Elaine Stokes, Co-Head of Loomis, Sayles & Company’s Full Discretion Multisector Team, and Adam Abbas, Co-Head of Fixed Income and Portfolio Manager at Harris Associates, sat down with Natixis’ Investment Strategies Group head Ken Herold for a look at global fixed income market dynamics for 2021. Highlights from the December 12 conversation are below:
What is your overall outlook for 2021?
Adam Abbas: I think it’s going to be a fairly complex year. It will require fixed income asset managers to be much more selective – and also be prepared for a lower return outcome. A theme we’re really homing in on for 2021 is selectivity. We really think there is going to be significant variance in return profiles depending on what sector you are allocated to. So as you can imagine in a low yielding environment, if you think we are right and there is going to be a lot of dispersion, it’s going to be even more important for active management.
There are really three categories we are looking to make calls on: At the asset class level we like owning credit spread over US Treasurys and other risk-free proxies. Within corporates, it’s the same theme. We like maintaining a lower quality bias, opportunistically moving down into triple B or double B risk. Finally, by sector, we like using risk-off periods to get exposure to travel & leisure. Some of these Covid-sensitive names still offer spread premium, we believe.
Elaine Stokes: I do agree with Adam on where he sees value. The other point I would add is that I really believe a lot of default and downgrades were pulled forward. And when we look at what our potential losses are, and from that risk perspective, the runway looks pretty good.
My word for the year is going to be imbalances. There are going to be imbalances everywhere. Imbalances that we don’t even know about yet. So it’s going to be all about active management. The dispersion is really big right now and will continue to be going forward.
It is the pandemic, or the reaction to it, that has driven everything up until now. So we have three big things happening. First the vaccine, which I call the light at the end of the tunnel. We now have a timeframe for when we can expect to start to see normal or whatever the new normal activity may be. Then, we have Fed policy that is promising to anchor interest rates. And I actually think there is a better chance to see fiscal stimulus now that we have an end – because it’s easier to think about how big the bridge needs to be. I actually think there will be two pieces, but that is a political thing. But I do think this will be a big help. If we get all of these things to come together, we will have predictability. Markets hate uncertainty and love predictability.
We think the credit cycle is now in recovery phase. But the thing I want to mention here is, especially as we look at the next few years, the recovery into expansion phase can be a long process. It can be a 10-year process. So I think we will grind tighter.
What’s next from the Fed?
Abbas: I think an underappreciated theme for 2021 could be this handoff by (Fed chair) Powell of monetary support to fiscal support. I think this handoff is absolutely critical and must be a smooth transition. I do not think the Fed can afford to drop the baton, let’s say, and succumb to an economic slowdown. The handoff to Congress will be key and may happen gradually in Q1 with a bipartisan stimulus bill.
Stokes: We can’t forget the rest of the world. Somewhere around 76% of the world’s interest rates are negative. There is central bank support everywhere. Europe is doing more quantitative easing. So interest rates are low or nonexistent everywhere. It’s more than just US support we need to consider.
Let’s start our lightning round of forecasting questions:
First, the US Treasury yield is still sitting a little below 1%, at about 90 to 92 basis points. Where will it be sitting at the end of 2021?
What about US high yield spreads?
Stokes: Around 325.
Abbas: I’m a little more conservative – about 370 to 360.
US investment grade spreads?
Stokes: 90. I don’t think there is much to go there.
Abbas: I’ll say right where we are today or maybe 10 basis points tighter. It’s going to be a collect your coupon year.
The VIX (CBOE Volatility Index) is around 20 today. Where will it be in a year from now?
Will the US dollar be higher or lower in 12 months?
Stokes: Lower, but not as dramatic as consensus.
Abbas: I’m going contrarian on this one. I think higher in the back half of 2021.
What worries you the most as we enter 2021?
Stokes: I have two. The first is climate change. Mother Nature is talking and we had better start listening. And I think there will be a lot of change because of that. My second big worry is the idea of customized news. People tune into the news they want to hear and don’t see both sides. This scares me because it leads to division of thought, beliefs, and facts.
Abbas: Later in the year, let’s watch how Powell and the Fed try to exit the asset purchases that they have been doing. This is not an easy task, even under the best circumstances.
How do you feel about liquidity in the bond market going forward?
Stokes: When you talk about liquidity in the bond market, you are really talking about two different things. To me there is liquidity for issuers – and that is wide open and fantastic. We can see that through new issue concessions. Globally, we are now seeing almost anyone can come to market.
When you think of liquidity as day-to-day trading – can I buy or sell bonds today? – I’ve been a little bit pleasantly surprised at what we have been able to execute this year. Even in some of the toughest markets, when we were large buyers, we were able to buy far more than I thought we would be able to buy. Right now it is a seller’s market. But we are finding out we can buy. I think there are enough players with enough different needs, especially cashflow needs, that there is a semblance of liquidity. It is not great. But we can work with it.
What are your thoughts on inflation in 2021?
Abbas: I think core inflation probably moves marginally higher if we are successful in ending Covid and opening the economy back up over a period of time here. But I think inflation will remain tame.
I take the stance that inflation is innocent until proven guilty. You know, excess central bank liquidity continues to create this response mechanism in asset prices, asset price inflation. But there is little evidence it is creating higher prices for goods and services. I also think the Fed would step in fairly fast with some explicit yield curve control if some inflationary forces spiked up over the next six months.
Are there any sectors that you are finding value in?
Abbas: Yes, there are a few. Hotels, leisure, anything Covid impacted we are scouring for value. When we look out 12 to 24 months, and we see several management teams that are actually inclined to return all of the cash to debt holders – they have cut off their dividend and stock buybacks – we see a pretty clear path for deleveraging. In certain situations, we think the free cashflow debt capture is likely better than it was coming into 2020. So there is value in certain pockets. I also think there are select opportunities in leveraged loans. You can actually move up the capital structure in public names, increase your yield, and lower your risk profile.
Stokes: I look at it as three places for profitability: Covid winners, Covid losers, and global growth. For the companies hurt by Covid, we are looking at names who may be cheap right now, may be coming back and we can invest in. Lodging and the airline space are good examples. Then for Covid winners, I see some areas where not everything is priced in yet. Take the auto sector, for example. The initial reaction was to downgrade. Then, some public transportation was cut because no one wanted to take it during a pandemic. So there are reasons and trends why people are going to want to buy automobiles. The move out of the city into the suburbs will also benefit automotives.
Finally, global growth plays. It may be time to look outside the US and start looking at emerging markets again. EM is another space that has some yield and exposure to global growth.
Be sure to listen to the podcast above for the full conversation.
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