Ahead of the curve | Friday, 12th March

Regime shift underway – Persistent bid for financials since Blue Wave.
After four consecutive years of underperformance, Financials have started 2021 well, with the MSCI AC Financials index outpacing the MSCI AC index by 870 basis points through March 10^th. Digging into the numbers, there seems to be an underlying bid to the sector that simply had not been existent since the pandemic began. Specifically, in the period from early March 2020 to January 5^th 2021 (date of the “Blue Wave” election win for the Democrats in the US Senate), Financials underperformed on 61% of the days during which the overall market fell. Essentially, if markets were down, Financials were very likely to be performing even worse. However, since the Blue Wave, that number has plummeted to just 35%. So even when markets fall now, the Financial sector is outperforming roughly 2/3 of the time. That is a quite stunning turn for a sector long maligned as being a pure beta play. Trends have turned, and investors are clearly taking notice.

ECB sanguine on rising bond yields – And better economic outlook.
After weeks of bond yields marching higher, all eyes were on the ECB’s Governing Council press conference to gauge the ECB’s response. Announcing that it would increase the pace of asset purchases under its Pandemic Emergency Purchase Programme (“PEPP”), the ECB also upgraded its economic forecasts, indicating that the risks to the economic outlook have become more balanced. European sovereign yields reacted dovishly, with yields coming in by 2-7bps. In repeatedly stressing the ECB’s “holistic” and “multifaceted” approach to assessing financial conditions, we believe Ms. Lagarde delivered the right balance of acknowledging the market’s concerns around higher bond yields while emphasizing the better economic outlook. Our takeaway is that gradually higher yields will be tolerated so long as the economic recovery remains on track. The reflation playbook remains very much alive.

Fiscal dominance – No signs of relenting.
Last week, the European Commission (EC) published guidelines for returning to fiscal oversight under the Stability and Growth Pact framework. Importantly, the EC suggested not reactivating oversight until Eurozone GDP returns to pre-pandemic 4Q19 levels, which the EC currently projects to be mid-2022. We view these guidelines constructively as it pushes out reinstatement to 2023 and shows the EC’s concern for premature withdrawal of fiscal support. Separately, Germany extended the suspension of its constitutional “debt brake” through 2022, suggesting Germany may not oppose suspension of fiscal rules in the European Council. In the US, as expected, Congress passed its $1.9 trillion COVID relief bill that, among other things, provides direct financial support to many Americans via $1,400 checks, an extension of a $300 weekly jobless-aid supplement. With the COVID relief package passed, attention now turns to the Biden Administration’s infrastructure and investment proposal. While details are scant, it is perhaps more significant than the relief package given potential impact to long-term economic growth.

M&A activity continues – Takeout of core holding.
Athene has been a long-time core holding across Algebris equity funds and this week was taken out by Apollo, which already owned ~30% of Athene and which manages 100% of Athene’s investment portfolio. While we long thought this was the likely end-game for Athene, we were somewhat surprised by the premium paid (~15%, paying just 1x BV despite a mid-teens ROE) and the timing, given the steepening yield curve was a clear tailwind developing for Athene. As they are paying in shares for Athene, our ownership in ATH will be swapped into Apollo, which we owned for several years in the past and believe strongly in their business model. The deal is highly accretive for APO, leaving the stock on ~9x next year’s distributable earnings (versus 15x for KKR and 19x for Blackstone). This looks very attractive to us and while we locked in some of our substantial gains in Athene on the day of the announcement, we expect to continue to hold a position as long as the see-through valuation remains compelling.