversal from the earlier agreed upon reduction to 7.7 million barrels a day. The move helps solidify the organization’s commitment to supporting the global oil markets that have been severely impacted due to the global shutdown from COVID-19. Agreed upon in April, the initial pact stemmed from the destruction in demand from COVID-19 in conjunction with the short-lived oil price war between Saudi Arabia and Russia. Additionally, OPEC+ has necessitated that participants that did not meet production cut quotas this time around, such as Iraq, Nigeria, and other laggards, adjust their underperformance with additional cuts from July through September. The industry has been impacted across the globe, with oil major BP announcing a 15% planned reduction in its workforce just this morning; this announcement follows on the heels of Chevron’s planned global workforce reduction of 10% to 15% announced in May. As of this Monday, West Texas Intermediate was trading around $38 per barrel with Brent Crude near $40 per barrel, a dramatic contrast to the negative contracts trading in late April.

The COVID-19 recession could add permanent leverage to investment grade issuer balance sheets

A recent Bank of America report estimates that investment grade (IG) companies could see an increase in their net leverage of 1x by the end of the year. The function behind this is significant declines in financial performance that arise during recessions, specifically in EBITDA. Analyst consensus forecasts that EBITDA will decline by 13%, causing a material increase in leverage as measured by net debt/EBITDA. However, as EBITDA recovers and the effect on leverage lessens, it now appears that the additional debt issued during the lockdowns could end up causing a permanent 20% increase in leverage. While consensus before COVID-19 was that companies would deleverage from record-high levels, it is possible companies might exit the recession with even higher leverage than they started with. Public Trust believes this could lead to some stress on credit metrics during the recovery and could lower investment spending as companies make decisions on how to position their capital allocation.  
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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