In this podcast, Sage’s CIO Bob Smith sits down with members of Sage’s investment committee – Rob Williams, Thomas Urano, Jeff Timlin, and Komson Silapachai – to review the past year and discuss our outlook going into 2021.
President & Chief Investment Officer
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Vice President, Research & Portfolio Strategy
In this podcast, Sage’s CIO Bob Smith sits down with members of Sage’s investment committee – Rob Williams, Thomas Urano, Jeff Timlin, and Komson Silapachai – to review the past year and discuss our outlook going into 2021.
Total time: 54:46
Bob Smith: Good day everyone. My name is Bob Smith. I am the Chief Investment Officer here at Sage Advisory Services. And I'm very happy to be joined today by other members of our investment committee; Thomas Urano, Rob Williams, Jeff Timlin, and Komson Silapachai. And together, what we'd like to try and do today is to give you a very quick review of how Sage saw 2020 and, and review some of the highlights and the lowlights. And at the same time, we'd like to then give you a sense of where we think we're headed in 2021 – give you our investment outlook, as we sit today, and perhaps discuss some of those highlights that we expect for the year going ahead. Overall, the global economic outlook is appearing a bit brighter to us. Clearly, the IMF projects this year was a real downer, global GDP will fall somewhere in the area of around negative 4.4%. But they do expect that it's going to bounce back and be up as much as 5.2% next year. By contrast, pre pandemic projections for 2020 and 2021 were roughly at around 3.3 to 3.4%. So that's a huge difference in terms of how we got to something close to those targets. If you averaged out this year and what's expected for next year, you're pretty much back on track in terms of long-term growth. But getting there was a bit of a rough ride. Given the recent economic trends across several indicators and central bank monetary policies that are currently in force, we do not foresee a global recession for next year. But the market will be jittery going into 2021. We have a new administration. We have a recovery underway. We have vaccines that are yet untested, and hopefully will prove to be the antidote to this horrible pandemic. So with all those concerns, you might expect that people are a little bit jittery about what's about to happen over 2021. With positive news on the COVID vaccines, the chances for a strong global economic recovery are good for next year. Risk assets have rallied over the past month of November. Oh, my goodness, November’s good news on vaccine efficacy that was announced by Moderna contributed to one of the strongest months for global equities ever on record – and in particular for the Dow Jones Industrial Average. We have reached 30,000, who would have thought back in March that that was attainable? So we're positive, we're constructive. Over the next year, our economic success will hinge on essential policy support on both the monetary and fiscal fronts with the hope and the expectation that it's not withdrawn too soon. With that in mind, I'd like to turn now to Rob Williams, who's head of our investment strategy and research group, to discuss kind of the bigger macroeconomic picture, kind of where we've come from and where are we today? So, Rob?
Rob Williams: Great, thanks, Bob. I appreciate it, great overview. And I'll put a little bit little more meat on the bones on some of the macro inputs. Certainly, we'll all be happy to get 2020 under our belts. It’s been a year like none other – deepest recession, one of the deepest on record, but also one of the quickest rebounds. And, you know, looking back and talking to clients, a lot of people wouldn't have expected the kind of positive returns it looks like we're going to end the year on. But just in the last couple months, the recovery itself has been exceeding expectations. So let's look at that first input of economic growth and add some detail on that. As Bob mentioned – robust global growth. We're on board with consensus in that neighborhood of over 5%. U.S. should be right up there, a little bit less, maybe four and a half percent or so but still very robust for the year, maybe a little slower out of the gate. Why do we stand behind this outlook? Well, for one, like I said, we've been very resilient the last couple months. If you follow U.S. data in particular, it has beaten consensus consistently, and that's without the additional stimulus. You look at China, the other engine of global growth, they've been strengthening, and they got on the strengthening path earlier than we did. Right? Their export growth is picking up. Very early, they had a property boom. And they have signs of a broadening recovery. So basically, what I'm saying is we went into this surge, this virus surge, the winter surge here on better footing than anyone expected. And additionally, lockdowns have been more limited. And with these vaccines on the horizon, we think we'll continue to avoid these broad-based blunt lock downs, and you'll start to see activity normalization over the first half. So that's kind of the economic path that we see and are hoping for. Policy has been a key input to this equation the whole time. And when you look to 2021 it is going to remain extremely supportive. So why this phase four fiscal stimulus package has proved pretty elusive. So far, we do expect one to get done at some point here, perhaps the end of the year, perhaps very early into the beginning of the year. Signs point at that being somewhere around a trillion dollars, maybe a little less than that – $750 billion to a trillion, maybe somewhere in that range. The other side of the equation, monetary policy going to stay extremely accommodative throughout the whole year, Fed has made that very clear, central banks around the world have made that pretty clear. That keeps borrowing costs low, that's going to encourage some risk taking and bolster sentiment.
Rob Williams: Policy, we can't stress it enough for investors, has been a key pillar of support. And it's really one of the reasons why we've been so resilient, is policy. If you think about it, the low rates kind of fed this housing recovery in the U.S., it has encouraged risk taking, it has encouraged flows into higher yielding fixed income, which helps spreads narrow throughout the year. And most importantly, it has stabilized liquidity in the fixed income markets early in the year when we really needed it. Also, one of the reasons why we've been resilient recently, consumer savings rate in the U.S. has risen. They haven’t spent all the stimulus that's given U.S. consumers a little bit of cushion, to kind of weather what we're going through right now. So that's supportive, we expect growth to continue. On the fundamental side, look, you know, this pent-up demand, strong consumer, we're on board with this idea of a robust kind of earnings rebound in 2021. That's typical in a recovery, you get some momentum, some upward revision momentum in earnings. And we've said time and time again, if you read our research to look at some of the linkage between kind of these global PMI or manufacturing survey indices, and earnings, and they're linked pretty closely together, and manufacturing data globally, that does support this notion that you're going to get a rebound in earnings. And it could be what consensus is saying in the U.S. is upwards of 20%. That's feasible when you look at the economic data. Hopefully stronger in certain areas, even like value in small caps, and some of the numbers overseas, where things have been beaten down even more are expected to also have a rebound. Finally, I'll touch on the political front, we could certainly do a whole call on politics, and we're not going to get mired down on that, but I'll give you a couple key takeaways. For the market at least is that, look, we didn't have this blue wave notion. So, you're going to get a little bit of a smaller fiscal package than what was thrown around six months ago. That's one implication to it. I think that the odds of tax hikes right now are small, because of the mix in Congress. And what I've read recently, even if the democrats were to win the runoff and get the edge, there are enough democratic senators in republican leaning states that make a tax increase a high bar. So that's the other thing that could, people could worry about that over the coming weeks, but the bar is high for that. And then the third thing is easing trade tensions. I think that's one clear investment implication of the election is that tariffs aren't going away. But you're going to have lower trade tensions, you're going to have improvement in some of the transatlantic partnerships, perhaps the idea of aggressive auto tariffs for EU are off the table, less heated sort of rhetoric. And that does feed directly into some investment implications, whether you want to overweight international and have a more diversified portfolio that I think is a benefit to some regions outside the U.S.
Bob Smith: Rob, well thank you very much that was a pretty good rundown of all things, macroeconomic and big picture. One of the things that jumped out at me in your statements, and I think that is a bit of a change right now is that policy is in a very good place in terms of being supportive of the market and the continuation of favorable market trends. There is policy and then there are policy makers. The known unknowns for us right now are Janet Yellen, who everybody would regard to some degree is a bit of a dove. She was as the Fed chair. A little bit different this time, though. She's now a devout democrat and has to carry kind of the party line in terms of the new administration. So it's going to be interesting to see what she does, because she's no longer the neutral party, such as Jay Powell would be, you know, the Federal Reserve Chairman. And I guess at this point, one would suspect that Mr. Powell will probably remain in the position that he's in. So the Powell-Yellen combination will be fairly interesting as we go into the new year, see what they undertake. But the third, and perhaps the more intriguing assignment was for the head of the Council of Economic Advisers. And that was Brian Deese, the former head of sustainable investing for all of BlackRock – and oh, by the way, a keynote speaker at our 2017 ESG Conference here at Sage. Brian is a very wonderful, gifted thinker, very much keyed in on climate. And it seems to me that climate is going to be a major priority for this administration, whether it's Green New Deal or not, who knows, but climate is definitely going to be front and center as part of the policy mixture that we're going to see from an economic perspective coming from this White House. And of course, as everyone knows, Sage is very much involved with the notion of ESG and ESG integration, so we welcome this view being brought into the policymaker environment. And we wait with bated breath to see what Brian will introduce to this mixture. So with that, let me go on and talk a little bit more about the fixed income market – something that we do well, and we do a lot of. And to lead that whole effort, we have Thomas Urano. And Thomas, I think you've got some very specific views about where we are today and what we should do to prepare for 2021.
Thomas Urano: Great, thanks, Bob. Fixed Income was certainly an interesting year, I think it was more of a tale of two halves, in the terms of how the market performed. So, let me just take a second just to reflect on a moment. If I could characterize how the first half of 2020 went versus the second half of 2020, I would say if you look back and said “2020, what happened,” the first half of the year was a position of max duration and high quality. You saw this environment where interest rates fell dramatically, certainly as the COVID shock and the economic recession took hold, and up in quality was the star performer. So it was very much of a high quality, long duration type trade in the first half of the year. But as we got into the second half of the year, it was the exact opposite. That situation changed dramatically. The star performers in the second half of the year, low duration and down in quality. Second half, we saw long duration treasuries underperformed, the market actually saw slight negative returns and very long duration treasuries in the second half of the year so far. And then interestingly, the weakest of credit categories, the very bottom of the barrel of credit categories have been some of the best performers. As an example, we look at the Triple C rated category of the high yield market – and let me remind everybody that's one stop before default zone – the Triple C rated category, the market is trading better than where it was pre COVID. It has outperformed its January 2020 levels. And I think that certainly is indicative of the mindset and the sentiment and the reach for yield that's going on in the marketplace today. So with that in mind, we think about where the opportunities lie in the market today. From a valuation standpoint, from a curve standpoint, where issues are going on, we look right now, I think valuations are really driven by chase for yield. We've seen well over two and a half trillion dollars of quantitative easing since March out of the Fed. If you add on top of that the amount of money that's been printed by the ECB the BOJ well north of 3 trillion U.S. dollar equivalents have been added to the global capital pool and everybody is looking for yield. So there's a global chase for yield that's pushed valuations on nearly everything back to pre COVID levels. So valuations are a little bit challenging. So that's something you have to take into consideration when we're positioning for portfolios going forward. The curve is also something that's changing recently. What happened immediately after COVID hit, the curve went very flat and interest rates went very low. But more recently, on the heels of the first stimulus package and the potential second stimulus package, we've seen a slow steepening of the Treasury curve. I think investors are starting to consider the amount of Treasury supply that needs to get done in order to finance some of the very large deficits that will be a function of the next round of stimulus. So we're seeing this slight uptick in longer duration Treasury rates, 10s 20s 30 year type Treasury yields. We're seeing a slight steepening in that while we're seeing the exact opposite in credit curves, and we're seeing a flattening in credit curves. And I think that's part in parcel with this global reach for yield on the heels of all this new QE dollars that are floating around the world. Investors are eagerly gobbling up credit, investment grade credit and high yield credit in any form or fashion. And they're going down the quality spectrum, and they're even buying some of the longer credit portfolios or credit positions in the market. So we're seeing this compression in credit spreads and it's consistent across the curve. And there's more juice in the 10 to the 30-year type credit areas, in those arenas, and there's plenty of investors around the world that are buying that up and pushing down credit premium. So we're seeing a flattening in credit curves and a steepening in Treasury curves. It's an interesting dynamic that's going on there.
Thomas Urano: All that is leading to what amounts to a decline in volatility. Basically, we're seeing the subdued market, if you will, valuations are grinding higher steadily, and we're not seeing very large bouts of whipiness, or volatility coming into the market, which is kind of a, it's been a steady climb higher in terms of performance and gains. Which is good and consistent with this more favorable economic backdrop that we have. So with that of kind of the current situation, I think the question is really what are strategies and positioning that we need to think about in 2021, to be successful, and you know, we're thinking about it in terms of what we call the three C's; curve carry, and then consumer oriented exposure. And on the curve side of the equation, as I mentioned, we're seeing rates drift a bit higher. So I think it's very important to think about managing your curve risk, and your duration risk. So duration overall, sure. But curve risk can be equally as important and as we're in an environment where Treasury curves are steepening and credit curves are flattening you kind of have to maneuver the portfolio exposures accordingly. And you know, it can take a deft hand in terms of making sure you have that exposure moved around accordingly given that there's conflicting movements in curves. Carry, I think, will be an important feature for 2021 – meaning we need to focus on yield, we need to harvest risk premiums and take that yield into the portfolio, that will probably be the driving force of performance, rather than price gains. The second half of the year, we saw a lot of price gain potential on recovery of that COVID volatility that hit the bond market. I think a lot of those gains have run their course. And focusing on carry, I think will be the driver of performance through 2021. So, managing your curve risk, focusing on carry will be these big core top level factors in the fixed income arena. And then I mentioned consumer-oriented exposure, right. And that's really a function of what we're seeing in terms of this economic recovery. Yes, unemployment rates are still a bit elevated, but as the global supply chains are starting to turn back on, manufacturing industrial activity is starting to turn back on, we think there will be further scope for improvement in job gains for the first half of 2020. People have been held up in their homes for months and months and month, I think there's going to be plenty of pent up demand that is available to be unleashed in the first half of 2020 on the heels of further recovery, vaccine improvement, hopefully the surge fades here and we get to a better position for economies to open up more broadly. And we think that leads to what could be a very large and positive consumption shock to the economy – a shock in a good sense. So, we want to be able to have our positions, our sectors, our issuer exposures geared towards some consumer sensitivity, I think there's plenty of scope for that – and spend again once vaccines have rolled out and some of the COVID concerns or virus case counts have declined. So those are kind of the key themes we're focusing there on fixed income positioning and structure.
Thomas Urano: And then I think one thing that is worth mentioning, in terms of next year, thinking about, you know, how is it shaping up right now? Generally optimistic, the first half outlook coincides with what looks like a double whammy of fiscal and monetary stimulus. The ECB just announced today that they're expanding their program of QE, the Fed is likely to talk about some further expansion next week. And we are kind of right on the 11th hour of getting some fiscal stimulus, second round of fiscal stimulus done. Let's hope that gets done before the end of the year, but if it happens in January, that's great. But the double whammy of fiscal monetary stimulus should provide some substantial support for the economy to continue to grow. And I think people are focused on that and valuations are reflecting that. So, I think performance may surprise people where it comes from in 2021. I think the first half of the year may be somewhat muted in terms of volatility, hopefully, let's hope that, you know, the economy opens up and start supporting where valuations in the market are now. But one of the problems with success is that it begets a policy change. In other words, we're promoting this stimulus policy. And if the stimulus policy works, both the fiscal and monetary stimulus policy work, then we won't need it. Ideally, we won't need the policy. So then the question becomes, how do we gently back away from policy stimulus in a manner that doesn't cause some concern for the market? I would suggest that, you know, performance may be generated from bouts of volatility that could come from the success of policy. And that may be more of a second half issue, whereby, we've recovered, the economy has opened back up, and policymakers think about how to rein in all of the excess monetary policy that's in place now. And I think that may generate some bouts of volatility in the market, and maybe the second half of 2021, that could create some opportunities for investors.
Bob Smith: Thomas, thank you very much for that. That was an exceptionally good and detailed analysis of everything that we expect to happen in the taxable fixed income markets next year. One of the other issues that's a bit of a sidebar, but I think emerging, again, that will come with the new administration, and its attitude is climate and carbon transition, and areas such as green bonds are likely to see a lot of interest and a lot more issuance as we go forward. Anything carbon friendly, net-zero friendly from a corporate perspective now that 90% of the S&P 500 companies are filing essentially CSR reports or sustainability reports every year. That might be another growing dimension in the taxable fixed income market that I think everybody should keep an eye on as we are as well. But the one thing that we're all concerned about in the longer term, which I mentioned, is the growing amount of debt that we have both on a global and on a national basis, never seen before in terms of proportionality to GDP. So it begs the question, well, what about taxation? And we know, we've heard a lot of things from the administration in terms of personal and corporate tax policy proposals, nothing is enacted, our sense is that things will be kept in check as we go forward, but a lot of that is yet to be determined. And so we will see what the political process brings us, but it definitely puts municipal bonds, right in the crosshairs of attractiveness. And I'm wondering if municipals wouldn't be the ‘asset du jour’ for next year if in fact, we start to get a heightened-up kind of concern about taxation. So to get a better view of that, we have Jeff Timlin, who is head of our municipal portfolio management activity, give us some sense of how the year unfolded for municipals – and then what we expect going forward in 2021, and maybe how the whole tax issue might have some kind of an effect or what effect it would have on the market in general, depending upon how it goes.
Jeff Timlin: Absolutely. Let me get into that. So municipals performed well in 2020, with an approximate 5% return for the broad market index. And then looking where performance came from, longer dated maturities outperformed as yields declined across the curve, but obviously, the longer duration, and the longer maturities contributed to more price performance. As a result of the market dislocation in March, and the subsequent reversal that we saw, high quality sectors outperformed, from a sector level GO’s outperforming revenue, and that's broadly speaking. In addition, looking at it from a credit perspective, triple A issuers significantly outperformed triple B's, as spread levels have not recovered to the pre COVID lows, at least not yet – they've been lagging in that particular area. But on a more positive note and kind of summarizing what happened for 2020, especially for Sage clients, our municipal strategies were able to outperform their respective benchmarks due to slightly longer duration profile, bullet and maturity structure, and overweight to double A and single A credits. And I guess even more specifically avoiding areas that lag the recovery. So actually, we've done a pretty good job in terms of individual credit selection. Now looking forward into 2021, Sage anticipates a low volatility environment with the municipal marketplace experiencing its main performance drivers coming from coupon income, and some potential principal appreciation from modest spread compression in several sectors. Now similar to 2019, and 2020 -- will remain a major area of support. New issues supply will probably be on par with this year, probably somewhere north of 425 billion. And we'll continue to see elevated levels of taxable Muni issuance, which has been a little bit of a change this year. As we saw a divergence between municipal and Treasury yields. Treasury yields compressed faster than municipal yields. So when issuers in the municipal arena were looking to refund deals that were done approximately 10 years ago, they were able to utilize the taxable market to provide them with lower after-tax yields in terms of their refinancing. And we think that that type of environment will continue, which will help anchor tax exempt yields and spread levels. And then in terms of the demand side without any negative catalyst, we think demand will be steady and robust as valuations across all asset classes or all other asset classes will remain rich. And tax efficient opportunities will remain desirable, a higher probability of an increase in federal and state taxes, like Bob talked about, and a desire for a lower volatility asset class that has a low to negative correlation relative to other risk asset classes. Now kind of going into a little bit of a deeper dive here into the municipal market. Obviously, the COVID related shutdown was and is an unprecedent event and severely impacted numerous businesses and a large portion of the population in one way or another. Sage anticipates a growing divide between the good, the bad, and the ugly credits, with spread levels adjusting over time to compensate for that risk. Now, that being said, the municipal market maintains a strong credit profile in defaults, particularly in the IG space, will remain rare. However, Sage expects an increasing number of credit downgrades, as issuers will need time to adjust and recover from this event. From a state perspective or for state GOs, all four areas of revenue generation – income, sales, corporate and miscellaneous tax revenue – have been negatively affected or impacted and will remain well below expectations. On a positive note, each state has a broad array of fiscal tools to adjust revenues and expenditures to ride out this economic storm.
Jeff Timlin: Due to a 10 year economic recovery in the housing market, local GO credits representing a strong area of credit quality as housing market valuations remain well above tax assessed valuations, which provides a significant cushion to revenue receipts for the next several years. Now moving on, kind of to the revenue area, the revenue sector is bifurcated between essential and non-essential service areas with the majority of yield opportunities in the latter. Essential service areas such as water and sewer, electric, transportation, continue to maintain strong balance sheets, stable or improving revenue, and are a necessity for daily life. And because of that, attractive investment opportunities are limited in this space as the majority of spread compression took place during 2020. But most credits still offer low volatility alternatives. Moving on to non-essential service areas such as hospitals, education, industrial rev, or pollution control rev, those remain more volatile and it may continue to be adversely affected by COVID related issues. However, yield enhancement opportunities exist in this space, but careful credit selection--. Lastly, the special tax area has not fully recovered to pre COVID spread levels and remains a primary area of opportunity for both principal appreciation and yield premium. The taxing authority of these issuers provides a high degree of safety for investors. With that backdrop of an economic recovery, these bonds should perform well during 2021. Now, let's address some challenges for the municipalities going into 2021. Regarding areas of concern, persistent and growing underfunded pension and health care obligations will put significant downward pressure on credit ratings and limit further fiscal flexibility in the future. In addition, revenue challenges will persist in a post COVID environment and force issuers to rely on rainy day funds, a reduction or delay in expenditures and potential deficit funding. Now, let's move on to two new areas that haven't really been discussed or thought about in the past, but have come to light as of recently. So those areas will put some significant long-term pressure on municipal credits if current trends continue. An acceleration of people migrating from high tax states to low tax states will slow any economic recovery and limit the ability to raise taxes further. In addition, the second one, an increase in climate related issues will at best add to the expenditure side of the balance sheet and at worst, have areas experienced costly environmental events. Sage, with the support, obviously, of our ESG research team has been and will continue to be mindful of these risks, and we'll adjust our exposure accordingly. And then finally, let me get into some positioning for our clients going into 2021, taking all that into consideration. We will maintain a modest duration overweight and a bulleted maturity structure in anticipation of back end yields rising. But due to inflationary pressures and additional fiscal bond deficit issuance, Sage credit tilt will be in a double A or single A area with a bias towards selective triple B issuers that maintain a stable credit profile and attractive spread premiums. In addition, Sage will focus on, as we mentioned before, education and special tax sectors that will benefit from an anticipated post COVID environment, going into the second half of the year. And finally, Sage will actively dissipate the new issue market to source attractive investment alternatives, especially if limited, secondary supply persists. And I'll end it there and hand it back to Bob.
Bob Smith: Jeff, thank you very much. That was a very complete summation of kind of where we are in the muni world. A couple of points I’d just add on. I think that, given what you're telling our listeners, it would seem to me that, you know, the muni market is adjusting and changing in many ways. One of the things I do recognize, and I think with the infrastructure focus that the administration is likely to bring to everybody's attention in terms of one of their national priorities, maybe we're going to see some more issuance in the taxable muni marketplace. We had the Build America Bonds under President Obama, ‘Build Back Better’ bonds, perhaps under the new administration, who knows, but a resurgence in that market seems possible. What do you think, Jeff?
Jeff Timlin: Yeah, I mean, that's definitely a potential. Obviously, we have seen just generic taxable muni bonds come to market. So that's one facility that the federal government or the Biden administration could utilize to enhance their agenda that they came in with and their promises, particularly on the transportation side. You know, obviously, I think it needs a little bit better thought than what was done the first time, it was kind of done haphazardly and without any real game plan, when they started to issue some of these bonds. However, the nice thing about this time is it doesn't need to be done in an emergency standpoint, where last time it was done to provide a lot of liquidity for municipal issuers. This time around being that yields are low, spreads have compressed, and we're not dealing with the same challenges we were back in March. That this facility could be utilized as a cost-effective way that the federal government could come in and support this particular area of the municipal market that is in dire need of actually some infrastructure improvements.
Bob Smith: Well, what I'd like to do now is turn to the other side of what it is that we do at Sage and have done for a very long time, since actually 1998. And that is our tactical ETF strategies, and at Sage people know us as being a fixed income manager, but we also look at the equity world and various other parts of the asset allocation spectrum and we capture that in our tactical ETF strategies. And we're very happy to have Komson Silapachai, a member of our investment committee, to come and kind of bring you up to date on where are we on not only all things fixed income, as expressed in ETFs, but also on the equity side, and to take perhaps a little bit more of a global perspective, and talk about some of the things that occurred in 2020, that may not likely reappear in 2021. And perhaps some of the things that we haven't seen for a very long time, that are actually going to start to show up in 2021, perhaps with some force. So Komson, what do you have to say?
Komson Silapachai: Thank you, Bob. Well, 2020 as my esteemed colleagues mentioned earlier in this podcast, has been a historic year. If you would have told me at the start the year that we would be seeing stellar returns across the board, not only in equities, but fixed income, credit, rates, I would have told you you were crazy, because the year really started off in one of the worst kind of crises, not only just for the markets, for risk markets, but for ETFs. We saw a lot of fixed income ETFs really get put to the test. And so, let me kind of recap the year across asset classes here. I think, within equities there's really three stages about the year here. The first was a COVID shock. It was A Tale of Two Worlds, you know, it was the stay at home stocks, versus everything else. And so during the COVID meltdown initially, there was a massive sale of risk assets, of equities across sectors. You saw technology companies like Zoom, cloud companies really come to the fore, aggressive growth companies really come to the fore, and that really persisted for the first I would say half of the year. And then the second stage of this equity journey this year, has been kind of this mega cap led rally. Off the lows in March there was a massive rally, but it was really only led by about, you know, five stocks, especially in the S&P 500. And just a crazy stat from the lows to the high of the year, Apple added $1 trillion in market cap. So that's about one unit of Google, which is the fourth largest company in the world. And that was just to tell you how much these mega cap stocks gained, versus the rest of the market this year. And so throughout the summer, it was really a story of mega cap tech, really leading the way. The top five names in the S&P 500 were up over 60% on average, while the rest of the index was negative. And so that's not the case today, but you know, at some point during the summer, that was really the case, and it was just, I would say this policy induced rally on the market was discounting these companies continuing to gain market share, continuing to kind of exist, and have advantages in this, kind of COVID dominated environment. And then the third stage is, and this is where we are today in equities, is your kind of classic, cyclical rally. And that really started, I would say, in November, I would say late October, going into the election when we were expecting a little bit more of a stimulus, but it really started in earnest on November 9, when Pfizer announced encouraging data on the vaccine that really kind of, I would say, solidified the light at the end of the tunnel, so to speak for markets. And on that day was a, I would say a several standard deviations move in terms of value rally, a lot of stay at home stock that been floundering all year, rally super hard, energy, stocks, resource names, really rallied. And I think that's the recovery that I think we've seen in the past off of recession lows, that's the recovery that we saw off the financial crisis lows. And so that's the stage that, I think that we're in right now, and how we're positioned in our equity allocations are for a further cyclical rotation. And so our recovery really underpins kind of two pillars. The first is consumer strength. So, consumers came into the crisis on very strong footing, there wasn't a big debt bubble or anything, you know, in terms of financial crisis during the COVID shutdowns, it was just incomes being taken away. And so what the Fed and the administration and Congress did with the Cares Act was to replace that income and savings rate at one point was up at 33%, it's fallen all the way down to about 13% on a personal savings rate, you know, a normal rate for that is about 4%. So, the private sector households still have savings to spend. And so we think that consumers, as a whole, there's definitely pockets that are hurting things like restaurants, retail, certain retail sectors, but as a whole, we still think that there's still some runway for folks to spend, and especially with the vaccine coming down now at the end of the year, you know, potentially approved here in December, we think that consumers will remain strong and come out of this relatively in a position of strength.
Komson Silapachai: The second kind of pillar of our recovery, and where we're focused on with our equity allocations is this industrial recovery. So, we're seeing a massive amount of encouraging data come out of the Asian region exports. Also, input prices are rising significantly, and what I mean by that are just commodity prices. That just kind of points to the fact that there's a ton of construction demand a ton of demand in order to restock global supply chains. And then coupled with what I mentioned before, about, consumption remaining resilient, we think that coming out of this recovery, you could see kind of a double whammy, where you have a restocking pent up demand and an increase final demand. And so just kind of a big upward thrust in terms of consumption. And so we're focused on those sectors, really on a global basis. What does that look like? That looks like value both in U.S. and international. That looks like being long emerging market Asia, a region that is tied to global growth. Within the U.S., we like small cap, we like value. We also are long transports, we think that is an area that will benefit with the upcoming environment in the next three to six months. We also like consumer names, as well as the metals and mining sector to kind of benefit from this industrial recovery. And so within the equities model, we continue to position for cyclical recovery. Another big theme in equities this year, and this is really persistent throughout the year from start to finish, was the rise of ESG. ESG has seen a tipping point, we think, and flows this year, over 25 billion in flows in the ETF space alone. That is, I would say more than all the prior years combined since the release of ESG oriented ETFs. And so that's something we're encouraged by because we launched some ETF strategies about four years ago, and to see the market follow suit is really encouraging to us. And within our ESG equity strategy, we're positioned the same way with small cap bias with the value bias, except, you know, we're expressing those through ETFs that have an ESG orientation. And so that's in equities. Within our multi asset class models, we're overweight equities. Within our multi asset income model, we're also overweight equities. And we continue to maintain allocations in spreads sectors and non-core spread sectors such as high yield emerging market debt. We continue to think that the Fed, central banks will continue to support credit markets. You know, valuations are definitely very full, and so we will be cautious in terms of the size of those positions. And I think that there'll be opportunities to play the reins, so to speak, you know, trim some when positions get overvalued, but also we think if there is volatility, it's a buy the dip type environment next year, just given policy support. Within our fixed income strategies, again, similar to our multi asset income, a mindful evaluation, but continuing to maintain a posture of out yield in the benchmark through spreads sectors, such as high yield corporates, mortgages, and then even within our ESG strategies, in fixed income, we are overweight, high yield in an ETF that has a superior ESG profile, we’re overweight spread sectors. In terms of our duration posture, we're slightly underweight duration. So we think that we will see potentially higher yields, but not too much, because I think the Fed, their best interest is not to have kind of higher mortgage rates and affect the U.S. consumer, given all the work that they've done this year to ease financial conditions. We were short, for much of the year, with a recent sell off during November, we started to pare that down, and we maintain a slightly short posture. But we think that our conviction in higher yields at this point is lower, and you'd have to see a different inflation regime, you'd have to see a pretty high realized inflation regime where we'd see a sustained level of inflation above 2%, for quite a while to see higher rates. And that's really all I have. I'll pass it back to Bob, thank you very much.
Bob Smith: Generally, in our investment committee meeting, one of the things that we like to do is very quickly review what might be a curveball – things that are perhaps the unknown unknowns or even a known unknown. And I'll just go around the horn here and ask each one of our participants today to give us their worst nightmare in terms of something that didn't quite work out, that has a reasonable possibility and could impact the market? Rob?
Rob Williams: Yeah, I mean, look, there's a lot of things to worry about, we're hanging our hat on a recovery that is based on success of the vaccine and the consumer continue to spend so something, some event that derails that earlier in the year would be catastrophic, right? If vaccines don't take hold, they're not distributed, they dropped the ball in some way, and we don't get off to a good start. Because a lot of positivity is baked into the cake here. We've been talking a lot about reflation and things like that and it’s based on activity coming back online, quickly and smoothly. And so, I don't know what would derail that. It looks good, but when things look good, often there's more under the surface that could derail that. So that would be something out of the gate and then many things later on in the year.
Bob Smith: Sure. So, I tend to agree with you, you know, science is science. And you know, that's why they have things called laboratories and if things don't work out, they kind of go back and have to figure it out again, going back to the drawing board. So, who knows? Maybe these vaccines aren't the wonder drugs that they are portrayed to be. And certainly, that has been featured in the valuations of securities around the world in the sense that there's great hope that's already priced into the market. So Thomas, what do you think is the worst curveball that you might have to deal with?
Thomas Urano: We had a conversation with the portfolio team this morning specifically about this. And I asked the same question – what is it that we think could cause some unforeseen turbulence or volatility in the market? And I think the answer was what I had mentioned earlier, which is success in terms of recovery and policy leads to a withdrawal of said policy. And that I think might be an issue for the market in totality, like the successful implementation of monetary policy means that we need to withdraw that monetary policy, and we're running at a pace of 120 billion a month of QE purchases just by the Fed. That's an astronomical amount of money that has to get placed every month. And when the flow of that QE stops, there's a question mark on valuations. And I think that's a concern. Right now, in the here and now, in the forward looking six months, nobody's talking about when the Fed is going to pull the punchbowl away, so to speak. And I think, in terms of valuation impacts, that probably would be one of the things that I think can cause turbulence in the second half of the year. It's certainly not a known. Nobody knows when or how or in what fashion or what magnitude the Fed will taper purchases whether the ECB will taper purchases, whether the Bank of Japan will taper purchases, but at some point, if policy is successful, the natural consequence of that success is you withdraw the stimulus.
Bob Smith: Well, I hope that we don't have taper tantrum number two, like we saw back in the middle of 2013. That was quite an event for the bond market to deal with. And going back to those kinds of times wouldn't be a welcome site for sure. What do you think, Jeff? What's the worst thing that would keep you awake at night, that didn't go right?
Jeff Timlin: Yeah, I mean, in addition to what both Rob and Thomas said, you know, it's interesting on the municipal side of it, it's a quirky asset class and the way that investors react to certain information is quirky as well. So where the taxable and the equity markets react to tangible information, or tangible projections, on the municipal side, it's a lot of hearsay, conjecture, and news articles, or what I would classify as headline risk. And if you really look back historically on munis, from a credit perspective, they've maintained a very solid and stable credit profile, you look at default characteristics and municipals, both from Moody's and S&P, and they're a fraction of what they are on the corporate side. However, when you have these little hiccups in the market, whether that be – and I shouldn't really say COVID is a hiccup – but when you have these events in the market, that where people should be flocking to munis, like they do to into Treasuries, they flee, like all other risk asset classes. And that's kind of where I'm going, is the major risk to munis is some type of headline risks that captures the municipal market, at least some segment of it and causes outflows in the market. What's been a major, I talked about this previously, a major driver of spread compression and lower yields is the amount of demand in municipal land. And if you look back historically, at inflow and outflow charts, outflows coincide directly with negative returns. Every other event, aside from say, 2008, which again, was a little bit more of a credit event, again, and the reason for that was the elimination of the insurers, the monoline insurers in muni land, so they had to reassess risk. But aside from that, munis are a stable credit, and really are just affected by flows in the market, and in particular, the outflows drive negative returns. So that would be my major concern. And again, but the nice thing about that is, even though it's a major concern, it's temporary. And those are usually areas of buying opportunities, or to deploy money at more advantageous levels relative to the credit risk you're taking. So, that's where I would say is the major risk for munis.
Bob Smith: Great, thank you for that insight. And Komson, let's finish it off in terms of what would be a real disappointment for you in terms of all the things that we think are going to occur?
Komson Silapachai: You know, I think the big disappointment for me would definitely be the recovery post vaccine. I think that market participants, I think everybody is expecting that. Let's say we have a rollout of the vaccine, you're going to see kind of economic growth snap back. And so, is there some friction, is there some event that causes us not to recover as fast? One thing that really keeps me up at night, even more than that is not really any one event, it's just the fact that the markets are more fragile today than they've ever been. Valuations, you don't have the valuation cushion at this point. And so, you know, whether it's a taper tantrum due to a tier two Fed speech or something that we would seemingly think is not a huge event and not a massive market movement event, at these valuations, anything can really tip the market and generate some volatility. Now, we think that stimulus will continue and will continue to kind of be around, especially during times of volatility. But that doesn't mean that, at these levels, you're not going to see wobbles in the market. We're looking at that environment as areas of opportunity for next year. And so, I think that the fragility of the market ultimately is something that I think I worry about more than anything.
Bob Smith: Okay. So, it sounds to me like we're going into 2021 with our eyes wide open and on the balls of our feet because anything can happen. But we are definitely pulling for a very constructive year. Let me just go real quick over our key positioning themes that we're looking for in the first half. So, what we're telling everyone is kind of stay positioned for the upside in terms of risk assets. We're overweight in equity. We're also overweight in terms of the spread sectors of the fixed income market, but very selective. We definitely have a tilt towards reflation assets, you know, the cyclical consumer led kind of sectors of the economy. We definitely think value will finally come back into the light, and there'll be a lot more attractiveness, a lot more flows in that direction. Right behind it, small caps, which have been dormant for quite some time, we're likely to catch some positive flow action. And then, of course, you know, the reflation trade. And everybody's talking about inflation and driving inflation higher, even from a Fed policy perspective. Two percent is looking mighty good and for a long period of time before they do anything to kind of curtail it. So TIPS, obviously, maybe a very interesting consideration in your asset mix. As far as you know, the yield curve is concerned, we want to be active, we're not looking for any kind of outsize kind of rate moves around the curve. But we are definitely biased for longer rates, or rates in the long end, to move a bit higher. So a little bit more steepening in the curve, but nothing disastrous, and certainly off the back of that, we think that yield spreads, as Thomas spoke about, and Rob spoke about and even Jeff, are very much supported by policy as we know it today. And hopefully, it kind of stays that way. But the valuations are starting to get, you know, rich in certain places. So you really have to be careful about the sector, the industry, and the individual names that you place in the portfolio. And we are doing a very active review, and we are pruning, and we are recultivating our portfolio to kind of reflect some of these concerns. I hope that this has been helpful to all of our listeners. I want to thank all the members of our team for sharing their thoughts and giving us their best ideas in terms of 2021. I would like to close by saying that our best wishes go out to all of you for a peaceful, a well-deserved, peaceful close to the year and we hope that you enjoy a much happier and indeed a very prosperous 2021. Thank you for listening.
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