2020 Midyear Outlook: A Quick Summary
2020 Midyear Outlook: A Quick Summary
A Roundtable Discussion
Tim Paulson: Welcome to the Lord Abbett Mid-Year Outlook. My name is Tim Paulson, investment strategist at Lord Abbett. Today, I'm joined by some of our leading investment professionals.
Giulio Martini: Hello, I'm Giulio Martini, partner at Lord Abbett and portfolio manager for multi-asset strategies.
Kewjin Yuoh: Hi, this is Kewjin Yuoh, partner and portfolio manager of Lord Abbett in taxable fixed income, specially focused on liquid and securitized products.
Leah Traub: Hi, I'm Leah Traub. I'm a partner and portfolio manager in taxable fixed income focusing on currencies and global bonds.
Andrew O’Brien: Hi, this is Andy O'Brien. I'm a partner at Lord Abbett, and a portfolio manager in our taxable fixed income area, where I focus on investment grade corporate bonds.
Daniel Solender: Hello, my name is Dan Solender. I'm a partner and a director of the tax-free fixed income group.
Thomas O’Halloran: Hi, I'm Tom O'Halloran. I'm a portfolio manager-- of the innovation growth strategies and a partner of the firm.
Paulson: Right. So unprecedented levels of government response, unprecedented times that we're going through. There will be some permanent changes on the other end of this. Let's just go around the horn with rapid-fire: Tell us about the permanent changes you see happening in the areas that you focused on the most. Giulio, let's start with you.
Martini: Yeah, the one thing I know is that we're going to come out of this with a lot more debt than we had going into it. And I think the first-order effect of high debt is that it slows down economic growth, keeps interest rates low, keeps inflation low. And so more of the same of what we've had for a number of years, but somewhat worse than it's been in the recent past: a more difficult job to get the economy going, more difficult for central banks to hit their inflation targets. And so that's what I think will kind of be the modal case, the most likely outcome, in my mind.
But at the same time, I think the chances of the two alternatives to that taking place have risen. One alternative is deflation. In other words, the economy's going to be very weak for the next couple of years. If we have another shock, another virus, a second stage of this virus, or some other thing that creates a bigger pressure on economic growth, we could slip into outright deflation–and that's a very, very threatening circumstance for financial assets.
On the other side, we could also go into an inflationary period. You know, as technological change really creates more winners and losers, and income distribution becomes more and more skewed between high and low, the pressure to really keep stimulative policy on that helps the disadvantaged increases. And we hear that rhetoric all the time.
And so it's possible that that's going to be one of the things that comes out of this situation going forward, as well. So while the modal outcome of just high debt creating slow growth, low rates, low inflation, I think is still the most likely, the ends of deflation and inflation have both risen as a result of what we've gone through in the past four or five months, and the debt burden that it's created, on top of what we already had.
O’Brien: I think one of the interesting aspects of this crisis is how deeply the federal government, other levels of government, and [the U.S.] central bank have gotten involved in Corporate America: you know, extraordinary equity purchases, lending money and really extending credit and extending a lifeline to a lot of different corporate issuers.
And so the two questions there are: How does it get resolved in this episode? And then, what will happen the next time we have a recession? In terms of this episode [we are all] trying to figure out, "Well, how much control is the government going to exert?"
If the government has lent support to a particular company, and that company decides that it wants to lay off some of its workforce, is that going to be politically unpalatable? Is the government going to say, "We bailed you out: You can't buy back stock. You can't [pay] dividends. And we want you to move your factory to a state that really needs the economic help here."
So figuring out how much influence, how much control, and what the politics are of having taken government support and what that obligates you to: [do]. Figuring out how that will play out in this episode, I think, is very interesting.
So, kind of a near-term [question]: How involved is the government going to get, and what kind of decisions are they going to make, or what boundaries are they going to put on corporate decision-making? And then a long-term question of what does it really mean to be a corporate issuer versus a government issuer if the government has shown its willingness to step in and provide such extraordinary support in difficult times?
Paulson: Thanks, Andy. Leah, any thoughts?
Traub: One of the lasting impacts that I can see is really the emerging market reaction to this crisis. For really the first time, we've seen widespread monetary stimulus being deployed during a recession.
[Emerging-market countries] have let their currencies depreciate. They're not concerned about the currency depreciation, for the most part. They're slashing interest rates to the lowest level ever. And for the first time, we're seeing a widespread use of quantitative easing in the emerging markets. And [this includes] countries ranging from South Africa to Hungary and Poland, to Colombia and Mexico, right? They're all looking at using this tool.
This is going to have a lasting impact in the emerging markets. As we've seen with the developed markets, once you kind of cross that Rubicon, you really can't go back, right? It's part of your toolkit.
In the Philippines, for example, [look at the level of] the government borrowing. These are going to have lasting impacts. They're thinking about the inflationary impacts, right? We didn't see those impacts in the developed markets. But in the emerging markets, you could start seeing those impacts.
But also this really has just moved these central banks into kind of a different realm that's going to be very, very difficult for them to kind of come back towards. And I think it will have a lasting impact - on the way we look at their currency markets as well. Because we're not necessarily seeing that the central banks are going to come in and intervene, necessarily, to maintain the currency values that maybe we've seen in the past. And that we have to start treating them a bit differently.
Paulson: Thank you, Leah. Kew, any thoughts?
Yuoh: I guess I would say that there has to be some permanent behavioral change on a personal and organizational level. Now, the magnitude of that change I am uncertain about. But there must be, right?
If you look at the consumer post-crisis in 2008, the savings rates shifted to almost double post the great financial crisis in 2008. And we have been at these higher, [at] 12%, 13% levels, for the last eight or nine years. Could that be a shift even further upward as we exit this crisis?
I'm not necessarily sure. But-- there was a significant amount of-- household balance sheet repair since the last crisis. Does that improve even further because of the nature of this crisis? But I would think that there are going to be behavioral changes on the part of the consumer and the individua,- which will certainly impact the consumer asset-backed securities market, which I focus on.
And then, on an organizational behavior [basis], and related to the consume: What happens to cities? What happens to office space? I know that office space [appears to have] a very weak outlook ahead. But at the same time, in 1990, every employee had 425 square feet of office space. And that's down to 125 right now, right?
So I imagine that we'll see a reversion to higher levels over the short term, as well. And that certainly has implications for the CMBS market. So I would just wrap my comment up saying that there are going to be behavioral changes on the personal and organizational side which may materially impact how you should [potentially] invest going forward, and the opportunities that you have that are related.
Paulson: Thanks, Kew. A lot of changes to navigate. Dan?
Solender: It's a interesting time. I've been managing municipal bond funds for almost 30 years. And we go through these crises every few years. And the reason they are crises is because something surprising happens that you don't expect. And every time you go through one, you have to make an adjustment.
And I look specifically at my market, because I can't necessarily control my reaction, you know, under what the Federal Reserve is going to do. But I can control how I manage portfolios. There are three things I kind of am thinking of a little bit differently this time and doing an after-action review of how the market performed.
But first of all would be the volatility. You know, we've been through a lot of time periods, whether it was 1994, or 2008, 2011, [or] 2016: There have always been markets where rates have moved more than they moved this time. The difference this time is [that] individual days had bigger movements than we ever saw. And we never saw days like that, where rates went up so much on a particular day.
So reacting to that and preparing for that is something' we have to do a little bit differently going forward because those that amount of volatility is something' we're not used to.
My second is liquidity. We’ve talked about the dealers being out of the market. And they've been reducing their risk-taking since the credit crisis of more than a decade ago. But this time, the cost of liquidity got greater. And one of the interesting things about the municipal bond market is that compared to a decade ago, there are a lot more players in our market, a lot more people behind the bonds every day and participating.
That also makes it more volatile, because people come in and out of the market, and their costs of liquidity are much higher this time to raise the cash we needed. So we have to, once again, look at the ideas and where we're finding our liquidity. And if we have to adjust the way we prepare for liquidity.
And then a final thing-- credit analysis is going to be different going forward. we're looking at a lot of scenarios that we never had to consider before.
What if an airport is 95% down in volume for a few months, what's going to happen? And fortunately, we find out that they're in very good shape [in our] perspective. But the scenarios we looked at before were if one airline pulled out, or something small in a certain time period. But never like these [events] where traffic totally disappears.
I think there are things we have to do differently. You know, we're adjusting to it
Paulson: Thanks, Dan. And then, Tom, you're certainly no stranger to a world of change. [You’ve] spent a lot of time focusing on it. I’d love to hear your thoughts.
O’Halloran:. This pandemic has created an incredible pain from an economic and personal standpoint. But it's been met with, as we've discussed today, an extraordinary government response. So we're still very vulnerable in the recovery here, but as long as there's no major setback, I think we improve over the next couple years. And we're starting from a very low base, so I see equity markets as being able to continue to climb a wall of worry from here.
As Giulio noted, we're coming out of this with a lot more debt. I see that as a weight on interest rates. So I think they'll be lower for a while. And that's good for equities. And that's why I think equities can go higher. And I think we come out of this much better.
I think we're all becoming more resilient through this crisis. I think we've seen how we can conquer distance problems and spatial problems through technology now that we've gotten the taste of it. We'll continue to accelerate that move. I think the health care system has had an extraordinary response to the crisis. I think it's getting a lot of support from the government. I think there'll be big advances in health care out of this.
The businesses I think are going to get hurt are those that depend upon crowds. Because I think we're going to be distancing for a while. And businesses that depend upon a lot of travel, because I think business travel will not recover to the prior level for a number of years.
So I think we're going to be fine. I think we're recovering from the crisis. We've had, and we'll get more government support. We'll be coming out of this stronger as individuals and with our technological advancements that we've learned to appreciate in this crisis. And I continue to be very optimistic on equities.
Unless otherwise noted, all discussions are based on U.S. markets and U.S. monetary and fiscal policies.
CMBS refers to commercial mortgage-backed securities.
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.
Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment.
Securitized products are investment vehicles created through the process of pooling financial assets and turning them into tradable securities. The first products to be securitized were home mortgages. These were followed by commercial mortgages, credit card receivables, auto loans, and student loans, among others.
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.
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