Looking back on 2020 is a great reminder that no matter how long you analyze the data, crunch the numbers or survey market participants, it’s really difficult to predict the future. The fallout from the global COVID-19 pandemic, both in terms of lives impacted and implications for markets and the economy, will stick with us for many years to come. While our return expectations for 2020, as laid out one year ago, were largely in line with actual returns, we never anticipated the magnitude of the volatility it took to get there. With this humble reminder, we now must turn our attention to what’s in store for the first quarter and full-year 2021.
- Credit markets proved their resiliency throughout 2020, posting strong returns following Q1’s rout. Market conditions today generally look similar to those of a year ago, but we view an eventual emergence from the pandemic and policy support as market tailwinds that were not present entering 2020.
- We maintain a favorable outlook, but baseline returns will be primarily carry-driven. So while the broad beta rally is unlikely to repeat, we believe excess return can be generated by active managers who can find opportunity in the dispersion that remains across asset classes, industries and ratings categories.
- Uncertainties do remain. COVID-19 case counts are still rising, prompting additional restrictions, and mass immunization is still months away, which could cause near-term volatility. Managers with the ability to act quickly and remain flexible should be best positioned to take advantage of these potential opportunities.
For all that happened in 2020, one could argue that seemingly not much has changed from one year ago to today. Spreads are generally tight, equity valuations are high, there are trillions of dollars in global negative-yielding debt, and the economic outlook is generally positive. However, there are some important, subtle differences that cause us to take a slightly different view for this year. In short, the tailwinds caused by an eventual emergence from the pandemic combined with both fiscal and monetary stimulus could contribute to positive momentum that was not in place one year ago.
The economic expansion preceding the pandemic was most recently characterized by its slow but stable growth. Perhaps for this reason, it was difficult to forecast that it was going to end in 2020, but few people felt particularly energized about its ability to persist. In our view, market participants felt we were in a late-cycle environment, but it was difficult to pinpoint exactly why that was the case or what would cause it to end. The pandemic, unfortunately, became that catalyst.
As swift and severe as the recession began, its end was equally as dramatic. A function of both the unprecedented level of fiscal and monetary stimulus and the perceived transitory nature of the pandemic, markets recovered in spectacular fashion. In our view, this “reset” of economic conditions is what makes markets today different than they were a year ago. While lingering questions about vaccines and reopening do persist, the market got the recession it had feared. Now, on the other side, interest rates are even lower than they were a year ago, and fiscal and monetary stimulus continues to flow. For these reasons, we think credit markets today have the potential for further upside and spread tightening than they had at the end of 2019.