Equity and Fixed Income Insights for a New Decade
Lord Abbett: The Investment Conversation
Equity and Fixed Income Insights for a New Decade
VO: Welcome to The Investment Conversation, Lord Abbett’s ongoing podcast series.
Will Andrews: With the end of the year approaching, we thought we’d switch things up for our final Investment Conversation podcasts of 2019. In this special three part series, Lord Abbett investment leaders will have one-on-one discussions about key themes for the coming year—sharing investment insights and ideas directly with our audience.
In this segment, part one of three, Lord Abbett taxable fixed income portfolio manager Kewjin Yuoh and our director of innovation investing for equities, Tom O’Halloran, will share their insights on their respective asset classes, covering topics from cloud computing to multi-sector investing. Kew kicks off the discussion with a question for Tom.
Kewjin Yuoh: Tom you and your team’s area of expertise is, of course, the growth and innovation strategies. What do you think investors should be looking for in 2020?
Thomas O’Halloran: Really good things for innovation in three big areas, consumer, health care and tech. In consumer, I'd expect continued growth in e-commerce. Continued growth in social networks, new social networks, more specialized networks.
The value of services and entertainment I think will continue to advance. I think streaming will be a catalyst for video, for example. In health care I expect some breakthroughs in biotech drugs, in medical devices for diabetes and other ailments, and big gains in diagnosis. What we're learning about cancer is it's a very complex disease. And so the real hope is with diagnosis.
And then in tech I expect continued gains in cloud computing, and newer markets like 5G and AI-- artificial intelligence-- to drive growth. So the outlook for innovation is very good. The outlook for those that are on the wrong side of this innovation is very bad.
And so equities are hitting highs today as we speak [November 18, 2019]. That means valuations are fuller. But the outlook is good. I expect higher equity markets in 2020, subdued somewhat by the [U.S.] presidential election which will raise volatility and keep a lid on things, I believe.
Yuoh: So when you mention consumer and health care and all the innovation that's in those industries—and this has been a trend
for a while now—what do you see as kind of the next game changer in terms of innovation?
O’Halloran: Well, we have these ongoing exponential processing gains which enable new markets. I think the big market five years from now will be the beginning of artificial intelligence. But there are many markets that will benefit in between now and then in consumer health care and tech.
5G in particular should be a very good market next year and then for the couple of years after that. And then there are things like digital currency--we have bitcoin which is not really a publicly traded vehicle yet. And now we have these new stable coins. And all of these offer the potential to really lower dramatically transaction costs. In energy storage there are breakthroughs waiting to happen which could speed ahead things like electric vehicles and automated vehicles.
So the outlook for innovation has never been better. With inflation subdued and low interest rates it's an ideal market opportunity because that means financing for these new ideas is abundant, and they can realize their potential. So I'm very optimistic. We will, of course, have the normal volatility. And there are a lot of things to worry about. But on balance I think the outlook for innovation is really terrific.
Yuoh: So Giulio Martini in another forum had cited “end of cyclitis” or whatever it was. Is that the biggest risk to innovation?
O’Halloran: I think the biggest risk to innovation is a big jump in inflation. That makes the future worth less, that means there'll be less financing available. And you know, that is something to be concerned about should it happen, and there are also risks associated with any threat to free markets. So greater regulation, and things like that, could derail some growth opportunities in innovation. But in terms of the economic cycle, we think innovation will grind right through that.
And Kew, what are your thoughts on the risks and opportunities ahead for the global credit markets?
Yuoh: When it comes to credit risk, and especially when you think about the globe, I think you can kind of break it up into three segments. You can think about credit risk in Europe versus the United States. And if you think about that, it's very interesting that the valuation of credit between Europe and the U.S. is very similar actually.
Investment grade spreads are very similar to each other, high-yield spreads at the top level are very similar to each other. And that's almost inappropriate, right? But the fact is that the ECB has launched into a $20 billion a month purchasing program because of the weaker of economic fundamentals while the U.S. economic fundamentals remain relatively robust because of the consumer.
So in that light you would suggest that U.S. fundamentals make more sense. The next area that we would look at in terms of global consideration would be EM [emerging markets]. Commodities have certainly hurt them. China uncertainties have certainly hurt them. And valuations look more reasonable as a result of those weaknesses. But I think that as you have kind of this growth compression between the U.S. maybe slowing down a little bit and EM economies picking up, that there may be some value there.
And so we're looking at EM sovereign risk and EM corporate credit risk. Then you bring it all back to the United States. And valuations in the U.S. just don't marry with the fundamentals. Right? But, you know, in this day and age, as I've mentioned in previous forums, there is this notion that you have to consider momentum.
But I think over 2020, what we really have to look out for is--given valuations where they are--within investment grade corporate credit, high-yield corporate credit, are there better opportunities within specific sectors? Taking a multisector approach and thinking about adding value through spread premiums through complexity. Right? Securitized products, a classic example, asset-backed securities, commercial mortgage backed securities where you can pick up yield and improve in quality.
So that's something we're focused on. And we also think that in terms of the leveraged credit market, bank loans represent an opportunity because they significantly underperform relative to high-yield. And CLOs [collateralized loan obligations], being related to bank loans, represent a similar opportunity. So we're very much focused on being long risk, because there are opportunities within various sectors that can still present you with attractive carry opportunities.
O’Halloran: And when you consider the two types of risk in fixed income investing, credit and duration, which is more troubling or more exciting right now? How do you see the risk and opportunities in both of those?
Yuoh: The credit risk is certainly a source of I think strangely enough higher volatility. We generally are duration neutral or don't take interest rate bets because interest rates can provide such a source of volatility.
And I think that as long as you don't have inflation expectations growing at a very significant clip, which we don't believe will happen in 2020, that means the 10-year U.S. Treasury [yield] should be anchored somewhere between 1.5%–2%. So the yield curve should be relatively stable.
Now on a probability weighted scenario we'd probably suggest that there should be a steepening of the yield curve-- because probability weighed you would think that inflation expectations will continue to creep higher-- which means the back end should move higher and we should get some term premium in there.
Andrews: That’s it for this special edition of the Investment Conversation. For those who listen on iTunes, please be sure to leave a rating for the Investment Conversation. Thanks.
VO: Please drop us a line on social media or visit our website at LordAbbett.com. Our audio podcasts are available on iTunes, Spotify, TuneIn, and other major streaming media services. Thanks for listening.
Additional disclosure for this podcast:
ECB refers to the European Central Bank.
EM refers to emerging markets.
ABS refers to asset-backed securities.
CMBS refers to commercial mortgage-backed securities.
Fed refers to the U.S. Federal Reserve.
Risk asset describes any financial security or instrument that is not a risk-free asset (i.e. a high-quality government bond). Risk assets generally encompass equities, commodities, property, and all areas of fixed income apart from high-quality sovereign bonds.
Term premium is a gauge of the level of risk inherent in holding a longer-term bond versus a series of shorter-term securities. It represents the estimated risk embedded in a longer-maturity bond that is determined by the difference between the actual yield and the “risk neutral” yield (represented by rolling a series of shorter-term securities extending to the same maturity at current rate expectations).
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.
Investing involves risk, including the loss of principal. The value of investments in fixed-income securities will change as interest
rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when
interest rates fall, prices generally rise. The [U.S.] municipal market can be affected by adverse tax, legislative, or political changes,
and by the financial condition of the issuers of municipal securities. Investments in foreign [non-U.S.] or emerging market securities may
be adversely affected by economic, political, or regulatory factors and subject to currency volatility and greater liquidity risk. The
value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of
particular companies and/or sectors in the economy.
No investing strategy can overcome all market volatility or guarantee future results.
Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
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