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Market View

After the March sell-off and the spring rally, where should investors focus their attention? Here, we outline four strategies that may align with different levels of risk tolerance in this uncertain environment.

Read time: 4 minutes


Despite the devastating blow to the U.S. economy from the COVID-19 pandemic, U.S. financial markets have staged a remarkable rally from the March 23 lows. Aggressive moves by the U.S. Federal Reserve and Congress to “insulate the economy against the full negative impact of the coronavirus shutdown… reduced tail risk in the markets that would come from an economy that was just going over a cliff without any bottom in sight,” says Giulio Martini, Lord Abbett Partner and Director of Strategic Asset Allocation.

Nonetheless, amid the extraordinary events of the past few months, uncertainties remain as the U.S. and the rest of the world attempt to emerge from the shadow of the coronavirus.  “We don't know exactly what's going to happen because of the nature of this crisis and what might come next” given the potential for a second wave of coronavirus infections later in the year, says Kewjin Yuoh, Lord Abbett Partner and Portfolio Manager for Fixed Income.

How might investors approach this uncertainty? The key may lie in one of the essential questions they have to ask themselves: How much risk am I comfortable taking? Here, we spotlight some strategies that have been featured in recent Market Views and other articles on lordabbett.com that may align with investors‘comfort levels as they consider the road ahead.

Stepping Off the Sidelines: Ultra-Short Credit

During the recent period of volatility, a lot of investor money went to cash, as evidenced by the large inflows into government money market funds, based on data from Lipper. Of course, those funds have featured very low yields. For those who want to take a step off of the sidelines, but still might be wary of another round of volatility in the equity or credit markets, very short term investment grade bonds offer a source of additional yield over cash or U.S. Treasury bills with potentially minimal exposure to duration or credit risk.

Take a look at Figure 1, which was featured in the May 29 Market View. It shows yields on select asset classes which are often included in ultra-short strategies (such as short-term investment-grade corporate bonds, commercial paper, and asset-backed securities) relative to three-month U.S. Treasury bills. Historically, these sectors have offered modest spread over Treasury bills with limited duration and credit risk, providing an option for additional yield and return potential over cash and money market securities, with lower volatility than short- or intermediate-term bond strategies.

 

Figure 1. Ultra Short Bonds Recently Offered Unusually High Excess Yield with Limited Credit Risk

Source: Bloomberg Barclays & ICE Data Indices, LLC. Data from April 1, 2014-April 30, 2020. 1Bloomberg Barclays USFRN <18mos. 2Bloomberg Barclays 3 Month U.S. T-Bill Index. 3ICE BofA ABS 0-3 yr Fixed Rate. 
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. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Figure 1 shows how yields spiked amid the grab for liquidity in March and then began a partial recovery which has persisted into early June. However, yields on alternative so-called “risk-free” options, such as Treasury bills, have moved well below 1% (after briefly dipping into negative territory in late March). Relative to Treasury bills and cash, short-maturity investment-grade bonds recently offered moderately wider spreads, while continuing to display their historical characteristics of very low duration and little credit risk.

Moving Back Into Investment Grade and High Yield: Multi-Sector Bonds

Similar to what we saw in the ultra-short market, credit spreads widened substantially across investment grade, high yield, and securitized product sectors in February and March. That was followed by a strong, though somewhat uneven rally since late March, as not all segments of the market participated in the recovery equally. We believe this has created potential opportunities for active managers to identify attractive relative value opportunities. We would also note that high yield spreads remain nearly 200 basis points (bps) above the levels seen earlier this year, based on the ICE BofAML U.S. High Yield Index. In an environment where the 10-year U.S. Treasury bond yield has jumped by 30 bps, but remains below 1.0% (based on Bloomberg data), the credit markets may offer sources of higher income and the potential for greater total return over Treasuries.  

Given the uncertain environment, investors may want to consider a diversified, multi-sector approach that has the flexibility to take advantage of opportunities across investment grade and higher yield markets. “If you want a place to be while the equity and broader fixed-income markets strengthen, or if you're looking for a way to participate in the early stages of a U.S. economic recovery,” a multi-sector approach could be worth a closer look, says Andrew Fox, Lord Abbett Investment Strategist.

Increasing Equity Exposure While Potentially Mitigating Risk: Convertible Securities

Those looking to increase equity exposure but concerned about the potential for another pullback in the stock market may want to consider convertible securities. As we have previously noted, the asset class historically has generated compelling risk-adjusted returns over the long term. One other noteworthy feature, in our view: Convertibles historically have participated in the upside of rising equity markets, while offering some degree of downside protection during most market pullbacks (see Figure 2). 

 

Figure 2. Historically, Convertible Bonds Have Outperformed in Market Declines

Source: Bloomberg. Max intra-year declines, starting January 1, 1990, for each complete calendar year through 2019. Start dates inclusive. U.S. Convertible Index = ICE BofA Merrill Lynch All Convertible, All Qualities Index. 1Downside capture: The downside capture ratio measures a manager’s performance in down markets relative to a particular benchmark. The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Past performance is not a reliable indicator or guarantee of future results.

 

While Figure 2 only covers the complete calendar years from 1990 through 2019, the convertible index repeated this pattern in the recent market correction, once again holding up relatively well compared to the decline in the S&P 500® index, based on Bloomberg data.

A Future-Focused Approach to Equity Allocations: Innovation Equities

One way to prepare the equity sleeve of an investment portfolio for the longer run—and further potential ups and downs of economic cycles--may be through increased exposure to innovation equities. These are stocks of those companies whose leading-edge products or services may position them for strong growth in the months and years ahead.

“Innovation was already leading the market in terms of return, and growing size in the economy, even before we headed into this pandemic crisis,” says Brian Foerster, Lord Abbett Investment Strategist. (See Figure 3.) “Cloud technology, artificial intelligence (AI), biotech and medical devices, e-commerce, and a new area that we've classified as ‘virtual empowerment,’” were among the industries that displayed the most resiliency during the recent downturn, he adds.

 

Figure 3. “Most Innovative” Companies with Highest Levels of Research & Development Spending Have Outperformed Over Last Decade

Source: FactSet. Data, based on a historical study, are the latest available. Most/least innovative stock excess performance is derived from highest and lowest S&P 1500 quintiles based on research & development as % of sales, normalized for market value, using one month returns for 10 years ended November 30, 2019. Baruch Lev and Suresh Radhakrishnan, “The Stock Market Valuation of R&D Leaders.” The performance data quoted represents past performance, which is not an indication or a guarantee of future results.

 

Many of those most innovative industries have rapidly progressed from their infancy to their prime in the past 20 years, and now make up the core of the global economy, notes Foerster. “We believe there is an innovation premium in the U.S. equity market, explaining why many stocks in high-growth industries are consistently cheap, even with above-average current valuations.”

Summing Up

While recent market performance would suggest that investor optimism appears to be in full flower, there are still a great many uncertainties associated with how economies and markets will respond to pandemic-related developments in the months ahead. Long-term investors weighing their options for such an environment may be well served by employing an active manager offering a breadth of carefully constructed strategies to navigate the changed investment landscape of a post-coronavirus world.

 

A Note about 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. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.

No investing strategy can overcome all market volatility or guarantee future results. 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes.

basis point is one hundredth of one percent,

Downside capture: The downside capture ratio measures a manager’s performance in down markets relative to a particular benchmark. A down market is one in which the market’s quarterly (or monthly) return is less than zero. For example, a ratio of 50% means that the portfolio’s value fell half as much as its benchmark index during down markets.

Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. Duration is expressed as a number of years.

Spread is the percentage difference in current yields of various classes of fixed-income securities versus Treasury bonds or another benchmark bond measure. A bond spread is often expressed as a difference in percentage points or basis points (which equal one-one hundredth of a percentage point).

The Bloomberg Barclays Capital US FRN < 18 months Index is a subset of the US Floating-Rate Note (FRN) Index, which measures the performance of USD denominated, investment-grade, floating-rate notes across corporate and government-related sectors. 

The Bloomberg Barclays 1-3 Month U.S. Treasury Bill Index measures the performance of public obligations of the U.S. Treasury that have a remaining maturity of greater than or equal to 1 month and less than 3 months.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

The ICE BofAML U.S. High Yield Index is a capitalization-weighted index of all US dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market.

The ICE BofAML All Convertibles, All Qualities Index contains issues that have a greater than $50 million aggregate market value. The issues are U.S. dollar-denominated, sold into the U.S. market and publicly traded in the United States.

The ICE BofA/Merrill Lynch ABS Fixed Rate 0-3 Year Index, is a rate- and maturity-specific subset of the ICE BofA/ML U.S. Fixed and Floating Rate Asset Backed Securities Index

ICE BofAML Index Information:

Source ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN “AS IS” BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD ABBETT, OR ANY OF ITS PRODUCTS OR SERVICES.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries. 

The S&P 1500® Index represents a combination of the S&P 500 Index, S&P Midcap 400 Index, and the S&P SmallCap 600 Index.

Indexes are unmanaged, do not reflect deduction of fees and expenses and are not available for direct investment. 

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

MARKET VIEW PDF


  Market View

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Find out what Lord Abbett’s experts think about global economic recovery and where they see potential investment opportunities.

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