Amplus Q3 2024 Commentary: Resilience, Strategic Moves, and Growth in a Changing Landscape
As the NFL season starts, we begin this commentary reliving Super Bowl LI. It began like any other championship game, with two teams stepping onto the field. On one side, the New England Patriots, a team known for their championship pedigree. On the other, the Atlanta Falcons, hungry for their first Super Bowl victory. As the game kicked off, the stage was set for what seemed like a familiar battle: offense vs. defense, experience vs. ambition.
By halftime, the scoreline told a one-sided story. The Falcons led 28-3, and it appeared that the night would end much like it had begun—with Atlanta on top, and the Patriots left wondering what had gone wrong. Few could imagine what would happen in the space between.
What followed was nothing short of legendary. The Patriots mounted the greatest comeback in Super Bowl history, as Tom Brady orchestrated a masterclass in resilience. With his help, the Patriots clawed their way back, scoring 25 unanswered points to tie the game. Overtime was needed and the Patriots completed the comeback with a final touchdown, sealing a 34-28 victory.
The end result may have showed one team win by less than a touchdown, but the fireworks in between—the plays, the moments, the heart—turned this Super Bowl into an unforgettable story of grit, determination, and redemption.
In many ways, Q3 2024 was nothing short of boring, despite what the headline numbers show. Credit spreads saw the journey begin and end at roughly the same point, but the path in between was marked by volatility and unpredictability. We saw sharp risk-off days in the beginning of August and September, which were both very short-lived. Our ability to quickly pounce on opportunities allowed us to deliver stellar results for our investors.
We are pleased to report Amplus Credit Income Fund closed up +3.7% for the third quarter of 2024, while year-to-date returns stood at +9.4%.
Credit Update and Forward Outlook
The fireworks started in early August. The VIX, a measure of volatility, surpassed 60 for the first time since the pandemic, but stayed above 30 for less than 48 hours. The perfect storm of an over-levered market, the Fed choosing to keep the overnight rate unchanged at the July 31st meeting, followed by a hawkish BoJ (a strengthening Yen) and a weak NFP number… all combined to force a major shock to the market as fund managers de-levered and triggered risk-control limits.
In fixed income, credit spreads moved as much as 15bps wider in IG, and 50+bps in HY during that time. Again, shortly lived. Yields, on the other hand, were the highlight in both Canada and the U.S. markets. The Canadian corporate bond index rallied from a yield of 5% to 4.04%, an astonishing 96bps, most of which was caused by a rate rally as weaker economic data, lower inflation and weak employment had markets reprice central banks easing conditions over the next 12-24 months. Spreads ended the quarter 3bps tighter in Canada, whereas the U.S. was 5bps wider. The outperformance of Canada echoes our shared view that Canada was the cheaper market to invest in. The divergence between both markets has finally narrowed, and we suspect that supply, mainly from banks, can now become more frequent in our domestic market. Flows continue to be very supportive, as IG had their 49th straight week of inflows. In terms of continued supply/demand dynamics: natural demand from maturities, tenders and coupons will still see demand outstrip estimated supply by an estimated $37bn going into year-end for U.S. markets, which is a strong precursor for Canada as well. This suggests a continued strong technical bid for credit.
While spreads were volatile throughout the quarter, widening in August and early September, we saw Canada as the continued go-to market to buy credit, especially in senior bank paper. So much so, that post Canadian bank earnings, all domestic banks chose to issue outside of Canada, as they had more attractive funding levels (tighter spread) elsewhere. The underperformance came in more cyclical names such as auto finance and energy. Having recently met the CFO of VW, we confidently added to the name on weakness.
As September came to an end, we saw a complete 180o from investors in credit, and spreads closed 10-15bps tighter on the month. Unlike before, issuance for domestic banks now becomes a real risk in Canada. With that, we’ve taken it as an opportunity to sell down our bank exposure, as we expect more supply to come to Canada.
A few additional interesting trends have unfolded of late. New deals over the past few weeks have been coming at negative concession; meaning that existing debt was trading cheaper to where a new deal was coming. As such, the September catalyst for the move in spreads has been the new issue market repricing existing debt tighter. Commentary from dealers hinted that some asset managers were underweight rate and credit duration. As the summer came to an end, they were forced to play catch up to the recent rally.
We have seen companies that don’t always have funding windows open to them, throughout the economic cycle, and finally issue debt. In CI Financials’ case, they issued debt at very cheap levels compared to any IG name in the Canadian universe and most HY names. As a tactical trade, we were fortunate to buy their 3-year deal earlier this month and our position has rallied 90+ bps so far, taking profitable sales along the way. On the other hand, and to our surprise, Allied Properties finally came to market at a very aggressive level (expensive) and repriced our existing positions by over 60bps tighter. Their new deal also rallied 20bps in secondary markets.
Performance for Amplus was mainly driven by:
- Portfolio yielding 8%
- Interest rate positioning benefiting from the rates rallying
- Credit spreads rallying, mainly in Canada
- Overweight exposure to REITs, continues to benefit from new bond offerings coming at negative concessions
- Long Algonquin Power bonds that rallied on the sale of their renewable power business
- Long Bell Canada exposure that rallied 15bps after Bell sold their stake in MLSE, as a credit friendly move
Going forward, we are mindful of the recent diverging trend of employment data between Canada and the U.S., and we are proactively taking advantage of the lack of marketing discounting a divergence between both economies. By simply looking at unemployment over the last three years, Canada is higher 0.3% to 6.5% (RHS), whereas it’s roughly the same in the U.S at 4.2% (LHS).
CANADA VS. U.S. UNEMPLOYMENT RATE
We also believe that with the spread basis compressing between healthy and unhealthy balance sheets, this market is now becoming more of a credit pickers’ market as we defensively position the portfolio. The following charts show an interesting perspective when looking at earnings. As S&P 500’s march to ever-higher levels, there’s another arguably bigger story also playing out – the rest of the economy is weak/weakening. Yes, the 500’s profits are at a record, but the S&P 600’s EPS are DOWN about 30% from their peak, and small company top & bottom lines are deep in recession territory. Recall in prior commentaries, U.S. companies with fewer than 50 employees are 44% of total employment. Those with less than 500 constitute 82% of all jobs. So far in 2024, 27 companies have defaulted on public securities totaling $18.4bn in bonds ($3.0bn) and loans ($15.4bn) and 32 companies have completed a distressed exchange totaling a record-high $37.7bn in bonds ($7.8bn) and loans ($29.9bn).
S&P 500 EPS REMAIN RISING, S&P 600 EPS DECLINING
SMALL BUSINESS PROFIT AND SALES DEEP IN RECESSION TERRITORY
Recent surveys are also showing that central banks continue to be the most restrictive on monetary policy since the global financial crisis. One can only wonder what the lagging impacts will be, especially at current valuations. The saving grace remains the 6.5 trillion wall of cash in money-market funds ready to redeployed into a sell-off.
MONETARY POLICY VIEWED AS MOST RESTRICTIVE SINCE GFC
When looking at credit spreads (carry trade), we keep a close eye on the VIX, as one is correlated with the other. Interesting how credit continues to rally, while the VIX creeps higher into U.S. elections. This decoupling is one of the main reasons we sold down our exposure to credit. We will continue to monitor both variables.
THE ODD DE-COUPLE
To conclude, learning from Tom Brady and the Patriots, we are focusing on resilience and patience for our investors during this time, adjusting our game plan for the long-term win. While valuations are on the richer side at current levels, it’s worth noting that both excess return and total return break-evens remain well above levels observed in the prior cycle tights in late 2021. With our recent portfolio changes, we are still getting paid well to wait, and we are in an even stronger position to buy on weakness.