“The global financial crisis - missed by most analysts - shows that most forecasters are poor at pricing in economic/financial risks, let alone geopolitical ones.”
Fed Policy, Economy, And Markets
In September, investors witnessed a certain disconnect between developing economic uncertainties and the financial markets. Sharply rising geopolitical tensions in the Middle East and Ukraine suggest the ongoing wars in both regions might expand further, rather than move toward imminent resolutions. While it is callous to discuss the potential future impact of war escalation on the global economy given the horrific loss of human lives (there is increasing rhetoric of attacks on vital energy infrastructure), the risk of sharply slower growth and increased joblessness, cannot be totally dismissed. The loss of livelihoods is also a potential consequence of war and geopolitical tensions, and the markets are not yet pricing much of the associated risk. By contrast, the financial markets keep marching on despite the escalation in global tensions. The Fed, for its part, is supporting asset prices by accommodative policy; the FOMC cut overnight rates by 0.5% at their September meeting – a decision Chairman Powell justified by referring to growing signs of a cooling off in the US jobs market – see chart below. Still, the September employment report showed a robust 254,000 in new non-farm jobs, suggesting that absent the development of the worst-case geopolitical scenario, the US economy will remain vibrant.
| Indexii | YTD TR (%) | Sept 2024 Monthly TR |
|---|---|---|
| US Large Cap - S&P 500 | 22.08% | 2.14% |
| US Large Cap – Tech Heavy NASDAQ | 21.84% | 2.76% |
| International Equity – MSACWI ex US | 14.70% | 2.72% |
| US Small/Mid Cap – Russell 2500 | 11.30% | 1.49% |
| Bloomberg Aggregate Intermediate Bond Index | 4.45% | 1.34% |
ii. Source – Bloomberg
Private Credit
Risks
The risk in any loan/debt instrument is the inability of the borrower to fully pay the lender in accordance with the contracted credit terms – which is the timely payment of interest and the repayment of principal at loan/debt maturity. While data on private middle market loans provided by private funds to private equity sponsored companies is limited, data on a close proxy – broadly syndicated bank loans provided by banks to large US companies is comprehensive, both in scope (across many industries/companies ) and through history. The charts marked “Leveraged Loan Default Rates” and “Leveraged Loan Recovery Rates” show both the “default” and “recovery” experience in the senior secured corporate lending over multiple decades. The key takeaway is that the highest default experience occurred during the Great Financial Crisis of 2008/09 when about 12% of all outstanding principal in the corporate bank loan space defaulted, yet recovery from the defaulted loans still averaged near 70%. Expressed in a separate way, the actual loss experience was about 3.6% (30% unrecovered from the 12 % defaulted loans). By way of long-term averages, the annual average default rate is less than 3% (see first chart above) and the recovery rate averages about 65% (see second chart above).
Recommendations
Considering the opportunity in Private Credit, we at Trajan Wealth are building a model Private Credit portfolio to enable our clients and prospects build allocations to an attractive sector in the Fixed Income asset class. The key caveat here is that there is limited liquidity in this sector (the loans are private), thus sizing the allocation appropriately in a well-diversified portfolio will be critical. We expect to roll this new product in Q1 of 2025. For help in reviewing your portfolios and making any necessary changes, please contact our Portfolio Management Group at 1 (800) 799-3320.
Udayan Mitra, CFA
Udayan is Trajan Wealth's CIO with over two decades of experience in the investment management industry. He earned a Bachelor of Science degree in Economics from the London School of Economics and an MBA in Finance from Rice University.
*Private assets may require accreditation. All figures are hypothetical and do not reflect fees. Past performance is not an indicator of future performance. Your results may vary.
