Third Quarter 2021

Every cycle is different and as investors, part of our job is to identify what makes each cycle unique. Our goal is to position client portfolios to take advantage of our insights and to lean into opportunities when we feel there is reasonable compensation for the risks that we undertake. This cycle has been distinctive in several ways including the catastrophic health issues of the Pandemic, the massive government stimulation that uplifted the economy and markets, the supply chain bottlenecks, and the compressed nature of the cycle relative to historical norms.

We are on the verge of transitioning from the extraordinary support of monetary and fiscal policy into a new, less accommodative regime for this cycle. The Fed’s increased comfort with the substantial progress in achieving their dual mandates has pulled forward the timing of Fed liftoff. Chairman Powell has indicated that tapering plans will be communicated at the November meeting. Market expectations are that tapering will be completed by mid-2022, with gradual rate hikes following. This shift to less accommodative monetary policy will be combined with a significant decrease in fiscal spending as well.

Supply chain disruptions have pushed inflation higher and have gained momentum and breadth. The shortage of semiconductors is impacting several industries’ ability to manufacture their products. While there are a lot of employers looking to hire, the Pandemic has created return-to-work concerns around health, safety, and family contributing to labor shortages. Energy supply and demand imbalances are occurring during a period of elevated environmental concerns. We expect that these bottlenecks will resolve themselves, but the unique health concerns of this cycle, create challenges that permeate and linger throughout the economy. The transitory inflation view may take longer to play out, creating market angst.

The key challenge across fixed income sectors are rich valuations. We expect greater volatility as we move forward with a less accommodative Fed. In general, tight spreads don’t provide much protection for a normalization of trading levels. We maintain a modest overweight to Credit as a strategy to capture carry and income. Our overweight is tilted towards BBB-rated securities that we believe have less balance sheet leveraging event risk. On the plus side, attractive yields for foreign investors and cash on the sidelines provide positive technical support for risk assets. Supply bottlenecks may hit earnings for some industries, while possibly providing margin support for others, so security selection remains important in this environment of tight spreads.

We maintain an underweight to MBS reflecting an expectation of modest spread widening into the taper, but we have become less negative on the sector. Differentials between model and actual prepayments have narrowed, reducing a major risk for investors. We are overweight non-Agency CMBS where we currently find attractive relative value versus other sectors.

We expect the 10-year Treasury to trade in a range of 1.20% to 1.75% for the fourth quarter. Surprises from economic or inflation data can act as a catalyst for breaking out of the trading range, but we expect the cross currents to persist and to keep rates within this range. Our strategy is to manage duration with a bias toward being neutral and to trade the range.


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 September 30, 2021.