Portfolio managers Jeremiah Buckley and Mike Keough discuss long-term fundamental factors that may prove to be more important than short-term uncertainty caused by the upcoming election.
- While new policies resulting from a change in the administration will have impacts across industries and companies, we think investors would do well to look beyond the upcoming election and focus more on long-term factors driving the U.S. economy.
- There are several factors that remain supportive of a constructive outlook for equity markets
in the year ahead – mostly notably encouraging progress on the development of a COVID vaccine and continued monetary support from the U.S. Federal Reserve (Fed).
- Nevertheless, volatility is likely to continue. We think it will be important to focus on
companies benefiting from new investment themes, strong balance sheets and long-term competitive advantages, whether in equities or corporate bonds, factors we believe will
prove more important for the long-term investor than short-term uncertainty caused by
It has been a year of ongoing market volatility, with the economy now starting down a path of recovery. As the November US presidential election approaches, investors are facing another dose of uncertainty as they evaluate the possibility of either unified or divided presidential and legislative branches and the resultant policy implications.
While new policies will certainly have impacts across industries and companies, we think the more important drivers for financial markets include the pace of progress toward a COVID-19 vaccine, the reopening of the economy and continued monetary support from global central banks. Thus, we believe investors would do well to look beyond the election and focus more on long-term factors driving the US economy and the outlook for equity and fixed income markets.
Government policy will continue to support businesses and financial markets
The swift action in March provided by governments and central banks worldwide has done much to help bridge the gap between the sudden economic slowdown and the gradual reopening of the economy. The US government and Federal Reserve (Fed) injected markets with a tremendous amount of fiscal and monetary stimulus, as well as liquidity, resulting in one of the sharpest recoveries in markets following any recession in history.
More recently, Chairman Jerome Powell introduced the Fed’s new average inflation targeting framework. This, in conjunction with the Fed’s forward guidance of keeping rates low to support a sustained economic recovery will, in our view, ensure that an accommodative stance remains in place for an extended period. Regardless of the outcome of the election, we do not expect this support to wane until the economy has recovered.
To date, lower policy rates and direct bond purchases by the Fed have driven down interest rates – and thus companies’ cost of capital – to historic lows, where they are likely to remain for an extended period. Many companies have been able to raise much-needed capital to support their businesses, while some have postponed or halted stock buybacks, resulting in increased cash on corporate balance sheets. It is also important to note that management teams focused on maintaining a strong balance sheet have been able to avoid dilutive equity offerings, providing further comfort to equity investors.
Progress on a vaccine and new investment themes are tailwinds for markets
Ongoing economic uncertainty and market volatility have driven the individual savings rate up dramatically as soaring unemployment caused investors to seek the safety of cash during the market downturn. As the economy and company results recover, there is the potential for this cash – on both the corporate and consumer sidelines – to move into equity markets.
Furthermore, the low interest rate environment has continued to make equity dividend and cash flow yields attractive. As investors remain hungry for income, this could provide additional support for both equities and corporate bonds. Meanwhile, progress toward the development of potential COVID-19 vaccines continues to be encouraging. The fairly rapid recovery in markets and continued strength in home prices has also helped bolster consumer wealth, which could lead to greater confidence in big-ticket spending in the coming quarters.
Finally, we have seen a number of investment themes emerge and accelerate through this year’s volatility. Increasing demand for technology-driven cloud software platforms to support the remote workforce and a rapid shift to e-commerce are two themes that have benefited specific companies. We believe companies able to invest in and/or that are poised to benefit from these themes will continue to drive equity growth opportunities.
While we are seeing some short-term volatility across markets as we approach the election, it is important to step back and consider where we are in the longer-term cycle. Following a recession, the credit cycle begins to come out of a trough as the economic recovery takes hold and corporations begin a multi-year process of repairing their balance sheets. As these companies’ credit risk declines, this sustained tailwind can often lead to tighter spreads and attractive return opportunities.
The Fed’s quantitative easing programme has also supported bond markets, although its purchasing of corporate bonds has had a larger positive impact on the investment-grade credit market. This has resulted in some BB rated bonds offering attractive spreads and relative value opportunities; we continue to see opportunities across BBB rated securities as well as in many higher-quality BB rated high-yield issuers.
Stay focused on fundamentals
Given the COVID-19-induced uncertainty weighing on the economic environment, we believe it is in the interest of both political parties (Republicans and Democrats) to remain accommodative and supportive of financial markets, consumers and the economy. This support – along with the development of a vaccine and the infrastructure to distribute it – may help further the economic recovery. While we remain constructive, volatility is likely to continue not only through the election but also through the ongoing recovery. As such, we think it will be important to remain active and to focus on companies with strong balance sheets, cash flows and long-term competitive advantages – whether in equities or corporate bonds. We believe these traits, along with other fundamental factors such as monetary and fiscal policy, will likely prove more important for the long-term investor than any short-term uncertainty caused by the election.
Credit cycle: The credit cycle is the cyclical expansion and contraction of access to credit (borrowing) over time, which has a consequent impact on business activity.
Spreads: The difference in the yield of corporate bonds over equivalent government bonds.
Quantitative easing: An unconventional monetary policy used by central banks to stimulate the economy by boosting the amount of overall money in the banking system.
Monetary and fiscal policy: Government policy relating to setting tax rates and spending levels is known as fiscal policy. It is separate from monetary policy, which is typically set by a central bank. Fiscal austerity refers to raising taxes and/or cutting spending in an attempt to reduce government debt. Fiscal expansion (or ‘stimulus’) refers to an increase in government spending and/or a reduction in taxes.
Credit ratings: A score assigned to a borrower, based on their creditworthiness. It may apply to a government or company, or to one of their individual debts or financial obligations. An entity issuing investment-grade bonds would typically have a higher credit rating than one issuing high-yield bonds. The rating is usually given by credit rating agencies, such as Standard & Poor’s or Fitch, which use standardised scores such as ‘AAA’ (a high credit rating) or ‘B-’ (a low credit rating). Moody's, another well known credit rating agency, uses a slightly different format with Aaa (a high credit rating) and B3 (a low credit rating).