Financial professionals have many factors to consider as they ready fixed income portfolios for the new year in the midst of health-crisis uncertainty. If fixed income is used as the ballast or risk reducer in portfolios, it may be even more critical to get it right. To help inform allocation decision making, portfolio managers, strategists and a global macro specialist from across Natixis Investment Managers’ complex share their thoughtful insight.
Low Rates, Inflation, Supply of Safe-Haven Assets
Lower for longer is an investment thesis that Jack Janasiewicz, CFA®, Portfolio Manager, Portfolio Strategist for Natixis Investment Managers, expects to be around throughout 2021. “That means we don’t see inflation coming back with a vengeance anytime soon,” said Janasiewicz. He believes the pandemic has created a deflationary environment that should linger awhile.
With today’s economic backdrop, Janasiewicz believes there remains a shortage of safe-haven assets in the world, therefore quality fixed income should remain in demand. “We still think the higher quality portion of the credit market will remain supported in this environment. Investment grade, or even out to emerging market dollar-denominated debt that is investment grade, could be favorable for some time.” As the extent of the damage from the crisis is still unknown and default risks are elevated, he believes more caution is warranted on high yield continuing into 2021.
Municipal bonds is another area now looking more attractive to Janasiewicz, as well. “We think on a relative value basis, when comparing yield to US Treasuries with similar maturities, munis have become interesting. In addition, with the economic recovery moving forward, albeit slowly and unevenly, as well as the prospects for some fiscal stimulus at the federal level in the next round of congressional support, we find some value in municipal bonds. Especially when you consider they sit at the higher-rated rung of the fixed income universe – which may help investors retain a quality bias,” says Janasiewicz.
Could Broad Infrastructure Needs Fuel New Munis?
We have witnessed the pandemic accelerate trends already under way, with the obvious being e-retail, food delivery, and work-from-home related. Infrastructure may be the next big area to consider. Jim Grabovac, CFA, VP, Municipal Bond Investment Strategist at Loomis, Sayles & Company, believes Covid-19 has redefined the breadth and depth of the term infrastructure. Going forward, he believes infrastructure will not only encompass traditional elements such as bridge building, but also the innovation to enable systems to evolve with society’s needs.
Loomis Sayles’ Municipal Bond Team expects to see significant infrastructure financing coming down the road. “It is not a question of if, but of when and what magnitude,” said Grabovac. “Cities have weathered economic dislocation and fiscal pressure. We believe they will ultimately evolve and thrive with infrastructure spending and innovation. We expect capital to be raised through the municipal bond market as traditional tax-exempt debt or some form of subsidized taxable issuance.”
Grabovac points out that municipal system administrators and investors are reassessing whether the long-term prospects for many critical sectors of the economy have changed irreparably. Municipalities will now have to reinvent processes and procedures to deal with the new reality caused by Covid-19 (and likely future pathogens that may inflict different health and economic crises).
As the economy and society attempt to recover and move forward from the pandemic, Grabovac says he is hopeful that policymakers will look beyond the short-term budget pressures and instead consider the cost-benefit and potential productivity payoff from a long-term infrastructure investment program. “We believe we are far more likely to get a strong and durable economic recovery if infrastructure investment becomes a policy priority over the medium term,” says Grabovac. After all, strong public infrastructure – including access to water and sanitation, modern and efficient transportation systems and highways – facilitates interstate and international trade, mitigates flooding, spans waterways and provides facilities to pursue education. All of these critical sectors are financed in the US municipal market.
What’s Next for the Credit Cycle?
While Covid-19 forced a rapid transition from late cycle into the downturn phase of the global credit cycle in early 2020, signs of repair and recovery are under way as we inch closer to 2021, according to Loomis Sayles’ Macro Strategies Team. The majority of signals continue to indicate credit repair. However, the team is seeing indicators consistent with the recovery phase of the credit cycle, especially when incorporating forward-looking views – including accelerating credit growth, high risk-appetite and near average and rising asset valuations. They do warn that a delay of an additional US fiscal package could slow the cycle's progress.
Loomis Sayles is also watching factors specific to current circumstances that might influence progress through the cycle. In their view, no individual variable is likely to single-handedly shift the cycle, but it may ignite a chain of developments that ultimately rotates the cycle. Here’s a snapshot of these special factors:
The chart presented above is shown for illustrative purposes only. Some or all of the information on this chart may be dated and, therefore, should not be the basis to purchase or sell any securities. The information is not intended to represent any actual portfolio. Views and opinions are subject to change at any time.
Craig Burelle, Senior Macro Strategies Research Analyst at Loomis Sayles, thinks the macroeconomic backdrop and continued progress through the credit cycle will be the principal drivers of performance over the long term. He and his team believe an effective vaccine and adequate vaccine distribution are upside catalysts that could help begin to lift social distancing measures by the spring of 2021. “In that scenario, economic growth could potentially roar back stronger than currently expected,” says Burelle.
Of course, the credit repair phase of the cycle doesn’t imply that economic challenges are behind us. It highlights a behavioral shift toward saving and deleveraging on top of easy central bank policy and above average but declining volatility. “It’s typically the sweet spot for credit as companies start to clean up their balance sheets. But deleveraging can also happen through rising bankruptcies and defaults, so we believe credit selection is critical,” says Burelle.
Finding Value in Credit Repair
Historically, Loomis Sayles’ Multisector Full Discretion Team, which follows a go-anywhere approach in its search for the best value across global bond markets, has leaned on the credit and corporate bond markets during credit repair phases. Elaine Stokes, EVP, Portfolio Manager and co-head of the team, says it is still a nervous time for credit investors. However, if you have the ability to navigate in these markets, and the credit research to analyze every sector and security, it is actually an interesting time.
Stokes explains that the Covid recovery has been far from even. “When you go through a downturn and there is so much stimulus that quickly, it’s impossible for all engines to be running at full speed. Therefore, you really have to understand industry by industry and company by company where we are,” says Stokes. A look at consumer behavior during the pandemic shows this economic unevenness – buying bikes, technology and golf-related items, but not suits, movie tickets, bar tabs or vacations. “So we really need to understand where money is being spent, what companies are beneficiaries, and which ones are being hurt and might not have the wherewithal to survive.”
The Multisector Full Discretion team is leveraging Loomis Sayles’ deep credit research skills to identify value in the lower quality investment grade BBB* space. “We are interested in focusing on names in the BBB space that may be under pressure but we don’t think will be downgraded, or that are really quality companies and even if they are downgraded we may benefit from owning them long term,” says Stokes. She also expects to increase high yield exposure through careful issue selection.
High Yield Market Makeover
A spike in downgrades and defaults in 2020 has definitely changed the makeup of the high yield market. “The high yield market is significantly longer in duration today. It’s higher in quality. There’s much more consumer exposure and a lot less energy exposure,” says Stokes.
After shrinking in size during the last few years, the high yield market appears to be growing again, as well. Stokes looks forward to going shopping in this expanded market in 2021. Overall, she expects US high yield should perform well as the credit cycle progresses toward recovery in the quarters ahead, as lower-credit-quality fixed income performance tends to be highly correlated with economic activity.
While 2021 may usher in the recovery phase, Covid-19’s full economic effects are still unknown. With so much uncertainty, utilizing skilled active fixed income managers with flexible mandates is one way to help take the guesswork out of when to make shifts in quality, durations and sectors. Risk management is another important factor active managers provide that shouldn’t be overlooked, especially amidst a pandemic.
Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity. Municipal markets may be volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.
This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary. The views and opinions expressed are as of November 20, 2020 and may change based on market and other conditions.
All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. Indexes are not investments, do not incur fees and expenses and are not professionally managed. It is not possible to invest directly in an index.
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Natixis Distribution, L.P. (fund distributor, member FINRA | SIPC) and Loomis, Sayles & Company, L.P. are affiliated.