Market Review as of 03/31/2016

Although major sectors of U.S. fixed income securities posted positive returns in the first quarter of 2016, the period saw a sharp increase in volatility. Securities markets in January continued their sell-off from the end of 2015, as investors continued to grapple with a strengthening U.S. dollar, a slowdown in Chinese economic growth, and a renewed slump in commodity prices. However, early February marked a reversal in U.S. dollar strength and commodity prices began a sharp rebound. A dovish tone coming from the U.S. Federal Reserve (Fed), combined with the European Central Bank’s unexpected interest rate cut in March, further eased investor concerns, sparking a significant rally for risk assets through the second half of the quarter. Speculation still remains, however, regarding the future pace of interest rate hikes and the quality and persistence of the recent rally. 

Following its policy meeting on March 15–16, the Fed released a statement suggesting that U.S. economic growth has continued to expand at a moderate pace, noting that the labor market continues to improve, though business investment and net exports have been soft. The Fed again noted that inflation continues to run below policymakers’ longer-run objective of 2%. During the March meeting, the Fed decided to maintain the targeted fed funds rate in the range of 0.25–0.50%, and declared: “The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2% inflation.”1 Fed policymakers’ median projected estimate for the fed funds remains at 1.4% for the end of 2016.2

U.S. Treasuries (as represented by the BofA Merrill Lynch U.S. Treasury Index3) posted a return of 3.35% for the three-month period ended March 31, 2016.  The high yield bond market (as represented by the BofA Merrill Lynch U.S. High Yield Constrained Index4) posted a positive return of 3.25% for the quarter after beginning 2016 down over 5% through early February. The floating rate loan market (as represented by the Credit Suisse Leveraged Loan Index5) returned 1.33%, which trailed the returns of the high yield bond market, although with less volatility for the period.  The convertible bond market (as represented by the BofA Merrill Lynch All Convertibles, All Qualities Index6) returned ‑1.56%, lagging other fixed income assets due to the underperformance of the underlying equities.

Among higher credit quality securities, investment grade corporate debt (as represented by the Barclays U.S. Corporate Bond Index7) posted a return of 3.97%. Agency mortgage-backed securities (as represented by the Barclays MBS Index8) returned 1.98%. Commercial MBS (CMBS) (as represented by the Barclays U.S. CMBS Investment Grade Index9) returned 3.56%.

The municipal bond market (as represented by the BofA Merrill Lynch U.S. Municipal Securities Index10), posted a 1.64% return. Given the favorable tax treatment of many municipal bonds, the after-tax returns were comparable with other fixed income asset classes during the period, although municipals exhibited much less volatility. Overall creditworthiness in the municipal bond market continues to improve, as most states’ finances experienced rising revenues, while maintaining balanced budgets.

Within emerging markets, the major drivers of strong performance included a dovish Fed, weaker U.S. dollar, and a strong rally in commodity prices. Thus, U.S. dollar-denominated emerging markets corporate debt (as measured by the JP Morgan Corporate Emerging Markets Bond Index Broad Diversified Index11) returned 3.89%, outperforming most U.S.-centric, fixed-income asset classes.                                                        

U.S. inflation continued to struggle to reach the Fed’s 2% inflation target, as overall Consumer Price Index (CPI)12 increased just 1.0% over the 12-month period ended February 2016. The CPI (excluding food and energy prices), however, increased 2.3% over the same 12-month period.13 Increases in prices in February were offset due to a decline in the energy index. The CPI for all items (excluding food and energy) increased 0.3 % in February, the same increase as in January.

The U.S. labor market continued to strengthen in the fourth quarter of 2015, albeit at a slower pace. The U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 215,000 in March, above the trailing three-month average monthly gain of 209,000, while the unemployment rate held steady 5.0%.14

According to J.P. Morgan Securities, high yield new issue volume reached a 10-month high in March, totaling $28.2 billion in March alone. High yield issuance totaled $51.2 billion for first quarter 2016, which was a 46% decrease from the year-ago quarter, but a 21% improvement from fourth quarter 2015. Institutional loan issuance, however, decreased 41% in first quarter 2016 from fourth quarter 2015, posting a modest $35.2 billion in new issuance. Default activity notably increased over the period, with the majority of defaults expectedly coming from the energy and metals and mining sectors. During the first quarter of 2016, $24.1 billion par value of high yield bonds and $7.2 billion of par value loans defaulted for a total of $31.4 billion of defaults.  This compares to a trailing five-year quarterly average of $8.5 billion of par value defaults, according to J.P. Morgan Securities.

Fund Review as of 03/31/2016

The Fund returned 2.01%, reflecting performance at the net asset value (NAV) of Class A shares, with all distributions reinvested, for the quarter ended March 31, 2016. The Fund’s benchmark, the BofA Merrill Lynch U.S. High Yield Constrained Index,4 returned 3.25% for the same period. Average annual total returns, which reflect performance at the maximum 2.25% sales charge applicable to Class A share investments and include the reinvestment of all distributions, as of March 31, 2016, are: one year: -5.37%; five years: 5.07%; and 10 years: 6.76%. Expense ratio: gross: 0.94%; net: 0.94%.

Performance data quoted represent past performance, which is no guarantee of future results. Current performance may be higher or lower than the performance data quoted. The investment return and principal value of an investment in the fund will fluctuate so that shares, on any given day or when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent month-end, call Lord Abbett at 888-522-2388 or visit us at www.LordAbbett.com.

Volatility in the credit markets experienced in the second half of 2015 continued into 2016, as markets digested the Fed’s interest rate increase. We believe volatility may continue as markets assess further potential rate increases, economic data from China, and supply/demand fundamentals in the commodities space. The Fund has underweight positions, relative to its benchmark, the BofA Merrill Lynch U.S. High Yield Constrained Index, in the healthcare and telecom sectors. Concerns relating to the pharmaceutical industry and a loss of earnings momentum in hospitals drove the Fund’s underweight in health care during the quarter, while competitive pressures within the telecom space drove the portfolio’s underweight therein. The Fund transitioned from an underweight position in the energy sector to a modest overweight position. We have found opportunities in select exploration and production companies trading at attractive valuations.

Security selection across the Fund detracted from relative performance, especially within the electric generation and integrated energy sectors. An underweight to the steel sector also detracted, as the sector posted strong performance relative to the broader high yield market during the quarter. On a relative basis, the pharmaceuticals and telecom/satellite sectors contributed to performance. The Fund’s underweight to both sectors, in addition to security selection, contributed on a relative basis. In addition, security selection within the cable and satellite TV sector contributed to relative performance.

Please refer to www.lordabbett.com under the “Portfolio” tab for a complete list of holdings of the Fund, including the securities discussed above.

Outlook

The Fed remained a driving force within fixed income markets in the first quarter of 2016. While the Fed’s liftoff provided some clarity at the end of 2015, it was followed by mostly dovish statements by Fed officials, which eventually proved to be beneficial for risk assets this quarter. We think there still remains much uncertainty regarding the pace at which the Federal Open Market Committee, the Fed’s policy setting arm, will continue to raise rates. Most market participants expect a slow and gradual rise, as has been indicated by Fed statements.  However, the effectiveness of the tools at the Fed’s disposal, coupled with increased instability in the global financial markets, China in particular, remain a cause for concern, as Fed officials seek to normalize policy after unprecedented levels of quantitative easing in recent years. 

Despite the initial overall positive market reaction to the Fed’s decision to raise rates in December 2015, investor sentiment soon turned negative, as worries about China’s sluggish growth and continued uncertainty regarding deflation in the eurozone resurfaced at the beginning of the year. The subsequent sell-off in risk assets raised doubts about the pace of the monetary policy normalization plan as laid out by the Fed late in 2015. As sentiment improved toward the end of the quarter, investors likely will continue to closely monitor key economic data, with a particular focus on inflation, for an indication that the Fed might have sufficient justification to accelerate its interest rate tightening cycle. Similarly, investors will be looking for reassurance that if U.S. growth stagnates, the Fed will slow its progression in order to support the economy. Finally, although fears have abated about China’s economic slowdown, and a consequent “hard landing,” the economic situation there remains an area of concern, as the country has the ability to disrupt global markets, including U.S.-centric fixed income and equity markets.

Broadly speaking, we remain generally optimistic that the U.S. economy will continue to grow at a steady, albeit subpar, pace. We think that the risk of recession has faded significantly, but we remain cautious, as global economic growth remains fragile and it is unclear how improved domestic economic indicators will affect risk assets. 

Contact a Representative