Marketplace Lending in the Age of Trump

Now that we are a month into the new administration, where exactly are we?

P2P Lending In a Good Position

The result of the Presidential election was a surprise to many people. Even the markets themselves had no idea how to react with futures down by more than 5% the night after the election, at first. Recovery from the drop was near immediate and the market has gained since then with the S&P 500 currently at 2365. This theme of increased volatility will likely continue and  p2p lending is positioned to benefit from the current market conditions and a new Presidential administration.

Economic Outlook

The Wall Street Journal is reporting that real GDP should grow for 2017 and 2018 to the 2.25% range with inflation and bond yields on the increase as well, as seen in this chart.

Forbes is predicting a 2% growth for 2016 and a slightly higher growth rate of just over 3% for 2017. In their notes from their late September and October meetings, the Fed’s FOMC (the Federal Reserve Open Market Committee) forecasts 2% growth in 2017 and 2018.

Summary: Many forecasters are saying similarly that there will be nominal growth with perhaps slightly higher growth than the last couple years for 2017 and 2018.

Market Reaction

In the meantime, investors look to be bullish on the US markets based on this Financial Times piece on equity flows. The flows are at near record levels. The FT piece goes on to say that these inflows are matching outflows from emerging market bond funds in markets like Mexico.

The market reaction is not limited to stock markets, inflation, and economic growth. There have been big movements in the currency markets as well. Here’s how the dollar has done against other important currencies.

The WSJ reports the biggest gain in the USD against a basket of 16 currencies since May in the week immediately following the election. The rally was 2.4% with additional records set a week later on the US Dollar Index per FT. Business Insider reports that the Mexican peso, a much talked about and important currency due to the amount of trade we do with Mexico, is down to a new low of just over 20 MXN per USD. The Chinese Yuan is down to almost 7 per 1 USD. CNN is reporting a record high in the USD against other currencies as well.

Summary: The USD has increased against nearly every major currency since the election. This is something that could continue or new trade policies could affect the USD against other currencies in an unknown way in the new administration. The stock market is reacting positively so far.

Increased Volatility

Surprises like this election result usually mean uncertainty and uncertainty means volatility. CNBC reports an increase in volatility in the market already and expects this to continue. The WSJ agrees that volatility should ‘remain high’ with quotes from economists and banks such as PNC and DeutscheBank’s Asset Management Group. The immediate reaction of a drop in all market futures prior to the open right after election day to the immediate recovery is a potential sign of the volatility to come based on the uncertainty of what a Trump administration might do.

The Dow hit a market high of just under 21,000 with an increase in volatility. The VIX, a measure of volatility and traded on its own on the CBOE, spiked from around 12 prior to election day up to 21.51 before dropping back to around 11.5 where it is today.

Morgan Stanley agrees with the volatility and potential increases in rates and inflation, maintaining the position that the Fed will raise rates in December (which they did after this article was published). Unlike the other projections here, they see a potential buying opportunity based on sectors that may be oversold, as well as the potential for corporate profits, decreased regulation and tax policy under the new administration.

Two fund managers who asked not to be named, one at a large fund and one at a smaller fund, commented to me on the volatility as well. One told me that ‘there is a bit of price volatility associated with markets and treasury rates that are having a minor effect in the [p2p lending] industry like any other short-dated, high yield fixed income investment, but which is being offset by positive news associated with some of the big platforms securing capital.’ The other said that ‘volatility is in a good place now and we are looking to deploy more funds into certain specialty marketplace platforms.’

Summary: The general consensus from bond market activity and the strategists is that rates will increase as well as inflation in an environment that is generally more volatile than where we have been the last couple years. The new administration’s tax and regulatory policies could benefit markets and investments when implemented.

 

If rates and inflation both increase, then where in fixed income are the buying opportunities?

Fixed Income Likely to Move to Credit Risk from Interest Rate Risk

A selloff in global bond markets means that US interest rates are at its highest level in a year. The benchmark 10 year Treasury is up 50 bips just since election day. The opinion in this same CNBC article shared by rate strategists at B of A Merrill Lynch, Nomura Securities and Brown Brothers Harriman is that an increase in rates is highly likely and will lead to an increase in inflation as well.

This is where things get interesting since P2P Lending is often seen as a substitute for other fixed income investments like bonds.

Summary: With this interest rate rise baked in, the fixed income markets are likely to move to an evaluation of credit risk instead of rate risk. Fixed Income options dealing with prime borrowers with high FICO credit scores, good incomes and good Debt to Income ratios are likely to take precedence in consumer and small business loan markets and be in high demand in this changing market environment. Many marketplace lending platforms fit this description of borrower type leading to a reduction in credit risk.

 

P2P Lending Portfolios are Quality Assets in Uncertain Times

Marketplace Lending is a desirable asset class to invest in for a couple of reasons regardless of who is in charge including the yields, low risk, lower volatility and lack of correlation with the stock market. Lending Robot, an automated investment service and robo-advisor for the industry, published a white paper in 2015 on volatility and correlation that still applies today. On page 6, they show a volatility study they did with results below.

Their initial portfolio is a selection of various stock and bond mutual funds covering small cap, mid-cap, growth and income, international and aggressive growth stocks as well as bonds. The returns are 5.1% per year for the peer loans versus 6.9% per year for the stock and bond funds (see Column 1), however, the volatility is way way less at 0.02 vs. 0.40 (see Column 2).

Incorporating Marketplace Lending into a portfolio that has stocks and bonds in it appears to keep returns steady yet bring overall volatility way down. This could become an important factor in the increasing volatility and rate environment most believe is coming in the next few years.

Another interesting part of the study is how P2P Lending assets don’t correlate with the markets. Page 8 of the paper shows an analysis versus all the stock and bond funds used to create the initial portfolio for the study.

Correlations go between 0 and 1 with closer to 1 meaning more closely correlated. Negative (red) numbers mean they are inversely correlated like how bond rates and bond prices move in opposite directions from each other.

A highest correlation of 0.19 is not highly correlated between Peer Lending and a stock market mutual fund and interestingly, the 2 funds showing a negative correlation are both bond funds (an Aggressive Bond Fund and a TIP bond fund).

Marketplace lending platforms have many different options for types of investment like small business, real estate or student loans as their focus. There are additional options based on the type of borrower with super prime, prime, near prime and subprime borrowers. The flexibility and number of platforms available means more ability to control the credit risk you want to take in your portfolio. For instance, there are platforms that only work with super prime, high-income borrowers if reducing credit risk is a major concern.

Consumer peer lending platform Prosper Marketplace reports that their average FICO credit score is 701, just a hair higher than the industry average of 695 and in the Prime category of the borrower. Another consumer platform Avant goes lower with an average FICO between 600 and 700 putting it in the near prime and part of the sub prime categories. As the rate strategists at Nomura and Brown Brothers said above, there is a high likelihood of increasing rates so credit risk is likely to be the fixed income focus going forward. Platform choice means more control of that risk. Choose wisely.

Mutual fund data company Lipper reported the week after the election ending 11/16 showed net outflows on bond funds of $5.9 billion and $0.9 billion for All bond funds and global and international bond funds respectively.

Summary: Eventually the money going out of emerging bond funds into the US stock market like FT reports or flowing out bond funds altogether like Lipper reports will want to diversify in some way and marketplace lending is a great option that won’t correlate with your existing investments when you’re ready to make the move. P2P Lending assets are quality assets for uncertain, volatile times.

Conclusion

A Trump administration brings some uncertainty into the investments world. Even with that uncertainty, p2p lending looks able to benefit from the changes we might see.
We have a positive economic outlook for the next couple years based on numerous projections of GDP growth of 2-3%. Markets have reacted positively with the Dow and S&P reaching new highs and the USD has gained in value against other major currencies. Volatility is on the increase and peer lending as part of a portfolio maintains steady returns and decreases volatility. Interest rates look like the rise started in December could continue creating a shift to credit risk in the fixed income markets. With numerous marketplace platforms to choose from, we can control how much credit risk we decide to take. Each of these factors benefits p2p lending as an investment option as part of profitable low-risk portfolio building.

About the author

Stu

Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending.

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