Should we be concerned about the credit cycle in the US?

Table 1 – Demand for Commercial and Industrial Loans by Size of Firm Over the Past Three Months*

*Question asked in survey – ​“Apart from normal seasonal variation, how has demand for C&I loans changed over the past three months? (Please consider only funds actually disbursed as opposed to requests for new or increased lines of credit)

Source: NY Fed

However, a silver lining in the SLOOS release is that credit supply (via bank lending standards) has not tightened materially. Typically, a slowing in the credit cycle would be more concerning if falling demand came as a result of tighter lending standards. Another positive is that despite the fall in credit demand, we have yet to see a material widening in high yield credit spreads (Chart 1). That is typically the ​‘canary in the coal mine’ for a meaningful slowdown in the credit cycle.

Chart 1 – US Corporate High Yield Spreads Remain Contained

Source: Bloomberg

What this tells us is that the fall in demand is mostly due to a change in the macro backdrop. Namely, that trade policy-related volatility is leading firms to hold off on investments and M&A activity until there is more clarity and consistency from the White House on the matter. That does provide some relief – as recessions rarely (if ever) occur as a direct result of Presidential policy on trade and tariffs.

Of course, this does not mean that we are in the clear when it comes to the credit cycle in the US. Left unchecked, frequent shifts in administrative policy can lead to firms holding off on investments for longer periods of time. That is why this weekend’s news of targeted export tariffs for a few of the big tech names is particularly important to keep an eye on.

But for now? We suspect that the fall in demand is a red herring that will need to be substantiated by further proof.

Tactical ETFs that we like: 

• ZAAA (BMO AAA CLO ETF): For now, we like prioritizing yield at short duration in the sub-sovereign space.
• ZWT (BMO Covered Call Technology ETF): Yield-enhancement product for anyone that is concerned about current tech valuation while also allowing for participation in a fair bit of upside.

Portfolio Strategy:

a.) Shorter-term trading will take its cue from US CPI this week, but despite what comes we still continue to favour Equities and Alts over Fixed Income. 

Equities: We remain neutral in our balanced ETF portfolio. Indeed, our optimism on the fundamentals (earnings) is tempered to a degree by extant valuation and sentiment. We continue to favour US large caps (tech, communications, financials and utilities) and like augmenting that with increased exposure to EM.

Fixed Income: We’re underweight this asset class in our balanced portfolio. We continue to optimize for ​‘high yield + short duration’ with preference for sub-sovereign exposure.

Alts/​Cash: We continue to like gold and infrastructure as diversifiers.

b.) Current holdings (balanced portfolio):

Fixed income

• ZDB (BMO Discount Bond Index ETF)
• ZBI (BMO Canadian Bank Income Index ETF)
• ZTS (BMO Short-Term US Treasury Bond Index ETF)

Equities

• ZUQ (BMO MSCI USA High Quality Index ETF)
• ZLB (BMO Low Volatility Canadian Equity ETF)
• ZLI (BMO Low Volatility International Equity ETF)
• ZIN (BMO Equal Weight Industrials Index ETF)
• ZEM (BMO MSCI Emerging Markets Index ETF)

Alts/Non-traditional Hybrids

• ZLSU (BMO Long Short US Equity ETF)
• ZLSC (BMO Long Short Canadian Equity ETF)
• ZWGD (BMO Covered Call Spread Gold Bullion ETF)
• ZGI (BMO Global Infrastructure Index ETF)

c.) Views