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    Capital Markets | 6 min read

    Taking Stock

    “At times like these, the discussions in the corridors of power are about history, not politics or economics.” - Ashton Carter

    Remember in the dark days of 2020 when we said aloud, “I can’t wait till 2021 when things are close to normal?” Then we got to 2021 and things were not even close to normal. Therefore, we just rolled the 2020 statement to 2021 and held out hope for 2022. So far 2022 may be as far away from “normal” as we have been in our lifetimes! We still have the global pandemic and now the first major land war in Europe, terrible supply shocks made even worse by that land war, and global inflation out of the barn, over the field and onto the road with desperate central bankers still trying to close the barn doors. Therefore, I thought it would be a good time to take some stock and perhaps provide some recommendations. I will start with my most pessimistic view, the war in Ukraine.

    Yesterday, risk markets got a jump on news that Russia and Ukraine started peace, or at least cease fire, negotiations in Turkey. Additionally, the Russians announced that they were repositioning forces away from the Ukrainian capital of Kyiv. I will address the former because the latter is only significant in the context of a tactical military outcome and not one that is anywhere near permanent. In the vein of Ashton Carter’s quote above, we need to look at some history. In 1994, with the encouragement of the U.S., UK and Russia, Ukraine agreed to what is referred to as The Budapest Memorandum. The agreement stated that in exchange for Ukraine giving up its nuclear arsenal, Russia would not use military forces against Ukraine. There’s some squishy language about what the U.S. and U.K. would do if Russia violated the agreement, but it was all a moot point because the agreement was non-binding. For us, it was a great idea at the time, a “win-win” if you will. We de-nuclearized Ukraine and we got the Russians to commit (as far as a non-binding commitment is a commitment) not to attack Ukraine in public. Did you know that the piece of paper Neville Chamberlin waived in his hand in 1938 guaranteeing “Peace in our time!” was also non-binding? It wasn’t even the famed Munich Agreement. It was a side-deal worked out with Hitler on the way to the plane back to London to let Chamberlin go home with something “tangible.” Otherwise, he would have gotten off that plane in London saying he just gave Germany half of Czechoslovakia for nothing.

    Now this time the Ukrainian government wants binding security agreements whereby, the United States (the other NATO nations are also supposed to sign on to this, but they really don’t matter in this regard) will, according to David Arakhamia, leader of the Ukrainian delegation, “Under the guarantees proposed by Ukraine on March 29, guarantor countries must consult each other within three days after the beginning of military aggression or hybrid war. After consultations, these countries must provide aid to Ukraine by sending troops, supplying weapons and protecting Ukraine’s sky.”

    Ukraine wants to join NATO without joining NATO. This is a non-starter both for the United States and for Russia. I certainly can’t blame Ukraine for trying because they really do not have any choices other than to keep fighting or surrender as long as the man in The Kremlin is calling the shots. Yesterday’s good news was really no news at all. However, when it comes to investing and risk managing, days like yesterday where stocks rise, corporate bond spreads tighten, crude oil falls along with energy producer stocks off what I consider to be false hope we can make some money. Sure enough, today Russia has thrown cold water on the story, stocks are down (except energy producers like BP and Royal Dutch Shell, they are up smartly), corporate bond spreads are wider and crude oil is rallying.

    In an earlier piece titled “If You Can’t Beat Them, Join 'Em,” I said that when commodity markets get volatile as they are now you want to own commodity producers with huge trading operations. Right now, buying BP and Shell a few months ago looks great, even after accounting for the hit each company is taking for divesting from Russia. Much of that great performance is due to the huge rally in crude. However, as long as trading in petroleum products is volatile, BP and Shell’s huge trading rooms will make tremendous amounts of revenue just like they have for the last few years. After all, who knows more about oil markets than they do? Therefore, when crude falls for a couple or a few days and BP and Shell have a kneejerk drop, I add them. I also do the same with Glencore (the U.S. ADR is GLNCY) as they nearly always end up on the right side of all things commodity. Have you heard of the latest nickel short squeeze on the clown-show also known as the London Metal Exchange (LME)? That is where nickel producing and trading giant Tsingshan Holding wound up so short that they were down about $8 billion on March 8 when prices spiked up over 200% in about 20 minutes. Guess who was on the other side of that trade? If you said Glencore, you were right! We’ll discuss what happened when the LME decided to cancel billions of dollars of trades to bail out the Chinese mining giant another time because it is a doozy. Glencore owned more than half the nickel in LME warehouses around the world at the time, so they did just fine. Very few, if any, cancelled trades for them, just wait till those first-quarter earnings come out.

    Next up we have short-term rates blasting upwards as now many believe the Fed could be hiking policy rates by 50 basis point at multiple meetings for the rest of 2022 (there’s six left on the 2022 calendar) and suddenly the market is worried about junky leveraged loans. From Bloomberg:

    High-risk companies that tapped the $1.4 trillion U.S. leveraged loan market have been largely insulated from rising short-term rates. Now they’re about to feel the pain.

    “A key lending benchmark, the three-month U.S. dollar London interbank offered rate, topped 1% on Tuesday, the highest since April 2020. That’s above the minimum level many junk-rated borrowers agreed to pay when calculating interest payments on their loans. So, until recently, an increase in rates might not have had much real impact on these corporations, but now this expense will likely rise over time for most borrowers.”

    I’ve been talking about this probably ad-nauseum for months now as I watched with astonishment how leveraged loans pulverized most of their peers in corporate space because investors focused on their floating rates as a good thing, as opposed to a bad thing as their debt service costs were going to go up a lot, along with many of their input prices as a result of inflation. Now, perhaps finally or perhaps not as the Wall Street CLO deal machine continues to hunger for product to securitize, investors have woken up to the fact that it won’t take much for companies that have next to nothing in free cashflow already to go belly up when the rates they pay start moving, sharply. Sure, floating rate bonds have little interest rate duration. However, they have an awful lot of spread duration. Run the difference in price between a 5-year loan that pays you SOFR (or Libor) +300 and then move the spread to +500. I bet you’ll see some duration! Retail investors own quite a bit of leverage loan funds and ETFs so that can get really ugly, pretty fast.

    However, all is not lost. I have been buying ETFs such as Invesco’s Variable Rate Preferred (VRP). It is made up of perpetual preferred stocks that have either pure floating rates that reset every 3 months or a hybrid structure where you get a 5-year rate resetting every 5 years. While the hybrids are not floating, I feel better taking duration risk on 5-year part of curve than the front end of the curve. This puts you into a yield curve flattener trade, which for now is nice. Most of the names in the ETF are well known, solid financial institutions. The “perps” are junior subordinated debt, but I’d rather take the credit risk of unsecured, junior JP Morgan than collateralized debt of Mattress Firm going into a probable inflationary recession. You won’t knock the cover off the ball with these types of investments, but they are set up for the current and coming environment to hit some solid singles.

    Things are getting dicey out there for sure. However, there are places to still get some decent returns as well as some shelter.


    Investing involves certain risks, including possible loss of principal. You should understand and carefully consider a strategy’s objectives, risks, fees, expenses and other information before investing. The views expressed in this commentary are subject to change and are not intended to be a recommendation or investment advice. Such views do not take into account the individual financial circumstances or objectives of any investor that receives them. All indices are unmanaged and are not available for direct investment. Indices do not incur costs including the payment of transaction costs, fees and other expenses. This information should not be considered a solicitation or an offer to provide any service in any jurisdiction where it would be unlawful to do so under the laws of that jurisdiction. Past performance is no guarantee of future results.

    Securities offered through SWBC Investment Services, LLC, a registered broker/dealer. Member FINRA & SIPC. Advisory services offered through SWBC Investment Company, a Registered Investment Advisor, registered as such with the US Securities & Exchange Commission. SWBC Investment Services, LLC is under separate ownership from any other named entity. SWBC Investment Services, LLC a division of SWBC, is a nationwide partnership of advisor.

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    Capital Markets

    John Tuohy

    John Tuohy is CEO of SWBC Investment Services, LLC, a Broker/Dealer and SWBC Investment Company, an SEC Registered Investment Advisor (RIA). In his role, John is responsible for identifying, developing, and executing the division's strategic plan and all business development, sales, and marketing activities.

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