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Market View

Our experts examine the factors driving the markets’ first-half performance, prospects for municipal bonds after their recent rally, and what may be ahead for the IPO market.

 

In Brief

  • Following a discussion of current U.S. economic conditions, Lord Abbett experts offered their observations on the investment backdrop for the second half of 2019.
  • First, our experts spotlighted the factors driving the strong market performance in the first half (through May 2).
  • Next, our director of municipal bonds noted that investors’ continued desire to reduce their tax burdens could potentially benefit the sector in the months ahead.
  • Finally, our lead growth-stock manager believes that after a strong year-to-date (through May 2) run for IPOs, a number of “promising” companies are poised to make their debut in the year’s second half.

 

We recently gathered six Lord Abbett investment leaders for a wide-ranging discussion of the current market and economic environment and to elicit their views on key investment themes for the second half of 2019. (Register for our June 13 webinar on our Midyear Outlook page.)

Our panel featured Lord Abbett Partners Thomas O’Halloran, Portfolio Manager for micro-, small-, and large-cap growth strategies; Giulio Martini, Director of Strategic Asset Allocation; Daniel Solender, Director of Tax-Free Fixed Income; Leah Traub, a currency expert and Portfolio Manager for Taxable Fixed Income; and Kewjin Yuoh, Portfolio Manager for Taxable Fixed Income. Joseph Graham, Investment Strategist, moderated the discussion.

After surveying prospects for the U.S. economy in the first part of our Midyear Outlook series, our panel set out to frame the investment backdrop for key asset classes in the second half of 2019. Graham noted that after a rocky fourth quarter of 2018, financial markets had enjoyed a “tremendous start” to the current year (as of the roundtable recording on May 2).

How Did We Get Here?
Martini provided some context for the markets’ performance. He noted that even with major U.S. stock indexes sitting near all-time highs as of early May, equity valuations had not returned to the previous highs of late September 2018. At that time, “U.S. stocks were selling at 18.5 forward earnings … right now, they're selling at 17 times” after having bounced back from about 14.5 earlier in 2019. “So while we've made new highs in prices, we have not made new highs in valuation.”

The multi-asset strategist added that high-yield spreads, at around 350-360 basis points (bps) as of May 2, were still wider than the 304 bps level reached in September 2018. “Even though there's been a rally in markets and investors have gotten the money back that they lost in the fourth quarter of last year, valuations have not recovered to those peak levels that they [reached] at the end of the third quarter.”

 

Chart 1. Valuations for Key Asset Classes Have Remained Well Below Recent Peaks
Data (monthly except for endpoint) for the period April 30, 1994–May 16, 2019

Source: JP Morgan, Bloomberg, and Lord Abbett. Data as of 05/16/2019.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

The easing of earlier concerns about overly aggressive monetary tightening by the U.S. Federal Reserve (Fed) bolstered market sentiment late in the fourth quarter of 2018. The Fed’s policy shift in January, when it indicated that it would not hike rates in 2019, also took many by surprise. Yuoh thinks the suddenness of the Fed’s shift may have “called its credibility into question, [but] in hindsight, economic data had turned softer,” with certain indicators retreating to levels “that we had seen at the end of 2016.” With financial conditions tighter, and inflation “not a problem,” he added, “you could make a case that the Fed’s action was appropriate.”

“At the end of 2018, the markets had totally priced out any possibility of a [Fed] hike,” Traub said, which helped to boost risk assets. Somewhat counterintuitively, she observed, the U.S. dollar did not weaken significantly versus other major currencies following the Fed’s shift, as other major central banks also became more dovish.

Martini noted one additional development that provided a tailwind: more favorable expectations for a resolution of the U.S.-China trade dispute. (In a subsequent commentary, Martini said that a new round of tariffs imposed by the two nations in mid-May was not likely to “unhinge expectations about the future paths of the U.S. and global economies.”)

Municipal Bonds: A Dash of SALT
Graham asked Solender if there were still opportunities in the muni-bond sector after muni yield ratios versus U.S. Treasuries had moved to multi-year lows.

Solender noted that the retail investors who dominate the muni-bond market “are comfortable with the rate environment,” unlike the end of 2018. That confidence “has carried over to very strong demand,” because of investor perceptions that “rates will not be too volatile.”

Solender also pointed to the tax environment in the United States. The 2017 tax bill has “led to surprisingly higher payments than expected this year.” Indeed, subsequent reports from relatively high-tax states such as New Jersey, California, Illinois, and Connecticut—where the newly imposed $10,000 limit to deductibility of state and local taxes (SALT) was keenly felt—showed higher-than-expected tax revenues for the month of April.1 The “SALT shock” and the stable interest-rate environment helped to create “very strong” demand for muni bonds, Solender added. He cited Lipper data showing that investors had poured about $30 billion into municipal-bond mutual funds in the first four months of 2019.

On the supply side, a provision of the tax bill that eliminated advance refunding bonds took away “about a quarter of our supply,” leading to what he characterized as “a current high demand/low supply market environment.”

Solender noted that lower quality bonds have outperformed other areas of the muni market over the past few years, and “we're in an environment where they keep doing well.” He believes that “there is still a lot of value in that part of the market,” and noted that the biggest flows of investor money into muni funds (as measured by Lipper) are going into the high-yield sector.

He summarized his view of the tax-free bond market: “There's good value, and credit's holding up well. Obviously, with all the strong performance, certain parts [of the municipal bond sector] are overvalued, but there are a lot of different parts of the market [where] things still look good.”

IPOs: Children of the Revolution
Graham noted strength in the IPO market during the first few months of 2019, and then queried growth-stock specialist O’Halloran: “Do you think the market’s getting ahead of itself here, or can it handle the recent IPO supply?”

“I think it can more than handle the supply,” O’Halloran responded. “These are great companies coming out.” He noted that a busy April for initial offerings came after a slowdown in activity because of the equity market correction in the fourth quarter of 2018. “So it was really six months where the IPO window was shut. And now these companies are coming out, having been bottled up for a long time.” O’Halloran cited two offerings as being examples of the “disruptors” he has long emphasized in his growth portfolios: one company innovating in the video conferencing space, and another establishing a strong e-commerce presence in Africa. “There are great software companies, social network companies. These companies are growing 50% to 100% a year, and they're very promising,” he added.

O’Halloran recapped a number of themes he has conveyed to investors in recent years: “I'm looking for opportunities in the tech revolution … things like search and hosted software and social networks and e-commerce.” He noted that the pace of technological change has accelerated because processing power continues to grow “at an exponential rate.”

Returning to his earlier discussion, O’Halloran said “I don't know whether these IPOs that have just doubled or tripled can sustain their prices, but they're very fine companies.” (In a subsequent email exchange with Market View, O’Halloran said he believed that the negative market response to the highly publicized IPO of Uber Technologies on May 10 was “company-specific…most of the April and May IPOs have performed nicely.”)

Looking at the bigger picture, O’Halloran said that the U.S. economy is continuing to expand, while inflation remains “very much under control.”

“I'm very bullish on the equity market,” he concluded.

Coming June 17: We’ll reconvene Lord Abbett investment experts for a final look at the economic and market picture for the second half of 2019 in the concluding segment of our Midyear Outlook series. You can get their insights in real time by registering for our June 13 webinar.

 

1Elise Young, New Jersey’s April Income-Tax Record Surprises Even Treasurer,” Bloomberg, May 14, 2019.

 

Webinar: Midyear Outlook
video
Register for our June 13 webinar with our investment leaders about their midyear outlook for the economy, fixed income, and equities markets.

*Financial professionals only.

MARKET VIEW PDF


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