MARKET OUTLOOK / STRATEGY
Third Quarter 2018
As we mark the ten year anniversary of the fall of Lehman Brothers, and the presaging of the Great Financial Crisis, an important lesson we recall is that the best of times might be followed by challenging times. We may again be in a period where the undercurrents of stresses are building and caution is appropriate, although perhaps we are early.
U.S. economic growth is robust and expectations are for this trend to continue into 2019. The benefits of late cycle fiscal stimulus is quickly bearing fruit, but is expected to peak next year. The current bump in growth, strong labor market and inflation approaching the FOMC’s 2% target rate will signal the end of an era of accommodative policy.
With FOMC projections for additional tightening to continue until 2020, the rise in short term Treasury yields and the dollar may exert pressure on the unstable segments of the marketplace, which could instill greater volatility into U.S. markets. In addition, there is increasing investor concern over the escalating trade restrictions between the U.S. and its major trading partners. Ultimately, the culmination of these events could halt the second longest expansion in U.S. history.Currently though, the probabilities of recession remain low. That said, we do view the political environment, both at home and overseas, as a risk factor.
Another stress point is likely to be the ongoing reduction of quantitative easing by other developed country central banks. Both developed and emerging markets have benefitted from the large-scale stimulus packages that propelled global yields lower and sent investors searching for higher returns by taking more credit and duration risk. As the normalization of monetary policy progresses, so does the likelihood that these riskier positions will be unwound.
The highlighted undercurrents have the ability to instigatea “risk off” episode. Within the corporate space, another pressure point may arise from the expected increase in issuance from debt-funded M&A and stock buyback programs, both of which are negative for bondholders. However, the biggest rationale for our defensive positioning is that corporate spreads are currently at the tighter end of their long term trading range. When we adjust nominal spreads for leverage, spreads are near pre-crisis lows, which indicate market participants aren’t being compensated for late cycle risks.
We maintain a relatively neutral credit stance given the risks that litter the investment landscape, and also retain a defensive positioning to prepare for more challenging times. We believe this current posture positions us to take advantage of market opportunities as corporate spreads revert to wider levels. The defensive positioning includes overweight allocations to both high quality CMBS and ABS. The portfolio is presently targeting its duration slightly short of the Index, in expectation of modestly higher yields.
Disclosure – As of September 30, 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.
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Source: Pugh Capital, Bloomberg, and Bloomberg Indices.
As of .