The U.S. Consumer Is Starting to Crack. Why Income Investors Should Worry.Consumer spending looks lackluster, and debt levels are rising. The could cause problems for asset-based securities.
By
Amey Stone
May 17, 2024 3:30 am ET
More consumers are starting to miss payment on credit cards. Investors could pay the price.
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Investors cheered this week’s consumer price index print, which pointed to lower inflation and higher chances for a Federal Reserve rate cut in September. Overlooked in all the excitement, however, is the fact that the U.S. consumer is getting a little green around gills.
The same day as CPI, April retail sales came in worse than economists were expecting, flat from March but down if you strip out cars, gas, and building materials. The New York Fed’s Quarterly Report on Household Debt and Credit, released Tuesday, shows debt levels and delinquency rates continuing to rise as more people miss payments on credit cards and auto loans. On May 10, the University of Michigan reported a sharp and surprising 13% drop in consumer sentiment in its preliminary May reading after little change the prior three months.
“We’re definitely starting to see additional pockets of stress as the savings cushion people built up during the pandemic is depleted,” says Shannon Saccocia, chief investment officer at NB Private Wealth, the wealth management arm of Neuberger Berman.
All of which could spell trouble for the many diversified bond funds that own securitized debt backed by payments owed on consumer debt, such as credit cards, auto loans, student loans, and home mortgages.
These so-called asset-backed securities are often investment grade, usually floating rate, and have been terrific performers while the Fed has been raising interest rates and the economy has remained surprisingly resilient.
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Income funds have added asset-backeds for their high yields and diversification benefits, says Michael Sheldon, chief investment officer at RDM Financial Group. They performed better than traditional bonds, which fall in price when rates rise, allowing investors to “take advantage of the most aggressive Fed rate-hiking cycle in several decades.”
A new crop of pure-play securitized income funds launched in the past year and have been performing nicely, despite growing worries about consumer credit. The Janus Henderson Securitized Income exchange-traded fund made its debut six months ago and boasts a current yield of 6.71%, with a veteran fund manager in John Kerschner. But even he admits to worries about consumer credit. “What concerns us isn’t the overall level of delinquency, which we are obviously keeping a very close eye on, but that spreads have come in so much,” he says. Spreads are the industry term for the yield an income security earns over a risk-free Treasury.
At the end of 2022, a subprime auto loan rated double-B would yield about eight percentage points more than a comparable Treasury, or around 12%, says Kerschner. Now that spread has dropped to around three points, or around an 8% yield. “That still looks pretty good to most investors,” he notes, “but you have to think about where the risk is going and take into consideration what you are being compensated for that risk and is it enough. Now we’re on the borderline of that.”
JSI is emphasizing securities tied to home mortgages and business loans, rather than consumer loans, but he concedes it’s virtually impossible for an investor to tell what’s what from the list of holdings. He suggests avoiding funds that use a lot of leverage, are too small, or that aren’t offered by an established firm. And of course, beware of too high a yield. “If it looks too good to be true, it probably is,” he says.
No, consumer spending isn’t about to fall off a cliff. But investors should weigh the risk/reward of investing in lower-quality consumer credit at this point. As Saccocia asks, “Is it worth it when we’re still getting attractive yields in higher-quality fixed income?”
Write to Amey Stone at amey.stone@barrons.com |
