Market Commentary

Time to Think Outside the Box

By Rob Sigler, MBA

February 28, 2025

As those of you who read our work know, we believe that economic growth is likely to disappoint in 2025.  While we applaud President Trump’s efforts to gain reciprocity from our trading partners, we worry that uncertainty related to timing, magnitude, and implementation of tariffs will cause corporations to pause decisions on capital investments, freeze employment, and cause near term distortions to inventories and pricing.  Additionally, while we whole-heartedly agree that shrinking the federal budget deficit is necessary, we worry that a chaotic reduction in federal employment levels will cause some negative impacts to consumer spending.  Finally, we believe slowing immigration will reduce economic output as well as spending.  As such, we aren’t surprised to see the equity market encounter volatility as investors question the growth outlook.  Many have posed the question of whether it is time to move to cash.  Our answer is categorically no.  As CNBC correspondent, Jim Cramer, frequently says “there’s always a bull market somewhere.”  Now is not the time to exit the securities market, it is simply the time to expand the consideration set.  In the quick paragraphs below, we highlight multiple investment opportunities that we think are ripe for robust returns.

Long Term Treasury Bonds—One thing has become abundantly clear during the Trump presidential administrations.  Our President tends to use the stock market’s direction as a proxy for how he is doing.  He enjoys pointing to rising markets as proof positive that his policies are working.  If some of these executive decisions arrest economic growth and cause equity volatility, we believe he will be quick to pressure the Federal Reserve to lower interest rates to counterbalance the situation.  That will provide a salve for bond performance.  Meanwhile, it appears the market is already starting to anticipate this scenario.  Long Term U.S. Treasury Bonds are up 5% year to date, besting equities by a wide margin.

Asset Backed Securities (ABS)—While these sound complicated, they aren’t.  ABS are simply financial instruments that pool together financial obligations (e.g.  loans, leases, credit card balances, mortgages, auto loans, music royalties, etc.), into a single security where the investor owns a proportional interest in the pool.  It is not dissimilar to owning shares in a mutual fund.  As opposed to a corporate bond where the investor is a creditor of a single institution, often with no specific collateral, ABS are backed up by the collateral of the underlying asset.  Let’s use the example of residential mortgages.  A typical mortgage-backed security will hold thousands of residential mortgages.  You receive a steady stream of income from the mortgage payments that the property owners pay.  The physical homes underlying these mortgages acts as your collateral.  In other words, if a homeowner were to default on his/her obligation, the servicing manager of the asset backed security would foreclose and own the home.  Given substantial home appreciation, the collateral underlying most of these liabilities is well above what is needed to cover the debt.  The beauty about most ABS is that they pay coupons substantially higher than corporate bonds, despite having substantial collateral protection, in addition to inflation protection.  We think this is an extremely viable fixed income alternative.

Triple Net Lease Real Estate—Investors purchase an interest in a partnership that invests and acts as a real estate landlord.  The investment manager buys corporate headquarters or retail buildings from the owner and then leases them back to the tenant.  The beauty of triple net leases is that the tenant is responsible for paying property taxes, insurance, and maintenance.  As the landlord, you simply collect rents.  We utilize a topflight manager that has marquee tenants (examples include Amazon, Chubb, Enbridge, Schlumberger, Dollar General, and Save Mart).  Leases are structured to be over 10 years in duration and include lease escalators that average 2% per annum.  What does that mean for to you as an investor?  You gather increasing income as time elapses.  If all works out well, the value of the real estate also increases in value.  You have two shots on goal so to speak.  At present, the vehicle that we use pays out a monthly dividend that annualizes at roughly 7%.

Private Infrastructure—These investment vehicles offer individuals access to turnkey private infrastructure investments.  When we speak of infrastructure, envision toll roads, marine ports, airports, cell phone towers, energy infrastructure like pipeline assets, energy transmission lines, energy transition categories like solar, wind farms, and geothermal.  Additionally, there are private partnerships to provide data center power and AI infrastructure that can be included in this category.  Many of these are regulated businesses with very predictable cash flow streams.  With the Federal government stretched to extremes on its finances, it needs private partnerships to improve, augment, and refurbish our existing infrastructure.  We see this as a rapidly growing category for years to come.  Typically, these investments offer the opportunity to gather both yield and capital appreciation and they generally are quite uncorrelated with broader equity returns (a big positive for diversification).

Distressed Real Estate Credit— As you may recall, one of our Top 10 Surprises of 2025 was that commercial real estate had found bottom.  The vehicle that we are investing in is a brand-new fund run by a venerable manager.  In other words, they own no legacy, problematic assets.  Instead, they are seeking to capitalize on the struggles that other real estate projects and developers have encountered with the repricing of debt financing.  Many of these projects became untenable at prevailing interest rates and leverage ratios, causing developers and property owners to jettison or sell at distressed prices.  Bottom line, your starting point is attractive.  Commercial real estate valuations are depressed.  There is a large refinancing need.  Banking stress has forced many banks out of the game.  Thus, competition is lower and yet there are still very strong fundamentals out there for many sub-sectors (hospitality, multi-family, retail, and industrial).

Distressed Debt/Opportunistic Credit—Much like the description above, with interest rates rapidly repricing over the past 24 months, many corporations who financed themselves with debt costing 6% are now seeing that refinance at rates in the 10% – 12% range.  That dramatic uptick in interest expense is proving overwhelming for some.  Many of these companies will have to engage in a bankruptcy re-organization to remedy their capital structure.  Distressed debt professionals know how to navigate this domain.  They purchase secured debt at deep discounts and then proceed to exchange that into new equity of a firm that engages in a Ch. 11 reorganization.  These opportunities only tend to present themselves roughly once per decade.  We believe a super-cycle exists today.  The wonderful thing for investors is that this is a cottage industry with very few investment professionals.  As such, the returns tend to be outsized during these discrete periods.

Private Equity—Private equity firms engage in multiple different disciplines.  They take publicly listed companies private, acquire divisional assets or carve-outs of larger enterprises, partner with family-owned businesses who want to grow but lack growth capital, and finally engage in consolidation strategies to bring smaller enterprises to scale.  Why invest in private companies?  While it is hard to believe, roughly 90% of all companies with over $100 million in revenue are privately held, not publicly traded.  In other words, you are missing a massive universe of companies by solely concentrating in the public markets.  Second, valuations of private companies tend to trade at substantial discounts to similar public equities.  That is especially important with the S&P 500 trading considerably rich relative to historical precedent.  Third, many of these companies are operating at inadequate scale.  By combining companies in identical industries, an investment manager can build synergies, lower incremental costs, and increase profitability.  The manager that we are presently using is one of the titans of the industry with 48 years of operating history and a superb track record.

To recap, now is not the time to retreat.  It’s time to think outside the box, expand the investment consideration set, and look for a different set of bull markets that are always present.  There is one important caveat as it relates to the investments highlighted above.  Each of these investments involves different risk dynamics, return potential, and in many cases embracing illiquidity.  Thus, this list above is not a “one size fits all” type of investment allocation decision.  As such, we are not making radical shifts in our model portfolio to accommodate these vehicles.  Instead, we offer them out as alternatives to consider.  If you wish to discuss how these options may fit your situation, please reach out to your investment professional.

 

 

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