Scorecard: Second-Half 2020 Outlook
We called for continued equity market volatility through the second half of 2020, and while that wasn’t a very complicated and risky call to make, it certainly came true. The combination of the Covid-19 pandemic and uncertainty over the US presidential and congressional elections were the main factors behind market turbulence. In addition, questions over when or if Congress would pass more fiscal stimulus, and concerns over growth stock valuations, were additional contributors to volatility.
Our second outlook idea concerned expecting greater investor interest in alternative investments. While we didn’t necessarily expect significant alternative ETF flows, our rationale for the increased interest was based on a few market factors. The thesis here involved the low yields going into 2020, combined with what we considered a richly valued equity market. Yet a significant increase of interest in alternative strategies doesn’t appear to have come to pass. Rates remained at record lows throughout the year, particularly after the rapid market declines of March and April were met with accommodative monetary policy on the part of global central banks. During the worst of the pandemic market crisis, many investors didn’t have time to research investing in alts while others opted to move to cash positions. When they came back into the security markets from cash, many invested in the red-hot equity market.
Our third outlook idea called for significant tax loss harvesting.2 We need only to look at Natixis’s Active Index Advisors (AIA) business, which is a tax loss harvesting and direct indexing provider, to see the tremendous growth in tax loss harvesting. AIA has been extremely busy supporting clients’ custom tax planning requests and has doubled their client assets over the last two years. We have also seen a flurry of merger and acquisition activity in the tax loss harvesting space, as large asset managers and wealth managers try to acquire this capability. As to why this trend is happening, there are a few reasons. Beyond the ability to harvest losses from the extreme market swings we have seen, some of the tax planning activity could have been driven by the anticipation of a Joe Biden victory in the 2020 presidential election. It has been speculated that federal income taxes and capital gains taxes may increase under a Biden administration.
A Look at the Year Ahead
- Buyers will likely favor US-focused ETFs over international ETFs.
As we lead into 2021 – and significant uncertainty over market direction in light of continued Covid-19 public health and economic challenges – we expect US investors to put most of their equity dollars to work in US ETFs as opposed to international ETFs. These investors are likely to have more confidence in the US economy coming out of pandemic more quickly than Europe and emerging markets. It’s also worth remembering that going into the Covid-19 crisis, there was more enthusiasm in US markets over international. The vast monetary policy support and fiscal aid undertaken by the US government is also reason for near-term optimism about US companies and consumers.
- Buyers will likely favor high quality bond ETFs over junk bond ETFs.
A similar theme carries from equities into the fixed income market. As health officials, policymakers, and financial professionals work to understand the near and long-term ramifications of the Covid-19 pandemic, we anticipate that investors will remain cautious. In addition, with concerns about companies’ ability to ride out several difficult quarters, we expect to see investors gravitate toward investment grade fixed income over high yield. In order to avoid defaults, credit research may matter more in 2021 than it has in many recent prior years. In this scenario, investors tend to prefer owning active fixed income products. There are a range of active fixed income strategies available to investors. Offerings from Natixis include the Loomis Sayles Short Duration Fixed Income ETF (LSST).
- ESG ETFs may have their biggest sales year ever.
Environmental, Social and Governance (ESG) ETFs have been gaining momentum for the last few years. It began in Europe, with both investors and governments driving flows, then became popular with US institutional investors. Now we are seeing an increase in retail investor interest. The US demand has translated into increased flows into existing ESG ETFs and the launch of new ESG ETFs. We expect this trend to continue in the year ahead. There seems to be increasing agreement among policymakers and business leaders that the world needs to do more to address climate change – and there is evidence that younger generations of investors prefer owning more sustainably mindful portfolios.
2 Tax-loss harvesting is the selling of securities at a loss to offset a capital gains tax liability.
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