Fourth Quarter 2020

While the weather and environment outside are frightful, as we roll-over to a new year, we find reasons for optimism. We expect a fiscal stimulus package which will include unemployment support. We are excited that there are vaccines for COVID-19 being made broadly available. We anticipate by the back end of the year, we will begin to shift back to more normal social interactions. We believe the health and safety considerations that have constrained GDP and business profitability will provide an uplift to corporate earnings and economic growth. There is light in our future!
While there is much to be sanguine about, there are many challenges. The pandemic has been an accelerant in furthering the gap between the “haves” and the “have nots”. But at the macro level, both groups will support growth. People who have money will be in a position to provide a boost to discretionary spending as the economy reopens. For people whose jobs rely on close contact with others, there has been a harsher reality and likely some permanent destruction. But the stimulus bill will provide a bridge during the vaccination period. Mostly, the markets will look past economic and health obstacles with a view that things will get back to normal late in 2021.
With unprecedented fiscal stimulus levels, the Treasury sector will experience a significant increase in supply this year. At the same time, spread sectors will see a meaningful drop in issuance. Ongoing demand for yield from investors and positive supply/demand technicals will support all spread sectors even with tight trading levels given the tremendous cash on the sidelines. Carry will be a key theme to eke out alpha where it can be found.
The path forward for markets will depend on whether the Fed and other Central Banks maintain their significantly accommodative stance. We believe the Fed will remain steadfast in their support of the economy and markets and are confident in this call. Massive liquidity was pumped into global markets in 2020 and we expect more in 2021. Quantitative Easing will remain an influence in investment opportunity sets and outcomes. This will favor risk assets as investors seek to enhance returns and cash moves out of money markets. One concern is that expected returns are not that attractive and this risk must be managed.
Corporate market spreads are trading near their 20-year tights, anchored by massive and continued monetary and fiscal stimulus and expected vaccine implementation. While improving fundamentals provide a tailwind, fairly full valuations make us more cautious. We believe that spreads are on the rich side and will likely experience more two directional trading. Tight spreads along with high leverage has us maintaining a defensive lens, but we still find value in BBBs. Security selection will be a key driver for alpha.
CMBS still looks attractive relative to other sectors, despite hotel and retail challenges, we maintain an overweight. We also remain underweight to mortgages. Although it benefits from sizeable Fed purchases, it is hurt by low interest rates and higher than discounted prepayments. We are monitoring this sector for a correction before increasing exposure.
With well-behaved inflation and a Fed on hold throughout 2021, 10-year U.S. Treasury rates should trade in a range of 0.65%-1.50%. If our optimistic path unfolds this year and the economy normalizes in late 2021, rates should move modestly higher.

Disclosure – As of December 31, 2020. 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.