Top of the Morning: Summer rally setup for preferreds
The desk believes a summer rally in preferred securities is likely due to emerging trends of improved relative value, favorable interest rate expectations from the Chief Investment Office (CIO), and historical mean reversion dynamics. Per the full note from UBS, Senior Fixed Income Strategist Frank Saleo highlights the recent performance divergence between $25 par and $1,000 par preferreds as a significant factor supporting this forecast. Key data from UBS indicates that market positioning appears conducive for $25 par preferreds as investors anticipate a return toward historic balance. This is underscored by their analysis of interest rate behavior in 2023, where shifts could catalyze investment flows back to these securities. The clock is ticking towards summer, a traditionally strong season for these financial instruments.
What the desk is arguing
The desk frames this as a strategic moment for traders to capitalize on the favorable setup anticipated in preferreds. Frank Saleo outlines that $25 par preferreds may witness increased demand as the market corrects from recent discrepancies in performance relative to their $1,000 par counterparts.
Saleo suggests that the factors contributing to the positive outlook include improving relative value and CIO expectations predicting stabilization or possible declines in interest rates. His commentary implies that historical mean reversion patterns historically favor the $25 par preferred sector after such divergences.
Where it sits in our coverage
Our current consensus on preferreds aligns with a projected target of 1.075, with the following assessments from various firms being noted: - jpmorgan: 1.10 (Mar-26) - bofa: 1.04 (Mar-26)
This outlook places the desk's assessment near the upper bound of forecasted returns amidst a consensus that is generally optimistic about preferreds during the season ahead. Notably, jpmorgan is among the firms supporting this bullish sentiment.
How other firms see it
In general, firms such as jpmorgan are aligned with the desk's optimistic view. In contrast, bofa has a more cautious stance, apprehensively forecasting lower targets for preferreds affected by interest rate uncertainties.
Market observers should note how this dynamic may affect related asset classes, notably as movement in U.S. Treasury yields could interact with preferred securities. Changes in Fed communication is likely to impact market sentiment, thereby also influencing preferred stock valuations.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Expected rally in $25 par preferreds bolstered by improved relative value.
- 02Historical mean reversion patterns suggest a correction of recent performance discrepancies.
- 03CIO's outlook on interest rates supports a favorable investment environment.
- 04Positioning considerations are crucial as summer approaches.
Market implications
Traders should monitor movements towards the 1.075 target level alongside potential shifts in the U.S. Treasury yield curve, which may determine short-term performance of preferreds. Keep an eye on market positioning as we enter the summer months, traditionally strong for this asset class.
Risks to this view
Should the Fed signal a more aggressive rate hike approach than expected, it could dampen investor enthusiasm for preferreds, leading to a significant downward revaluation. If macroeconomic indicators suggest a recessionary shift, demand for higher-risk preferreds may wane, causing potential losses.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, we will focus back in on fixed income markets, specifically preferred securities.
Joining me here at the 1285 Podcast Studio in New York, glad to welcome back Senior Fixed Income Strategist Americas from the UBS Chief Investment Office, Frank Saleo. Frank, first off, great to have you back here at the table. Thank you for dropping by and for spending some time today with our listeners and clients here on Top of the Morning.
Thanks, Dan. It's great to be here. So Frank, very timely that you're dropping by today.
I know you just authored a blog post entitled, Summer Rally Setup for Preferred Stocks. So to begin, Frank, can you tell our listeners a bit more about the setup and why do you expect preferreds to rally this summer? Sure.
I think there are a number of trends that are converging right now that should provide supportive underpinnings for $25 par retail preferreds. And those trends are improved relative value, also our CIO expectations for rates, and thirdly, the recent performance divergence between $25 par preferreds and $1,000 par preferreds and the historical mean reversion trend that typically occurs after similar periods of divergence have occurred. So Frank, that's interesting.
You're making a distinction between $25 par and $1,000 par preferreds here. Other than the obvious differences in par value, Frank, what are the other differences that investors should be aware of? Sure.
So taking a step back, preferred securities are any coupon-paying corporate securities that are subordinated to senior debt but above common stocks or higher in the capital structure than common stocks and securities that pay discretionary coupons that can be canceled, suspended, or deferred without incurring or creating a default event. So these preferreds come in two forms based on par value. You have $25 pars and $1,000 pars.
Now, the $25 par preferreds, sometimes called retail preferreds, are usually exchange listed on the New York Stock Exchange, sometimes NASDAQ, and they typically pay a fixed rate coupon. The $1,000 par preferreds, sometimes called institutional preferreds, typically trade over the counter. It's very similar to a corporate bond, the way corporate bonds trade over the counter, and they pay variable rate coupons.
Importantly, although $1,000 pars are sometimes called institutional preferreds, they are very accessible and very available to individual investors and private clients here at UBS. And we actually generally do recommend that the best strategy is to look to invest in both $1,000 par and $25 par preferreds and then position strategically. Now when I mention mean reversion, I think the $25 par preferreds have recently been oversold relative to $1,000 par preferreds.
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