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13 December 2021

Don’t Stop Believin’

By Robert O. Abad

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Another Covid variant, China property market woes and inflation fears. Markets have been unsettled over the past few weeks by these asteroid warnings, and rightly so, as they all have the potential to deeply impact people and portfolios—as was the case when the first COVID-19 wave rained down in March 2020. But we believe these threats too shall pass, as have the majority of others that have come before.

Lost in the din of sensationalist headlines and Twitter tantrums are several key facts that bear reminding:

1) We’re not stuck in January 2020. Today, people are much more aware about Covid risks and taking the necessary precautions to protect themselves and their loved ones. And thanks to the unsung heroes who have worked behind the scene creating the vaccines, we now have the key to reach the other side of the pandemic.

2) We’re not crashing into a recession. Despite all of the data cherry-picking on both sides of the global growth debate, the net result is that economies in Europe and Asia are cooling off after a strong, year-long bounce-back and are now looking to find their footing. In the US, where investor attention is highly attuned to ongoing suspense over the Fed’s next policy moves, we’re happy to report that consumer and corporate fundamentals are still sound and there’s a clear economic pulse.

3) Supply chain pressures are abating. Yes, governments and businesses were blindsided in the early stage of the pandemic, but since then have been making tangible progress in recalibrating raw materials’ sourcing and inventory, and moving goods to their final destinations. This bodes well for the recovery story and should steadily pour cold water on the burning inflation pyre over the coming quarters.

All that stated, the tug-of-war over each of these views will rage on, as they always do. But we continue to stand by our long-term, fundamentals-based investing approach and our steadfast view that markets will look to where the proverbial hockey puck is headed, not to where it is right now.

This is why we view any spike in rates over the near term, induced by inflation fears or Fed misspeak, as an opportunity to tactically add duration where we see fit across our portfolios—not because government bonds such as US Treasuries represent a deep value investment, but rather because they continue to offer solid hedging and diversification benefits against portfolio-level spread risk. Case in point, look at how global government bonds reacted when the first news of the omicron variant hit the tape and how those bonds have performed since then.

We also stand by our view that credit markets, while shaken by the recent turmoil in rates, have hardly been stirred into panic mode. Improving broad market metrics such as leverage, cash flow coverage and default rates, combined with strong corporate earnings, give us comfort that there are still compelling income-generating opportunities in sectors such as bank loans and high-yield despite the aggressive spread tightening we’ve witnessed in the last year and half. Should pandemic fears further abate, which is our expectation as we move past 2021 and deeper into the new year, this should reinvigorate and boost other spread sectors such as emerging markets, where idiosyncratic risks still linger, and various pockets of structured credit, such as commercial mortgage backed securities, which have lagged the overall rally.

Market volatility, while uncomfortable, comes with the territory. But in times like this, when valuations across risk assets could use a reprieve, volatility is a welcome guest for the active manager looking to exploit price anomalies and identify relative value gems that appear in moments of uncertainty and fear.

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