MARKET OUTLOOK / STRATEGY
Second Quarter 2024
Our base case scenario is for persistent and modest growth. The probability of a recession this year remains low. The reality of how people experience the economy is often a function of their financial well-being. Consumption, especially on services, continues to be a driver of growth, with wealthy households consuming a disproportionate share of spending and benefiting from strong asset appreciation. Middle- and lower-income households have fared worse as they are harder hit by inflation, have less disposable income and savings. Signs of weakness in higher delinquencies on credit cards and autos are concentrated in lower FICO score borrowers. We are an economy of very different realities.
Inflation has been sticky in the past year after declining from the highs in 2022. The Pandemic created unique challenges for supply and demand for goods and services that are still impacting prices and the economy. The Fed and markets have had to continually recalibrate expectations of the timing and path of interest rates, as incoming growth and inflation data have proven to be resilient. Uncertainty in the path of monetary policy could result in elevated interest rate volatility. While our bias is skewed towards the Fed cutting interest rates, we think they will remain on hold at least until the fourth quarter. The election introduces additional risks and is another potential source of volatility. We maintain a neutral duration position and a trading range of 4%-5% on the 10-year U.S. Treasury.
Yields remain elevated and enhance the risk/reward characteristics of fixed income. Current yields provide solid income generation for investors that become meaningful with longer holding periods and affords some cushion for both rate and spread volatility. The front end provides the highest yields along the curve. Our team likes shorter duration securities such as ABS and front-end corporates as a stable source of income.
Corporate fundamentals continue to be healthy. While debt levels have ticked up slightly corporate earnings are expected to increase in the coming quarters. Cash balances are elevated and continue to generate decent income. We maintain a modest overweight to the corporate sector but constructed from a bottom-up lens and use duration along the curve as a lever to manage our risk profile. We continue to favor BBB rated companies given their deleveraging profile and higher yields, combined with our analysts’ convictions. Our focus continues to be stable to improving credits that should prove resilient throughout the credit cycle.
We like the agency MBS space which has limited credit risk due to their government-backed credit guarantee by the issuing agency or government-sponsored enterprise. Higher rates translate to an Index with a decent dollar price discount and an improved convexity profile. Their spreads are also flagging attractive on an absolute basis and relative to corporates. Spread tightening will likely be minimal as banks and the Fed, which were significant buyers, have moved to the sideline. We also find ABS appealing and have a strong overweight. Non-Agency CMBS is cheap on a spread basis but is experiencing stress from the office sector. We take an opportunistic approach to the sector.
DISCLOSURE
Past performance is not a guarantee or a reliable indicator of future results. Investing involves risk; principal loss is possible. 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 June 30, 2024.