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Our investment professionals share and challenge each other’s views, creating a diverse marketplace of ideas for the Wellington Blog.

Factor investing – tilting a portfolio toward securities that have certain attributes (e.g., attractive value, quality, momentum, etc.) – has become widely accepted and practiced in the world of equities. Within fixed income, it is in a more nascent stage.

However, we believe that applying a factor-based investing framework can lead to valuable insights into what is driving performance in different sectors of the bond market. Even more important, it may allow investors to better position their portfolios to take advantage of…

MARKETS
THEMES
Brendan Fludder
CFA
Research Manager
Boston
Samuel Steere
CFA
Investment Director
Boston

When I think of “old school” emerging markets (EMs), I think of Mexico. What started out as an exercise to determine if Mexico could be a “Biden trade” soon turned into my belief that some Mexican equities could perform well going forward regardless of the election outcome.

Mexico is not a “COVID reopening” trade, in my view, because President Andrés Manuel López Obrador (AMLO) neither locked the country down aggressively amid the pandemic, nor took any bold steps to stimulate the market. In fact, by not pursuing deficit spending in response to COVID, Mexico’s balance sheet may hold up better than most EMs’ heading into 2021.

More to the point for investors, some Mexican companies appear to be pivoting toward…

MARKETS
THEMES
Jamie Rice
Jamie Rice
CFA
Equity Portfolio Manager
Boston

I was recently asked, “How can you be confident that value investing will work again, when the historical results look so skewed to growth?” It’s a fair question. Looking at the Russell 1000 Growth and Value indices, growth is ahead on a one-, three- five-, 10-, and 30-year basis, and indeed since 1978, when data is first available. Among the most striking results are the one-year returns (37.5% for growth and -5.0% for value) and the 10-year annualized returns (17.3% for growth and 9.9% for value).1

However, these numbers mask how quickly the picture has shifted. As recently as February, value was beating growth since inception. And before the global financial crisis, value was ahead by more than 2% annually over almost three decades since 1978. Perhaps more importantly, there has been a strong cyclicality to the performance of growth and value that makes some “extreme” periods seem a bit more ordinary.

Haven’t we been here before?

In 1999 and 2000, growth was beating value since inception — and on a trailing one-, three-, five-, 10- and 20-year basis. Then, too, investors were asking, “Is value dead?” But value was…

MARKETS
Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

With the prospect of a Democratic sweep looking more and more plausible with each passing day leading up to the US election, some observers note that such an outcome could usher in major policy shifts in taxation, health care, energy, and perhaps tech regulation for 2021 and beyond. Should investors start repositioning their portfolios accordingly? Not so fast.

Nick Petrucelli’s macro insights

I tend to be skeptical of government policy-driven trades playing out to the extent that financial markets often anticipate. Indeed, there have been several political changes in recent years whose impact on assets has turned out to be fleeting and, in some cases, just the opposite of…

2020 US ELECTION
MARKETS
Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
Boston
David Lundgren
David Lundgren
CMT, CFA
Director of Technical Analysis
Boston

The US Federal Reserve’s (Fed’s) recent adjustments to its monetary policy framework are impactful for short-term investor returns, affirming our expectation that short-end interest rates will likely remain at or near zero for at least the foreseeable future. This brings short investors back to the dilemma many knew all too well post-2008: With most deposits and money market funds earning next to nothing in yield, how should I invest my liquid and reserve assets?

For clients’ second-tier cash bucket (reserves or excess liquidity), here are three suggestions to modestly increase income without adding significant risk.

1. Increase duration flexibility for excess reserves

Money market funds are governed by strict rules that limit the investable universe. There has also been a surge of inflows into money markets (Figure 1), further suppressing potential income from assets meeting the money market criteria. Thus, we believe expanding one’s opportunity set beyond the traditional money market rules — while still remaining on the short end — may…

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

The short answer is that they up and left, at least judging by the percentage of value managers (80%) that were recently underweight value stocks (Figure 1). Some observers may offer reasonable arguments for why such positioning seems justified in the current environment, but the fact is that value equity managers have traditionally tended to lean into relative valuation extremes like today’s. Instead, most are leaning away.

Figure 1

Opportunity in value stocks? 80% of value managers were recently underweight the group

Déjà vu all over again?

This calls to mind a 20-year-old quote from retired Wellington Portfolio Manager Ed Owens that is relevant again today. In January 2000, Ed opined that “value is particularly attractive now, because it has…

MARKETS
Andrew Corry
Andrew Corry
CFA
Equity Portfolio Manager
Boston

With the US elections only a few weeks away and Democratic nominee Joe Biden holding onto a comfortable lead in most polls, the prospect of a so-called “blue-wave” scenario — where Democrats win the White House and seize control of both houses of Congress — looks more and more plausible with each passing day. (Granted, polls are notoriously fickle and a few weeks is an eternity in politics; anything could still happen between now and November 3.)

Many investors are wary of a blue-wave outcome, fearing it would spell bad news for the US economy and markets. But would it really? After taking a closer look…

2020 US ELECTION
MARKETS
Michael Medeiros
Michael Medeiros
CFA
Macro Strategist
Boston

While the UK equity market appears attractively valued and has the potential for a rebound, I remain neutral on UK equities for now as I believe the uncertain political outlook provides a poor basis for active risk taking. In essence, the outcome of the Brexit negotiations is hard to judge, and a non-cooperative outcome could prove highly disruptive for the UK economy and equities. In my view, this risk is not priced into the market at present.

The UK has had a poor COVID crisis

The UK’s health and economic outcomes have been in line with the worst in Europe, and managing this twin crisis will remain problematic in the near term. At the same time, the UK faces longer-term challenges, such as changes in the migration framework, a sharp rise in minimum wages and the perennial issues of low productivity growth and a large current-account deficit. Together, these near-term and structural challenges create a…

CORONAVIRUS
MARKETS
Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London

While economic activity is likely to recover slowly in the euro area, I believe the risk of a much worse outcome has abated. Improved macroeconomic policy should lead to a stronger recovery, driving further reductions in the valuation gap between US and euro-area stocks.

The COVID-19 crisis has caused a deep recession in the eurozone, and I don’t expect activity to return to end-2019 levels until mid-2022. A recession of this magnitude leaves many kinds of economic scars. Jobs and businesses are destroyed, and the necessary reallocation of labour and capital is expensive and takes time. Balance sheets are damaged as a result of falling incomes, and the continued uncertainty constrains investment and consumption.

On the plus side, I believe Europe’s management of the health crisis and the economic policy response have been strong enough to substantially reduce downside risks to…

CORONAVIRUS
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Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London

The COVID-19 pandemic has represented a near-perfect storm for the world’s leading technology companies. Both earnings growth and valuation multiples have risen to extraordinary levels. Naturally, this raises questions about the sustainability of the current dynamics and the prospective risks and opportunities for investors.

The enduring case for tech

The technology sector’s strongest companies were already executing at a high level coming into 2020 — growing fast, expanding margins, and reinvesting in their value propositions. The COVID-19 pandemic has accentuated these characteristics by accelerating the need for consumers and enterprises to digitize. In addition to the COVID-19 tailwind, I think these firms deserve significant credit for their agility and decisiveness — as both attributes have allowed them to pivot quickly to capture these growth opportunities. Furthermore, I believe these companies’ unprecedented…

CORONAVIRUS
MARKETS
Daniel Pozen
Dan Pozen
Equity Portfolio Manager
Boston
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In recent months, the convertible-bond market has provided tremendous opportunity for investors looking to position their portfolios strategically for an eventual recovery from COVID-19. Convertibles have experienced a meaningful uptick in supply during the first half of 2020, including substantially elevated new-issue and secondary-market volumes. Most of this supply surge, which includes a number of notable transactions, has been driven by companies looking to boost liquidity and capital.

So what now? While the market has been engaged with the theme of a rapid recovery in economic activity post-lockdown, helped by an abundance of monetary and fiscal support, there is still potential for significant setbacks to investor confidence and for COVID-related news flow to keep volatility at relatively elevated levels. As the market’s perspective on the likelihood of a fuller, more sustained reopening of the economy continues to evolve, we believe the convertible-bond sector may offer…

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Ronan McCullough
Ronan McCullough
Director of Capital Markets
Boston

As detailed in a “Fed series” penned by my colleagues Amar Reganti and Caroline Casavant — most recently, Corporate credit and monetary financing: A new era in Fed policy — the US Federal Reserve (Fed) has adopted a “whatever it takes” stance to support the ailing US economy amid the ongoing COVID-19 crisis. In broad terms, the extraordinary steps taken by the Fed over the past several weeks include (but are not limited to):

  • Conventional monetary easing (i.e., cutting interest rates to the zero lower bound);
  • Regulatory guidance designed to encourage banks to continue lending; and
  • Large-scale asset purchases, both on and off the Fed’s balance sheet.

While many of the tools the Fed has unveiled harken back to ones used during the global financial crisis, its off-balance sheet purchases go well beyond…

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

Income is getting increasingly difficult to come by these days. Amid the severe market downturn in March, global central banks aggressively cut interest rates in an effort to lessen the damage. Meanwhile, as many large corporations effectively ceased to operate, stock dividends began to collapse.

Although the headlines focused mainly on the immediate impact of these developments, investors who rely on the equity and fixed income markets to generate regular income in the form of dividends and/or bond yields — from insurance companies to pensioners and endowment funds — will, unfortunately, likely feel the impact of this unprecedented crisis for years to come.

The crisis has also shone a bright spotlight on various strategies, across asset classes, that pay out regular income to investors, particularly the manner in which many of these strategies have been…

CORONAVIRUS
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Matthew Bullock
Investment Director
London

As I argued in my March 17 post, “Technology: The future is on sale,” now may be an opportune time to “buy the future” at potentially bargain-basement prices, particularly in the technology sector. By way of a follow-up, here is my latest thinking on trends and industries that look poised to emerge as winners (and, conversely, losers) on the other side of the COVID-19 crisis:

Potential winners

  • Streaming
  • Digital advertising
  • E-commerce
  • Fintech
  • Digital goods consumption (e.g., video games)
  • Cloud collaboration tools
  • Online education
  • Direct-to-consumer business

 

Potential losers

  • Linear TV, cinema
  • Traditional advertising
  • High-end retail
  • Physical branch banking
  • Physical goods
  • Business travel
  • In-class education
  • Supply chain/middlemen

A number of quality companies in the “potential winners” column have recently been trading at attractive relative and absolute valuations. I believe equity investors should consider using this opportunity to add (or increase) exposure to some of these stocks.

CORONAVIRUS
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Brian Barbetta
Global Industry Analyst
Boston

Amid the impending government stimulus, the issue of stock repurchases has once again hit the headlines. Buybacks are often framed as the poster child of corporate greed or lapses in governance, designed to line executive pockets and enrich existing shareholders at the expense of broader long-term value creation. But the first critical point to remember is that buybacks should be a distribution of profits that remain after all constituents have been taken care of, and they should not be done at the expense of any stakeholder, including employees.

Let’s assume that the buybacks we have seen have been made with good intentions and examine what influenced the decision making. Stock repurchases are one of five capital allocation tools available to public companies, along with business reinvestment, acquisitions, dividends, and debt reduction. Like any other capital allocation decision, there are times when buybacks make sense, and times when they don’t. How, why, and when management teams take these actions matters greatly. Skilled capital allocation separates…

 

CORONAVIRUS
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Mark Whitaker
Equity Portfolio Manager
Boston

The S&P 500’s substantial market rally from recent lows has led many investors to question whether a new bull market has begun. In my view, bear market history should give pause to anyone who thinks we are off to the races again. In the US, prior to the recent crash, there have been nine bear markets of at least 20% since 1987. Figure 1 offers several lessons from these bear markets (each gray and white section), showing the meaningful lows and gauging the magnitude and quality of any rallies that were recorded as each bear market unfolded. For instance, in 1987 there were two major lows. Between the crash and the next low, the market rallied…

CORONAVIRUS
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David Lundgren
David Lundgren
CMT, CFA
Director of Technical Analysis
Boston

After its recent bounce, the S&P 500 is now wrestling with our near-term upside target in the 2,700 range. In my view, we are starting to see evidence that the market is normalizing, setting the stage for a bottoming process to begin. And even if the market sees new lows in that process, I believe it will hold above 2,000 – 2,100. From this point forward, however, I think whether or not we retest the bottom before moving higher is irrelevant. I believe it is time to ignore the market and instead focus on the factors, regions, industries, and stocks that will lead in the next bull cycle.

Will the market see new lows?

The dominant consensus view seems to be that the market will see lower lows. Investors then appear to be split between the bulls and the bears, but both camps seem to confidently expect this near-term outcome. My best-case scenario is more bullish…

CORONAVIRUS
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David Lundgren
David Lundgren
CMT, CFA
Director of Technical Analysis
Boston

Recent price-to-book (P/B) ratios relative to history underscore how wide the performance dispersion within emerging markets (EM) has become amid the COVID-19 crisis (Figure 1). Looking ahead, I expect this trend to persist and perhaps accelerate.

Figure 1

EM equity valuations in historical context

As a result, I believe we have entered a period in which country selection — or more precisely…

CORONAVIRUS
MARKETS

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Vera Trojan
CFA
Equity Portfolio Manager
Boston

What would Winston Churchill say today?

It would be interesting to hear Churchill’s thoughts on the current crisis. Sadly, we will never know, but we do know he didn’t think much of currency traders:
“There is no sphere of human thought in which it is easier for a man to show superficial cleverness and the appearance of superior wisdom than in discussing questions of currency and exchange.”

With those stinging words ringing in my ears, here are my thoughts on currencies in the current environment.

The euro faces existential threat

I think the euro will face an existential moment in the coming weeks. That can be avoided if the eurozone countries move to risk-sharing and towards a full fiscal transfer mechanism. Since adopting the single currency, Italy has hugely underperformed (30% below the average level of GDP of other member states, as we enter this crisis) and has suffered high…

CORONAVIRUS
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John Parsons
Currency Portfolio Manager
London

While obviously a challenging market environment, we believe that high-yield bond and bank-loan spreads, in the 97th and 98th percentiles, respectively (as of this writing), could more than compensate investors for forward-looking potential credit losses.1

  • In the case of bank loans, an average market price of around 782 seems to imply that investors are expecting more than 50% of the market to default. However, the worst five-year cumulative default rate for loans historically has been 25.3%.3
  • Additionally, investing in high yield at spreads over 1,000 basis points (bps) and then staying invested for three or more years has historically produced annualized total returns of at least 14%.4
  • As a result, despite today’s challenges, we believe there may be…
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