Full Discretion Team
Update and Outlook
As of December 7, 2020
In March 2021, Dan Fuss, Vice Chairman of Loomis Sayles and Executive Vice President, will mark his 45th year with the firm. Dan has elected to honor this notable anniversary by taking a significant step in the Full Discretion team’s longstanding succession plan.
Effective March 1, 2021, Dan will no longer serve as a co-portfolio manager on any Loomis Sayles mutual funds or offshore funds. Matt Eagan, Elaine Stokes, Brian Kennedy and Todd Vandam will remain co-portfolio managers on all funds for which they are already named co-portfolio managers.
It is important to note that Dan is not retiring. He will remain a member of the Full Discretion team in a senior advisor role and will continue to share insights on topics he has passionately followed for the past 62 years—the global macro environment, fiscal and monetary policy, geopolitical and military events, climate change and the global flow of funds—with the Full Discretion team and the rest of our organization. He will remain Vice Chairman, Executive Vice President and a member of the Loomis Sayles Board of Directors.
Dan’s investment and business experience give him a truly unique perspective, and his unwavering commitment to putting clients’ needs first remains the cornerstone of our culture.
This page provides the Full Discretion team’s latest views on the emerging economic recovery. We share insights on key themes, market activity and global policy responses, all of which impact how we position our portfolios for the future.
OUR BASE CASE:
What a trip. In just 12 months, we’ve been in all four phases of the credit cycle:
Economic and market conditions have continued to improve. US consumer health looks to be healthy in aggregate, and global manufacturing and services purchasing manager data have been strengthening. The Federal Reserve’s forward guidance has indicated that monetary policy should remain accommodative for the foreseeable future. This appears to be boosting business and consumer confidence and keeping risk appetite strong. Multiple COVID-19 vaccines have shown encouraging results. We believe the economy could begin to normalize with successful vaccine distribution efforts and less restrictive social distancing measures in the second half of 2021. However, global GDP is unlikely to reach its 4Q 2019 peak until late 2021 or early 2022, in our view.
These are positive signs, but the near-term outlook is not certain and we expect some unevenness. Surging COVID-19 cases worldwide and dwindling fiscal support could slow economic momentum. We think fiscal stimulus is essential for recovery, and we anticipate a fresh US fiscal package in 1Q 2021, if not sooner.
The Fed’s powerful intervention in US fixed income markets has pushed Treasury yields to historic lows. We believe the Fed’s heavy hand should remain a strong downward force on the yield curve at least until the uncertainty surrounding the crisis abates and excess slack in the economy is worked off. We believe it will take a couple of years for economic health to return to pre-COVID-19 levels. In the meantime, Fed policy should continue to be a big technical driver in capital markets.
The yield curve typically steepens in the early stages of economic recovery, and the yield curve has steepened moderately since August. The curve could steepen further as the economy continues to recover, but much will likely depend upon how quickly the Fed walks back its easy monetary stance and to what extent inflation rebounds. We think the Fed is likely inclined to sit on the policy rate for an extended period given its new policy of allowing inflation to overshoot its 2% target in order to make up for periods of undershooting. Locking down the front end of the yield curve for an extended period would also help anchor rates on longer maturities. Thus, we see the scope for higher yields to be limited for the foreseeable future. This view becomes murkier a couple years out, but structural fiscal deficits and massive US Treasury borrowing needs will pose risks for bond investors in the future.
OUR VIEW: We increased credit exposure during the market dislocation earlier this year and have maintained it throughout the credit repair phase to help capture balance sheet improvement, improving liquidity and tightening spreads. Corporates have rallied strongly since March and while valuations currently look less attractive, we believe they are reasonable from a fundamental perspective. We believe the low-rate environment will likely continue to drive the search for yield and help provide a positive technical backdrop for corporate debt as well.
OUR MOVE: We assess corporate health issue by issue. We believe there is currently opportunity to add value with strong security selection, particularly within the fallen angel space.
IG: Our strategy is to source value potential through bouts of volatility and new issues coming at a concession. We will continue to seek to build positive convexity into the portfolios by identifying potential fallen angels to purchase ahead of downgrade.
HY: We are using careful security selection to focus on companies we believe are “survivors” and weed out those we believe are destined to default. Episodes of volatility or new issues could provide chances to add to existing names.
OUR VIEW: Since February, nearly $164 billion of debt has been downgraded to high yield. Loomis Sayles credit research estimates that another $168 billion of debt is still at high risk of downgrade.OUR MOVE: Default risk and fallen angel activity are likely to be more moderate in the near term than they were last spring. But the recovery has been uneven and varies by sector. We still see opportunity to add value through credit selection and are monitoring for potential fallen angels, particularly in COVID-19-related areas like consumer cyclicals, lodging & leisure, retailers and restaurants. We look to opportunistically purchase names prior to downgrade, when prices are typically lowest. Fallen angels have historically provided attractive total return potential largely because of their structure (non-callable, deep-discount), though they are a higher-risk segment of the market.
OUR VIEW: Global growth has improved significantly since Q2. The US dollar has weakened recently, likely in reaction to the stronger prospects for global growth. Though some countries have been losing economic momentum, vaccine prospects and ongoing fiscal support on a global scale would be positives for the recovery and for continued non-dollar investing. In our view, global reflation is key for the non-dollar sector.
OUR MOVE: We like to catch a weak dollar trend as global growth is rebounding. These variables haven’t lined up well over the past few years. We are evaluating non-dollar given recent improvements in global growth and the Fed’s continuing highly accommodative stance.
OUR VIEW: Equities have posted strong performance since bottoming in March. As the recovery emerges, conditions should support equity performance, though we expect volatile episodes.
OUR MOVE: Stocks tend to lead other asset classes during recovery. With yields at very low levels, industry-leading companies that can sustain and grow dividends could offer opportunity. While go-go growth stocks have led the way while the economy struggled and interest rates reached new depths, the reversal of those conditions could pave the way for value to perform better. Volatility is a consideration, especially because the growth trajectory could be bumpy.
OUR VIEW: As we enter the recovery portion of the economic cycle, we would expect revenues and earnings to continue to trend higher and think profit margins are likely to expand. We would also expect to see marginally higher interest rates. Convertible bonds, particularly those closely linked to the underlying common equity, can provide potentially positive convexity and total return to a portfolio even in the face of higher interest rates.
OUR MOVE: New issuance has been robust as issuers access liquidity. We will continue to engage in opportunities in both the primary and secondary markets.
OUR VIEW: We currently view liquidity as adequate from both the standpoint of issuers’ ability to access markets and investors’ ability to transact across markets. The Fed has accomplished its goals of keeping interest rates low and allowing credit to continue to flow throughout 2020. These Fed accomplishments have helped many corporate issuers to both build cash “war chests” and also conduct liability management exercises to pay off near-term maturities.
OUR MOVE: We recognize that liquidity is fleeting and we continue to position portfolios with a layer of liquid reserves that serve two purposes. Reserves provide us with cash to buy into illiquid markets while also providing a buffer during periods of volatility for daily redemption vehicles. The post-financial crisis era lacks a strong broker/dealer presence and has at times seen short-term periods of extreme volatility and illiquidity in bond markets. These periods can represent both an opportunity and a challenge as the ability to swap one risk asset for another is at times difficult. Having liquidity in portfolios allows us to dictate price in illiquid situations without relying on bid interest on offsetting risk assets.