#WellSaid

The Wellington Blog — A diverse marketplace of ideas, where our investment professionals share and challenge each other’s views. They decide independently how to draw on those ideas to sharpen their investment decisions, unconstrained by any single “house view.”

In my last blog post, I asked, “Is this the end of secular stagnation?,” which I defined as low nominal economic growth due to insufficient aggregate demand. While I didn’t (and still don’t) have a simple “yes” or “no” answer, I shared my latest thinking on the topic, including some investment positioning ideas for clients.

This time, I’d like to look more closely at one of the main causes of secular stagnation — a global “savings glut” over the past decade-plus — and whether it’s likely to persist going forward.

How did we end up with a savings glut?

Outside the US, the “savings glut” to which I refer dates back to before the 2008 global financial crisis (GFC). Following the GFC, the US also began to accumulate…

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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

In my 2020 insight, “Debunking four common myths about CLOs,” I highlighted what I saw at the time as compelling value in several tranches of the collateralized loan obligation (CLO) market. Looking at recent CLO spreads and valuations, I believe that remains the case as of this writing.

CLO spreads rebounded quickly from last year’s COVID-19-induced sell-off. Despite spread tightening across the capital structure over the past year, I still find CLOs attractive versus competing asset classes, such as corporate credit (Figure 1)…

Figure 1

CLO spreads vs corporate credit spreads

…especially in light of my positive outlook for CLO fundamentals. As the market has recovered, the underlying bank loan collateral credit metrics have…

MARKETS
Alyssa Irving
Alyssa Irving
Fixed Income Portfolio Manager
Boston

Recently, a few people have asked me a version of: “So, when will we start to see some climate events?” I can interpret this question in one of two ways. They either believe worsening hurricanes, wildfires, floods, and other climate events are simply bad weather, or they are displaying a cognitive bias, where bad memories associated with disturbing events fade quickly.

Investors risk becoming desensitized to the increasing frequency and severity of climate-related events and discounting the long-term consequences for capital markets of a changing climate. It would be difficult to dismiss the many record-breaking (and near-record-breaking) climate events that occurred in 2020 (and recent years) as a spate of “bad weather.” Devastating hurricanes, floods, and wildfires are occurring more frequently, and climate models project similar increases in the probability of…

SUSTAINABILITY
Chris Goolgasian
Chris Goolgasian
CFA, CPA, CAIA
Director of Climate Research
Boston

How to incorporate environmental, social, and governance (ESG) research and ratings into fundamental security analysis can be a vexing question for investors. The connection of ESG issues to equity returns isn’t always clear and disconnects can persist for companies that screen well on fundamentals but poorly on ESG. As ESG-focused investors with extensive fundamental investing experience, here are some ways we help our colleagues think about applying ESG to their investment process.

Yolanda’s perspectives

Look for red flags. I see ESG as a cost-of-equity scaler. The more material ESG red flags there are, the more concerns the market may have about a company’s financial risks. These concerns can reduce the likelihood for strong fundamental performance to translate reliably into strong share-price performance over the long term. Conversely, the more a company’s ESG profile improves and concerns abate, the more the stock’s…

 

SUSTAINABILITY
Yolanda Courtines
Yolanda Courtines
CFA
Equity Portfolio Manager
London
Mark Mandel
Mark Mandel
CFA
Equity Portfolio Manager
Boston

The number one question most cash investors are asking themselves (and us) these days is: How long are we going to be stuck in this “zero-bound” range for short-duration interest rates? Here are our latest thoughts on that and related matters.

  • All eyes on short-term rates: We expect the short end of the US yield curve to remain anchored lower for the foreseeable future, but we believe the risks are skewed to the upside in the second half of 2021 due to COVID-vaccine progress, a gradually reopening (and recovering) economy, and the massive amounts of fiscal and monetary stimulus already flowing through the system. Those factors may result in mounting inflationary pressures in the months ahead, which in turn could lead the market to begin pricing in higher short-term rates (i.e., a potential Fed rate hike) sooner than currently anticipated.
  • No Fed? No problem: As of year-end 2020, the permanent closure of some of the US Federal Reserve (Fed) lending facilities that were created by the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act —particularly the credit facilities (PMCCF and SMCCF) and TALF — removed…

 

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Caroline Casavant
Caroline Casavant
Investment Analyst
Boston
Andrew Bayerl
Andrew Bayerl
CFA, CAIA
Investment Director
Boston

The short answer is no, but it’s not completely hyperbolic to suggest we could be heading in that direction longer term.

Several of my Wellington colleagues and I are collaborating on an ongoing macroeconomic and geopolitical research project around the theme of “Biden and the world.” This blog post encapsulates some of my latest contributions to that effort, with a focus on the US-China relationship and the latter country’s growing role on the world stage.

China could become the world’s largest economy on President Biden’s watch.

According to the International Monetary Fund, the US was the world’s biggest economy as of year-end 2020, with a nominal gross domestic product (GDP) of US$20.8 trillion, followed by China at US$14.9 trillion. However, a December 2020 report by the Centre for Economics and Business Research stated that the size of China’s economy could surpass that of the US by…

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Santiago Millan headshot
Santiago Millán
CFA
Macro Strategist
Hong Kong

The dramatic 2020 US election is finally behind us, but 2021 is not lacking in global political activity of which investors should be aware. For example, the new year brought a busy docket of upcoming elections across various emerging markets (EM) countries. Figure 1 provides our EM debt team’s 2021 election calendar and assessment of the risk of populism in each case.

FIGURE 1

2021 EM elections calendar

Important takeaways

  • Across large parts of the EM landscape, economic growth had already been weak for several years leading up to the COVID-19 crisis. We believe the pandemic’s…
MACRO
Tushar Poddar
Tushar Poddar
PhD
Macro Strategist
London

The widespread economic fallout from the COVID-19 crisis dealt a formidable challenge to many municipal bond issuers’ ability to maintain and improve their credit quality. Given the need for state-level lockdowns and the subsequent realization that a return to pre-pandemic activity would take much longer than anticipated, the outlook as of mid-2020 pointed to an extremely trying period for the municipal bond market.

However, a combination of factors came together over the course of the year that led to more benign conditions than initially feared and set the stage for many better-than-expected credit outcomes. While some municipal credits have been downgraded since the pandemic began, most have…

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Conor McEachern
Conor McEachern
Fixed Income Credit Analyst
Boston

Momentous changes have taken place in India over the past 12 months that I believe have helped to fast-track the country’s nascent growth story. It’s now clear that Indian Prime Minister Narendra Modi is going all out to spur an economic renaissance.

Pre-COVID-19, there were some initial signs of positive policy reform in India, notably a substantial corporate-tax cut in 2019. Post-COVID, the Indian government has stepped up these efforts, announcing a flurry of key economic initiatives, including:

  • Farm-sector and labor-market reforms;
  • A potentially huge production-linked incentive scheme;
  • Increased spending on the country’s physical infrastructure; and
  • The unprecedented policy of privatization of public-sector enterprises.

Most recently, the presentation of the country’s annual budget on 1 February 2021 and Prime Minister Modi’s speech on 11 February left no doubt as to his intentions. Never before has…

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Niraj Bhagwat
Niraj Bhagwat
CA
Equity Portfolio Manager
Singapore

My previous inflation-related blog posts have focused on the debate around the threat of rising inflation going forward and on the potentially disruptive portfolio effects of higher inflation, particularly how it can upend the traditional equity-bond relationship in client portfolios. This time, I’d like to: 1) explain why the specific source of the inflation matters; and 2) provide a “playbook” of sorts to help asset allocators monitor and mitigate inflation risk based on its source.

Consider the source of inflation

Many investors use standard inflation indices, such as the Consumer Price Index (CPI) or the Producer Price Index (PPI), to track changes in inflation over time. While useful to a degree, these broad indices are only intended to serve as…

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Nick Samouilhan
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore

Over the past few years, I have discussed at length the potentially compelling long-term investment opportunity in financial technology (“fintech”) — which we define as companies creating or leveraging technology to disrupt traditional financial services. While much of our internal dialogue has focused specifically on the fast-growing digital payments space, I’d also like to share my thoughts on the fintech industry more broadly and what the increasing relevance of its products means for traditional financial services.

In future blog posts, I will explore some of the below points in more detail for investors who want a deeper dive. For now, the main takeaways I want to leave you with are…

THEMES
Matt Ross
CFA
Global Industry Analyst
Boston

Hopes and expectations for generous fiscal stimulus to be delivered by the Biden administration are largely baked into the current market narrative. More broadly, the ongoing COVID-19 crisis has provided fresh justification for many of the social and economic policies long proposed by US Democrats — health care for all, stronger safety nets, entitlement protections. For the most part, I have viewed such proposals as fodder for future negotiations with Republicans, but as politically unrealistic given the partisan divide in Washington.

However, I now believe there’s a big paradigm shift in the making. It’s becomingly increasingly clear to me that economists close to the new administration want to fundamentally redefine how people think about government spending and responsible fiscal policy. If they can rewrite that narrative, so to speak, it could be…

MACRO
Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

As investors scrutinize sky-high prices in some areas of today’s equity market, comparisons with the dot-com bubble of the late 1990s are common. Having lived through both periods, I see some important differences between the two environments, as well as some potential lessons from the dot-com sell-off.

The dot-com bubble was a twofer

Obviously, the heat and light of the bubble we saw in 1999 was the internet sector, with established players and startups trading at crazy valuations that often were not linked to earnings, cash flow, or even revenue. A tidal wave of oversubscribed IPOs was a big part of the picture as well. However, I would argue that the broader market was…

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Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

Commentators have written extensively about the recent surges in various pockets of the equity market — most recently, in heavily shorted stocks. Given the complexity and opacity of this market segment, the breathtaking moves left many investors understandably unsettled. While there is still more to learn about the volatility unleashed by the so-called “short squeeze,” for now, I’d like to address some client questions about the episode and attempt to put it in a larger context.

What happened?

A group of retail investors identified a handful of beaten-down stocks deemed to be “COVID losers” and went long these companies, both outright and on a leveraged basis via options. Positive investor sentiment in combination with thin market liquidity drove the stock prices higher. Call options buying accelerated the upward climb, as banks (which sold the options) had to…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

In my August 2020 blog post, I highlighted a potentially compelling return opportunity in the often-scorned universe of “fallen angels” — formerly investment-grade-rated corporate bonds whose ratings have been downgraded to high-yield (i.e., below-investment-grade) status by major credit rating agencies. I noted that, within two years of being thus downgraded, fallen angels as a group have handily outperformed the broader US high-yield index (and all three of its quality subgroups) over the long term.

Fast forward to early 2021: What I call the “fallen-angel effect” appears to have lost none of its luster. And notably, my latest research revealed that it’s not limited to just…

MARKETS
Robert Burn
Rob Burn
CFA
Fixed Income Portfolio Manager
Boston

My team and I often say recessions wipe the slate clean and create new investment patterns that will likely be dissociated from the last cycle. If there was a dominant theme of the last cycle — from the global financial crisis (GFC) in 2008 up to the onset of COVID-19 in March 2020 — it may have been “secular stagnation,” which I define as low nominal economic growth due to shortfalls in aggregate demand. Naturally, this begs the question of whether or not secular stagnation will still have legs in the post-COVID era.

I don’t claim to have a simple “yes” or “no” answer yet, but for now would like to share my latest thinking on the topic, to be followed by deeper dives on specific aspects of it (and hopefully more definitive answers) in additional blog posts throughout 2021.

Whence secular stagnation?

By way of context, it’s helpful to consider how we got here in the first place. Economists have attributed secular stagnation to…

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Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston

The Biden presidency, bolstered by Democratic majorities in the US Senate and House of Representatives, indicates a paradigm shift in climate policy at the highest levels of government. Along with immediately rejoining the Paris Agreement, President Biden has announced ambitious plans to position the US as a global leader in several climate-related areas, including clean energy, clean technology, and sustainable infrastructure.

Biden’s plan views climate change as an “existential threat — not just to our environment, but to our health, our communities, our national security, and our economic well-being.”1 The initiative also includes language linking clean energy with job growth, a connection I’ve been…

SUSTAINABILITY
Chris Goolgasian
Chris Goolgasian
CFA, CPA, CAIA
Director of Climate Research
Boston

I call it: “Cheap US equities: the low-rate adjustment.”

The strong post-March 2020 rebound in US equity prices rekindled rumblings about stretched or even “bubble-like” valuations. Myriad metrics can be rolled out to suggest “excessive” price levels, but how often do these arguments account for the broader investing landscape — inclusive of interest-rate expectations and the relative risk/return offered by US Treasuries? I believe they should.

Acceptance of paradigm shifts

One way to think about the relative value and appeal of equities is to look through a fixed income lens with a focus on risk-free rates. For the past decade, US stocks have remained cheap relative to Treasuries because…

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Connor Fitzgerald
Connor Fitzgerald
Fixed Income Portfolio Manager
Boston

As he enters the Oval Office, US President Joe Biden faces a full inbox of post-Trump challenges. One area where I expect some strong wins is in his relations with the European Union (EU). Here, I look at three potential benefits of his presidency.

1. Improved and more predictable US trade and foreign policymaking will reduce macro uncertainty and risks.

A year ago, markets were worried about a full-blown trade war between the US and Europe and a breakdown of the global trade order. With the new US administration, European exporters should benefit from increased predictability in policymaking in all spheres and thus reduced volatility, even in a world where the US and China remain in strategic competition. EU firms with a large presence in the US or with global supply chains or markets will see…

The current state of global equity markets is one of the frothiest I can find historically, in terms of both long-term valuations and short-term sentiment. Of course, there’s a compelling story behind this: Central banks are distorting asset prices, rendering traditional valuation metrics unreliable. Aided by this monetary (and fiscal) support and the likelihood of economies opening up later this year, 2021 should be a year of strong growth. And a long series of inflation undershoots means monetary policy likely won’t tighten on a near-term growth pickup.

These are earmarks of a classic “Goldilocks” scenario. It’s a powerful narrative for asset prices and, frankly, one that’s hard to refute. Yet it’s become more and more consensus. When investor optimism is running this high, it’s often a good time to pause and at least consider what could go wrong. Here are five potential risks to keep an eye on in the coming months…

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Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
Boston

With the Democrats having secured a narrow sweep of the White House and Congress, where will the new Biden administration set its policy focus? We know that pandemic control and economic stimulus will be top priorities, and I expect climate change, trade, and inequality to be on the list as well — with a range of investment implications.

Starting with the health and economic crises

In his January 14 speech, Biden made it clear that he sees a need for more stimulus, as he rolled out a US$1.9 trillion proposal. The new president’s negotiating skills will be tested as he works to move the proposal forward, and the details and dollar amounts will surely evolve. Ultimately, I think the next package will come by March 14, when unemployment benefits are set to expire. In addition to an extension of those benefits, the package could include a third round of stimulus checks, more state and local aid, and an extension of the eviction moratorium. In addition, I would expect more…

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Juhi Dhawan headshot
Juhi Dhawan
PhD
Macro Strategist
Boston

Broadly speaking, as of this writing, we believe municipal bond (muni) valuations may offer an attractive entry point for discerning investors. As of December 2020, municipal credit spreads had yet to make up for ground lost to the COVID-19 sell-off earlier in the year (Figure 1). Lower expected 2021 tax-exempt supply and strong retail demand suggest there is room for further spread tightening.

Having said that, challenges remain. Fundamentals in some areas of the muni market continue to be tested by the COVID-induced economic slowdown. Accordingly, deep credit research remains critical in this space. Let’s take a closer look on a sector-by-sector basis.

Figure 1

BBB muni spreads have tightened but remain elevated

1. Not-for-profit health care: Jenn Soule (Sector Analyst)

2020: Lessons learned

  • Market tends to overcompensate after…
MARKETS
Timothy Haney
Tim Haney
CFA
Fixed Income Portfolio Manager
Boston
Brad Libby
Brad Libby
Fixed Income Credit Analyst
Boston

Previewing the Biden economic and foreign policy plans

In this 25-minute video, Geopolitical Strategist Thomas Mucha, Macro Strategist Michael Medeiros, and Multi-Asset Strategist Nanette Abuhoff Jacobson explore the investment implications of Biden’s domestic and foreign policy agenda and opine on which asset classes, factors, and industries they expect to outperform in this new environment.

video-iframe

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Thomas Mucha
Thomas Mucha
Geopolitical Strategist
Boston
Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston
Michael Medeiros
Michael Medeiros
CFA
Macro Strategist
Boston

This is the third in my inflation “series” of blog posts based on ongoing client conversations. In the first one, I explained why rising inflation is not an imminent threat, but could be down the road. The next one compared today’s inflation worries with those that arose following the 2008 global financial crisis. Now I’d like to shift to a topic of even greater interest to many clients: the implications of higher inflation for investor portfolios.

Inflation can affect a portfolio in multiple ways over time. One way is through its potentially profound impact on the basic equity-bond relationship, which is typically critical to the performance and resilience of a diversified portfolio.

Dissecting the relationship

Bonds have often rallied (or at least mitigated downside) during equity market selloffs, thereby providing portfolio diversification benefits. What some investors overlook is…

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Nick Samouilhan
Nick Samouilhan
PhD, CFA, FRM
Multi-Asset Strategist
Singapore

In my conversations with clients at the end of 2020, many of the same questions kept coming up. Here are five that topped the list, along with my thoughts in response.

#1: Given last year’s robust market gains and the current state of the economy, how optimistic are you about 2021?

There are always risks for investors to navigate. Notably, this latest surge in COVID-19 cases, hospitalizations, and deaths marks a tragic phase in the ongoing global health crisis. However, as we learned in 2020, markets are forward looking. I believe the recently approved COVID vaccines, gradually reopening economies, and easy fiscal and monetary policy should provide a supportive backdrop for potentially solid gains from risk assets in 2021. So optimism seems in order, but given that is the consensus view, I am only moderately bullish on global equities as of this writing.

Figure 1

There is pent-up demand to “get back to normal”

#2: What’s your take on what a Biden presidency might look like?

Many investors are concerned about a progressive Biden agenda. However, the president-elect’s razor-thin majorities in the House and Senate and a low likelihood of removing the Senate filibuster have dimmed chances for proposals like the “Green New Deal” and “Medicare for All.” That said…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston
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