The Investment Conversation
Narrator: Welcome back to Lord Abbett's Investment Conversation. I'm Tony Fisher. To kick off this new season of the Investment Conversation, we're bringing you an excerpt from our 2021 Investment Outlook. Lord Abbett's bi-annual Investment Outlook brings together a special lineup of subject matter experts and portfolio managers.
This year was no exception. But it came with a twist. The event took place during a week of turmoil in Washington D.C., presenting our panelists with a number of new questions from the days' event participants. We're sharing that question and answer session with you now, in today's edition of the Investment Conversation. We'll start with commentary from partner and portfolio manager Tom O'Halloran, discussing the blue wave in Washington, and what he thinks about U.S. equities.
Tom O’Halloran: The market doesn't seem to be too concerned about the fact that we have had a blue wave. It was by a razor-thin-- margin in-- in-- in-- in most respects. And so extreme policies are therefore unlikely. But, you know, we'll have to see how it unfolds. But I'm looking at the market and the market is telling me that it's relieved that the election is over. And all of the good things about equities, the low interest rates, the improving economy, the tech revolution, those are all still intact.
Narrator: Shifting focus to the global scene, partner and portfolio manager Leah Traub shares her thoughts on current trends in currencies.
Leah Traub: December really saw a very sharp decline in the dollar broadly. So it's continuing [to decline] against developed market currencies and also picking up steam versus some emerging market currencies. Positioning has gotten very stretched. In the dollar, it became very much market consensus that the dollar would continue weakening. And that's one of the kind of consensus trades that we feel may not continue to play out, especially as we are seeing [U.S.] Treasury yields rise a little bit. I mean, granted, still very low. But they are increasing, especially in the longer end of the yield curve, they are increasing with expectations of a stimulus but also the vaccines and the better economic growth that we may be seeing. And as those Treasury yields increase, it's going to widen the yield differential back out between the U.S. and other [currencies], especially developed market economies.
Narrator: Of course, equity and currency markets are heavily influenced by central bank policies. Another topic that kept coming up during the conversation was the U.S. Federal Reserve, its position on rates, and the prospect of rising inflation. Partner and portfolio manager Kewjin Yuoh discussed inflation expectations now and in the months ahead.
Kewjiin Yuoh: In the inflation markets, it's interesting that we have seen inflation expectations rise significantly over the last few months. Where 10-year inflation expectations are north of 2% now, suggesting that the markets believe that the Fed will be successful in terms of it- average inflation targeting, and achieving their goal. But, you know, to that end, inflation expectations being where they are, you'd be hard-pressed to get that they're going to go much higher from here given [that] inflation continues to be very stable, [and that] rates continue to be low. And consensus expectations arethat it will take a year or two before we get back to that 2% level. So I think inflation is something that investors have somewhat put to the side and are not necessarily concerned about right now. It really is about the Fed and their new approach to monetary policy.
Narrator: The conversation then pivoted from U.S. monetary policy to tax policy, especially its effects on the municipal bond market. Partner and portfolio manager Dan Solender had a lot to say about that.
Dan Solender: From a tax-rate perspective, we already were facing the scenario where tax rates were not going to go down. If anything, they were going to stay the same and possibly go up. We're still in that scenario, not that necessarily that rates are going to go up for individuals. But it's like the highest probability with things like corporate tax rates going up, and while that may not seem like a bit deal for municipals, banks and insurance companies have historically been big buyers. They've been much smaller buyers since the tax law changed a couple years ago. That could bring them back in, which would [create] a lot of demand. We could have things happen with the cap on state and local taxes, which is not a terrible thing for a market but has been something that could add some more demand to our market. Things could happen with AMT. And then one of the things we saw in the tax bill was [that], you know, our supply last year looked really large because of, as we've mentioned before, taxable municipal bonds were used for refunding bonds. If that reverses, if the Democrats--some of them have been pushing that for a while--that could bring some more supply to our market, which is really needed. It would not be a negative, it would be a positive, given the demand.
Narrator: Taxes were also top of mind for another Lord Abbett expert, partner and portfolio manager Giulio Martini. Here he looks ahead to next year.
Giulio Martini: I think, you know, taxes will eventually be an issue-- but not before 2022 at the earliest. You know, the biggest priority right now is to really, you know, deal with the health care crisis and, you know, vaccine distribution, and whatever has to be done. That's, you know, a necessary condition for getting the economy back up to full speed. And-- you know, they will also really support the economy until that happens. And so, you know, tax increases are not helpful for reviving the economy, regardless of-- what type of increases they are. So I think that's bound to be pushed out to 2022 or later.
Narrator: Building on Giulio's comments about tax rates, Kew also had a few points to share about this topic, including the implications for U.S. companies after a 2020 borrowing spree.
Kewjin Yuoh: I would just echo what Giulio said in terms of this being a 2022 issue and it'll still take some time to figure out what the exact tax policy changes will be. But as far as corporations, what happens to their margins in this new tax environment and what those implications are for prices, inflation, and everything else-- I think those will be kind of specific to each company. But in the overall sense of the economy-- given that we have a Democratic government in place, with a significant amount of expected spending-- the tax cuts will most likely fund that and we'll find ourselves in a situation where in fact the GDP and the overall economy is relatively neutral.
Narrator: One area of the U.S. economy that felt the sting of the pandemic was commercial real estate. Here, Kew talks about key issues for the sector, including deferred foreclosures and evictions, plus the effects on small businesses.
Kewjin Yuoh: If we're talking about the commercial real estate market, I would say within the securitization space there is probably not too much to worry about at the current time. I think what you asked was small businesses, borrowers defaulting on their potential real estate loans and not being able to make payments. There are certainly those types of risks. But those types of small businesses are generally a very small portion of CMBS deals. So the ramifications of these types of small business defaults are for the broader economy than they would be for the commercial mortgage-backed securities market. And when you look at the CMBS market, it's important to note that the structural aspects of the CMBS market and the protection that those structures provide is something that is different from the thematic aspects that can be taking place in the broader economy, perhaps the thematic aspects such as the small business failures. But within the markets themselves, we don't see that as a large risk to CMBS performance in the near term.
Narrator: Of course, the pandemic was a topic that surfaced frequently, with a lot of topics about COVID-19, vaccines and herd immunity, and longer-term employment. Here's Giulio's perspective.
Giulio Martini: I think what we're looking at is achieving herd immunity sometime in the third quarter of this year. You know, assuming that vaccine rollouts improve in their efficiency and we get, you know, more people vaccinated on a daily basis. I think that's a reasonable expectation to believe that by the third and fourth quarter the sectors of the economy that continue to suffer like restaurants, like airlines, like vacation and leisure type of activities and recreation, sports arenas, things like that-- all come back to normal. I think, though, that the employment picture is going to lag a little bi- because one thing that companies have done extremely well during this period is to preserve their profitability and to preserve their margins by really being able to find efficiencies in various ways that have really preserved working capital, reduced personnel costs—[they’ve] done well with those things. And typically, I think companies are going to try and preserve some of those [efficiencies]. So we will see, you know, hiring recover but, it's going to take a while to get back to the low unemployment rates, 3.5% or so, that we had early in 2020. We're at 6.7% right now. You know, that's a long way away from 3.5%. And the interesting that we found out is that 3.5% was not full employment. There was still more to go because labor supply increased with people coming in from out of the labor force to take the employment opportunities that were being created at those low unemployment rates. So I think we will be back to normal operating mode- by the end of this year. But [the United States] probably will not get back to those low unemployment rates until, you know, sometime in 2023-2024, assuming we don't have another problem in the interim.
Narrator: So what might 2021 bring, after the remarkable events of 2020? Our experts will continue to assess developments and investment opportunities throughout 2021. Stay tuned to the Investment Conversation for more insights as the year unfolds.
To hear Lord Abbett's 2021 Investment Outlook in its entirety and more, visit LordAbbett.com. subscribe and write us on Apple podcasts, Spotify or your favorite streaming app of choice. And thanks for listening.
Unless otherwise noted, all discussions are based on U.S. markets and U.S. monetary and fiscal policies.
AMT refers to Alternative Minimum Tax, a tax policy within the United States that places a floor on the percentage of taxes that a person must pay the government regardless of the number of deductions or credits the filer may claim
CMBS refers to Commercial Mortgage Backed Securities. These are fixed-income investment products that are backed by commercial property mortgages.
A credit spread is the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality.
Fed and Federal Reserve refer to the U.S. Federal Reserve.
Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
Yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. One such comparison involves the two-year and 10-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.
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