-Servicing debt is cheaper for the US
-Experts are saying defaults will rise
-The recent tech sell-off created an opportunity for us to start legging in
Hi there—here is this week's update!
Servicing the US debt
While our national debt is ballooning to nearly $27 trillion, the interest payments over the next few years will be cheaper than it has been for decades.
Stanley Fischer, former vice-chair of the Federal Reserve, said Friday in an interview that a low interest-rate burden means the Fed can do more to cushion the economy. "It means that the Fed can keep going with very cheap money, that it can go on for a much longer time at this rate," he said.
Experts are saying defaults will rise
While the US government has been able to borrow cheaply, so too have businesses. The main difference is that the world seems to be OK with the US continuing to borrow more and more, seeing examples like Japan's high debt-to-GDP ratio.
With businesses, it's not going to be as easy.
With COVID's effects on economic recovery, we are likely to see more businesses going bankrupt. We've seen experts, like Jeffrey Gundlach, say that high-yield bond default rates may double.
Jim Millstein, the co-chairman of Guggenheim Securities, said financial markets are headed into a period of "significant volatility" with default rates expected to spike as we move closer to the end of the year. He said, "Fasten your seatbelts, it's going to be a bumpy ride."
On top of this, the S&P Global Ratings expects the pace of defaults to increase "amid the continued impact of Covid-19 on economic and credit conditions," Sudeep Kesh, head of S&P global credit markets research, wrote in a report last week.
We've mentioned this in past updates, but it's important to know why defaults will rise. Business growth rates have faltered due to COVID, which has put pressure on profitability. This has also led businesses to borrow more money, to the point where corporate borrowings have reached extraordinarily high levels.
This type of pressure and scrutiny leaves businesses with tiny margins for error.
Introducing the Emerging Cloud Index
In an environment where economic growth is faltering and will remain low for the foreseeable future, businesses that can outpace that growth become more attractive. Long term, we believe that tech will continue to dominate the markets.
As a result, we've decided to make a small allocation to the BVP Emerging Cloud Index. Our view is that the companies highlighted in this index are attractive businesses that are growing efficiently. We believe that these valuations have some room to fall, but during the recent tech sell-off we found an opportunity to start legging portfolios into these rapidly growing businesses.
We are still cautious with recent valuations; however, we are looking toward the long-term, and we will continue to increase allocations as valuations fall.
September is generally a volatile month, and the fact that the economy is not recovering as quickly as some had hoped isn't doing the markets any favors.
Coupling this with the recent tech sell-off, a high likelihood of election-related volatility, and the fact that an additional stimulus package will likely not be passed before the election, we believe it's necessary to be careful during these times.
We're excited about the Emerging Cloud Index on the portfolio side, and we'll continue to inform you as we change our allocations.
See you next week,
-Saul & The Round Team
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