First Quarter 2018

Pugh Capital’s outlook for greater volatility and more challenging market conditions materialized sooner than we expected. Although economic data points to continued positive global growth and optimism remains high, risks are rising due to the U.S. shift to more aggressive protectionism policies and rhetoric. Enacting tax cuts and deficit spending with an economy running near capacity is also concerning. Balancing the increased risks in the markets and the opportunities that arise in a higher volatility environment will be important in driving portfolio performance.

Looking forward, geopolitical and leadership risks have moved to center stage, usurping monetary policy as a central focus. The Trump Administration has implemented aluminum and steel tariffs, and worries about escalating trade wars are rising. Of particular concern will be the evolution of the U.S.-China trade relationship and whether it proceeds in an orderly and rational fashion. Significant turnover in the President’s cabinet also elevates uncertainty. As the year progresses, more insights into these risks will become available, but risk premiums should remain high due to greater uncertainty and the potential for unintended impacts.

The handoff to a new Fed chair went smoothly, as Chairman Powell maintained general consistency with the policies of his predecessor. However, the Fed’s March dot plots indicate expectations of modestly higher growth and inflation, and an upward shift in the trajectory of Fed Funds. The Federal Reserve’s path toward normalization will become more impactful as their balance sheet unwind and rate increases become a bigger drag on the economy. It is also possible that the Fed determines it needs to be more aggressive in its rate hikes while other central banks are also likely to begin reducing accommodation. With the lags in policy impact and the myriad of fiscal policies being introduced late in this cycle, the risks of a policy misstep increases over time.

As the labor market continues to tighten with significant fiscal stimulus already unleashed, the prospects for higher inflation have more support. Inflation expectations have shifted higher, while actual inflation remains relatively muted. Our outlook is for inflation to trend modestly higher, but to remain well behaved and within Fed targets.

Our outlook for the 10-year Treasury is for a slightly wider trading range of 2.00% to 3.25%. We expect increased geopolitical risk, financial instability and lower than expected inflation to support lower rates. Stronger global growth, optimism and increased inflation support higher rates. Market technicals including dumping of U.S debt by foreign holders, unwinding of the Fed’s balance sheet, and increased Treasury borrowing also support higher rates. The yield curve should continue to flatten with short rates moving higher.

Pugh Capital has shifted to a more defensive posture with regard to credit management. We are paring back risk, both through asset allocation and security selection. The combination of rich valuations, robust new issue supply, a significant M&A pipeline, and elevated idiosyncratic and regulatory risks have increased our level of caution. We believe positioning matters as we move into a more volatile market environment. Managing downside risk will be a primary focus, providing us the flexibility to be a liquidity provider when bonds become available at attractive levels.

The Mortgage sector has cheapened and is starting to look more attractive. While it faces supply headwinds from the Fed balance sheet unwind, we expect to increase the allocation as mortgages cheapen further. We remain overweight both ABS and CMBS for their attractive risk-adjusted return profile. However, we have reduced the non-agency CMBS exposure as the expected environment will cause spreads to leak slightly wider.

Disclosure – As of March 31, 2019. Source: Pugh Capital, Bloomberg, and Bloomberg Barclays Indices. This market outlook and succeeding pages contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions are subject to change without notice. Investors should evaluate their own risk tolerance, time horizon and other restrictions for their investment decisions. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions, and investors should evaluate their ability to invest for the long-term, especially during periods of volatility in the market. Please do not redistribute. Refer to the Legal & Disclosures section for additional disclaimers, disclosures, forecast, outlook and other information.


Past performance is not a guarantee or a reliable indicator of future results. Investing involves risk; principal loss is possible. Fixed income market data provided is drawn from the Bloomberg Indices for informational use only and is not representative of account performance. It is not possible to invest directly in an index. Investors should carefully consider risk when investing in bonds or other securities, which include, but are not limited to, default, credit rating, interest rate, duration, prepayment, liquidity, and structural risks. Securities are also subject to general market risks due to factors that affect the overall market, which may include, but are not limited to, government actions, investor behavior, and economic conditions. Economic conditions may be influenced by liquidity risk, geopolitical risks, monetary and fiscal policy, interest rate risk, and inflation, among others. There is no guarantee that investment strategies presented will work under all market conditions. Risk management processes including diversification cannot eliminate the risk of losses nor assure the likelihood of a gain. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn or volatility in the market. Refer to the Legal & Disclosures section for additional disclaimers and disclosures regarding performance, risk, and investment process.

Information presented is for informational purposes only. It is not intended as investment advice nor an opinion or a recommendation as to the appropriateness of investing in any particular security, asset class, strategy, or product. Nothing in this publication is intended to be relied upon as a forecast or research; legal, tax, securities, or investment advice. Nothing in this publication is a solicitation of any type.

This commentary contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions, outlook, and strategies are subject to change without notice. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

This report is intended for U.S. institutional investors only. No part of this material may be modified, distributed or duplicated without the explicit permission of Pugh Capital Management.

Source: Pugh Capital, Bloomberg, and Bloomberg Indices.

As of .