Markets & Economy

The first half of 2020 has been a dizzying ride. Investors were faced with both a massive market selloff and an unrelenting market rally in the same six months, all against the most uncertain market backdrop in a century.

During last week’s outlook webinar, we attempted to make sense of all the volatility. We discussed what happened and why, provided our updated outlook for the rest of year, and answered questions from listeners. Below, we selected and answered several of these key questions.

1. How do you identify trending sectors before they trend upward?

   It is hard to identify trends before they happen. If you are first seeing it on the news, you are likely too late.

   We are successful at finding opportunities before the market, we believe it is because of our energy, expertise, and discipline. We encourage our sector analysts to focus on the long-term, and we provide them with space to explore for the next area of growth.

   In addition to the flexibility to focus on the long-term, we provide a structured investment framework to help put those ideas into perspective. Not every growth area is here to stay, and many fade away. This process is all about discipline, because even if an area is high growth, the underlying investment opportunity may not always be a good one in the end.

2. Can you talk about tail risk and protecting investor money in a bear market?

   In our view, the best time to protect wealth is before a bear market. If you wait for the spark that ignites the selloff, you’ll be too late.

   That is why we try to avoid guessing at what specific event will trigger the next drawdown. Tail risks, rare, unpredictable events with severe consequences (e.g., a global pandemic), fit closely into this idea as well.

   We’ve discussed the analogy before, but it is akin to worrying about what will start the forest fire, rather than paying attention to the conditions that enable the fire. It could be a cigarette butt or a lightning strike that sparks it, but either way, your odds of a forest fire are much higher after months without rain.

   Heading into 2020, for example, financial market conditions were worrisome. The US economy was on the tail end of its longest economic expansion ever, and the market appeared due for a pullback. We did not anticipate that a global coronavirus breakout would cause the next selloff, but we did know that frothy conditions were setting investors up for disappointment.

3. How will extended low interest rates affect the ability to generate income?

   In short, interest rates have fallen for nearly four decades straight, boosting bond market performance, and we believe this run of lower rates is likely coming to an end.

   Bond prices and interest rates move inversely. As rates fall, existing bonds became more attractive, generating capital gains for existing bondholders. For example, a Treasury bond issued in 1995 at a 7% coupon is much more attractive than a Treasury bond issued in 2020 at 2%, so its price will rise, creating a gain 1995 Treasury bondholder.

   This steady drumbeat of ever lower interest rates enabled fixed income investors to generate strong performance with relatively basic bond portfolios. With rates now at all-time lows, and nearing zero across all but the longest maturities, we believe they are unlikely to fall much further.

   In response, investors should look to active managers who have other tools at their disposal beyond passive bond portfolios. Strategies that actively manage duration, can invest in other areas of the market (e.g., high yield), or target other asset classes entirely (e.g., securitized credits), can help investors generate the yield they need to meet long-term goals and objectives.

4. Will our investments change if the administration changes this Fall?

   We look at political uncertainty through several lenses. First, we analyze the range of possible outcomes to identify areas of opportunity and risk, keying in on areas that stand to be similarly impacted regardless of result. For example, US-China trade relations are likely to continue to get worse before they get better, no matter who wins the White House this year.

   Second, we take our top-down perspectives, and meld them with bottom-up analysis to identify the sectors, themes, or individual companies that are most likely to be impacted. Continuing with the prior example, companies that are heavily dependent on the US-China trade may be at greater risk going forward. Therefore, we would consider these elevated risks before making a potential investment.

   As an investment manager, we believe separating emotion from the investing process clarifies decision making and helps avoid unnecessary mistakes. This discipline is particularly valuable during election season, a time when emotions run especially high. Our years of experience have shown that a levelheaded analysis of all possible outcomes for potential areas of risk and opportunity is the best way to help clients stay on track amid political changes.