Pimco, Prudential Say Next Big Buy in Junk Is the U.S. Consumer

  • Pimco’s Kiesel says consumer is ‘bright spot’ in economy
  • U.S. consumer confidence near five-month high in July

Some of the world’s largest junk-bond investors are betting big on the U.S. consumer.

Money managers including Pacific Investment Management Co. and Prudential Financial Inc.’s PGIM are buying high-yield bonds tied to home builders, lumber, lodging, air travel and other parts of the economy driven by retail customers. Some of these investors are cashing out of energy junk bonds, which have surged since mid-February, as part of the shift.

The thinking is that U.S. consumers will continue to spend, whatever political and economic trouble may be brewing across the pond after the U.K.’s vote to leave the European Union, or whatever may happen to oil prices. U.S. consumer confidence was near a five-month high in July, according to a report Tuesday. Low mortgage rates helped push new home sales to the highest level in more than eight years last month, a separate report said on Tuesday.

“We think the consumer is one of the bright spots in the global economy,” said Mark Kiesel, global credit chief investment officer for Pimco, which oversees $1.5 trillion. With energy bonds showing signs of stabilizing, “you tilt into these domestically focused U.S. names,” he said. His funds have reduced some high-yield energy exposure recently, and are overweight consumer sectors including building materials, telecom and medical equipment.

Other investors seem to be making the same bet, judging by market movements. The Bank of America Merrill Lynch high-yield index of U.S. consumer product companies has risen 2.81 percent since the Brexit vote in June on a total return basis, compared with a 2.40 percent gain for junk bonds overall.

One bond that looks attractive is homebuilder M.D.C. Holdings Inc.’s $350 million of 6 percent notes due in 2043, said Henry Peabody, a portfolio manager at Eaton Vance Corp., which oversees $325.6 billion. The debt trades around 87 cents on the dollar, and yields more than 7 percent. But the company has a conservative land acquisition strategy and manageable leverage, Peabody said. The bond has room to trade closer to par over time, he said. 

Earlier this year, some of the best-performing junk bond funds were those that bet big on energy. The price of oil rallied from just above $26 a barrel in mid-February, its lowest level in a decade, to as much as $51.23. Energy junk bonds jumped more than 50 percent, including price gains and interest income, according to Bank of America Merrill Lynch Indexes.

In recent weeks, the price of oil has stabilized and shown signs of a decline -- it fell to a three-month low on Tuesday. Betting on energy bonds is harder now than it was at the beginning of the year, Pimco’s Kiesel said. “We’re less aggressive there,” he said.

‘Coming Apart’

Companies with heavy international exposure are also harder to bet on, said Mike Collins, a portfolio manager at Prudential Fixed Income, which oversees $621 billion. The International Monetary Fund slowed its forecasts for global growth after the U.K. voted to leave the European Union.

“The rest of the world feels like it’s coming apart at the seams, but the U.S. is benefiting from a safe-haven status,” Collins said. “As soon as the Brexit happened, we all looked at each other and said, this is a windfall for U.S. assets.”

Among the other sectors that could benefit from a strong U.S. consumer are telecom, cable, packaging, and healthcare, said Chris Barris, portfolio manager at Alcentra, a fund manager that is part of Bank of New York Mellon Corp.

Diamond Hill Investment Group, which oversees about $18 billion, decreased its energy allocation among its high-yield holdings to 5.1 percent in the second quarter from 10.3 percent in the first quarter, according to the firm. Over the same period, it increased its exposure to the leisure sector to 8 percent from 4.8 percent.

“We’re just not being compensated for commodity risk at this point,” said John McClain, a money manager at Diamond Hill. On the other hand, “the U.S. consumer is still doing reasonably well,” he said.

Trimming Europe

Equity investors have a similar idea, according to a July 19 report from BofA Merrill Lynch, which found that allocation to European equities is underweight for the first time in three years as positions are being moved into U.S. domestic sectors.

As the U.S. economy remains relatively strong, consumer spending should continue to grow, and related bonds could continue to rise, said Prudential’s Collins. Retail sales were up 0.6 percent in June, according to a report from the Commerce Department earlier this month. While car and truck sales are showing signs of stabilizing, other areas, including online merchants, are seeing growing demand.

“In our view, the U.S. consumer is in the third or fourth inning,” Collins said. “They’re just getting going.”

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