U.S. Fixed Income: Room to Run in ‘21? | Lord Abbett
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Market View

Our experts offer their views on key trends that could influence the U.S. economy and bond market in 2021.

Read time: 6 minutes

Editor’s note: This Market View is excerpted in part from a white paper offering a detailed examination of factors that could influence global fixed-income markets in 2021. We urge you to read 2021 Investment Outlook: Economies, Rates, and Fixed Income or download the full version.

For investors, annual financial market outlooks have become a December fixture, much like twinkling holiday lights or sappy seasonal songs. But pegging the market trends to watch in 2021 seems anything but routine following the annus horribilis that was 2020, a year that saw a global pandemic, volatile markets, economic downturns, and political turmoil.

However, times of tumult often present opportunity, and investors embraced risk assets in 2020 after a period of COVID-fueled market upheaval in March and April. (Read more about this remarkable recovery in a related white paper.)  Could this “risk on” behavior continue in 2021? Which economic and market trends should investors be watching as the New Year unfolds? In this Market View, the first of a three-part investment outlook for 2021, we will focus on macroeconomic developments and their implications for U.S. fixed income.

Setting the Scene for the COVID Vaccine

Giulio Martini, Partner, Director of Strategic Asset Allocation: The development of effective COVID-19 vaccines was among the key factors that supported investor sentiment in 2020. What remains less clear is the road leading to the second half of 2021, when we expect the COVID-19 vaccines to be widely available. The first half of 2021 could be more difficult if the number of infections and hospitalizations continue to climb at an alarming rate.

Aside from the human toll, which has been tragic, continued COVID-19 spread could further damage the U.S. economy. The extent of the damage depends on Congress agreeing on a fiscal package that preserves purchasing power for unemployed workers, delivers aid to state and local governments with budget constraints and sustains companies in industries where consumption is inherently social. If Congress falls short, economic growth could more likely hit a pothole.

Regardless, the investment markets will still be reassured by the prospect of a full recovery by the end of 2021 due to the vaccines that are on the horizon, in our view. As the healthcare crisis peaks and more uncertainty is sure to come, 2020 is still ending with a large portion of uncertainty in retreat and a return to normal social and economic behavior visible down the road.

U.S. Corporate Issuers: What to Do with All That Cash?

Andrew O’Brien, Partner & Portfolio Manager, Taxable Fixed Income: In 2020, U.S. corporations have been adjusting their balance sheets by taking advantage of historically low interest rates to refinance shorter term debt and lock in low longer-term coupons. Record levels of corporate bond issuance in 2020 contributed to the purpose of improving capital structures, interest coverage as well as available cash on corporate balance sheets (see Figure 1). Our positive stance on corporate credit takes these factors into account.

 

Figure 1. Cash on U.S. Corporate Balance Sheets Is Near Multi-Year Highs

Source: Board of Governors of the Federal Reserve System. Data as of 09/30/2020. Based on Nonfinancial Corporate Business; Checkable Deposits and Currency; Asset, Level.
 

Looking out to 2021, one of the key questions, however, will be how that capital is deployed—either in additional capital expenditures where tax incentives reside, or in the form of share repurchase programs or increased dividends to shareholders. Recent attractive equity returns may limit the latter but if the equity markets languish in the coming year, pressure from shareholders to return a portion of that capital is possible.

We remain positive on the U.S. corporate bond sector, but also vigilant of the risk-taking posture of corporate management and how they will manage capital structures going forward.

Which Sectors Might Benefit from the Low-Rate Environment?

Kewjin Yuoh, Partner and Portfolio Manager, Taxable Fixed Income: The low to nearly negative real yield environment within the U.S. Treasury sector has created an appetite for risk as investors reach for positive real yields in credit and support valuations. An additional backstop has been the transparency from the U.S. Federal Reserve (Fed) with its intent on maintaining its policy of low short-term interest rates, providing relative stability of the yield curve and low interest rate volatility which has enhanced risk appetites further.

On a fundamental level, the importance of the COVID-19 vaccine can’t be understated especially considering the number of jobs that were displaced during the crisis. Taking the view that potential full employment may be reached by the end of 2021 given successful implementation of the vaccine, we anticipate the economic recovery and return to strong employ­ment levels could be powerful contributors to credit fundamen­tals in the year to come.

Aside from any unexpected policy shift by the Fed, the environ­ment for credit as we look out to 2021 could support additional spread tightening within the framework of an economic recovery lifting credit fundamentals. Credit segments that may offer relative value in that environment include sectors where yields have not compressed to pre-COVID 19 levels, such as U.S. high yield (see Figure 2).

 

Figure 2. Spread Opportunity in U.S. High Yield by Credit Rating
ICE BofA U.S. High Yield Index: spreads by credit quality, February 1, 2020–December 4, 2020

Source: Bloomberg. Data as of December 4, 2020. Spreads referred to in basis points (one basis point is one-one hundredth of a percentage point). 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.

 

Next: Our experts assess prospects for the equity market in 2021.

Webinar: 2021 Investment Outlook
January 7, 2021

Giulio Martini, Andrew O’Brien, and Kewjin Yuoh will be among the Lord Abbett experts joining Investment Strategist Tim Paulson in a discussion about fixed income and equity markets in the year ahead, plus thoughts on key economic indicators, global trade, fiscal stimulus and monetary policy, a COVID-19 vaccine and more. Register now!


A Note about Risk
: 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. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk. Credit risk is the risk that debt issuers will become unable to make timely interest payments, and at worst will fail to repay the principal amount. 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. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements.. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

This material is provided for general and educational purposes only. The examples provided are for illustra­tive purposes only and are not indicative of any particular investor situation.

This Market View 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.

Real yield refers to the nominal yield of a security minus the rate of inflation.

Risk asset generally refers to assets that have a significant degree of price volatility, such as equities, commodities, high-yield bonds, real estate, and currencies.

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 ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $100 million.

ICE BofA Index Information:

Source:  ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofA 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 BofA 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 & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.

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

The opinions in this 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

2021 Investment Outlook


  Taxable Fixed Income

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