The 2020 pandemic brought the longest U.S. economic cycle on record to an end. Last year also brought the quickest recovery on record, fueled by unprecedented monetary and fiscal policy stimulus across the globe. For markets, despite the volatility, 2020 saw broad-based gains in risk assets, turning out to be the best year for the Nasdaq 100 Index since 2009 and the best year for U.S. Treasuries since 2011. Saying 2020 was an extraordinary year may be the understatement of the decade.
Despite sharply worsening COVID-19 outbreaks in the U.S. and abroad, the discovery of more infectious virus mutations, weakening economic data, a potentially contested election, Brexit and a delayed second stimulus, the rally in risk assets and rotation out of Treasuries and the dollar continued in the fourth quarter.
By any metric, 2020 proved to be the year that would test many aspects of the economy, governments, financial markets, health care systems and civil society. The year brought about many brave and aggressive actions by policymakers, the entire front line of the health care industry and the scientists developing vaccines and therapeutics.
Fourth-Quarter 2020 Performance Highlights
- During the fourth quarter, the Thornburg Limited Term Income Fund (I shares) returned 0.93%, outperforming the Bloomberg Barclays Intermediate Government/Credit Index, which returned 0.48%. The fund remains in the top 10% of all funds in Morningstar’s Short-Term Bond category on a one-year, three-year, five-year and 10-year basis versus 574, 514, 458, and 300 category funds, respectively, for the period ended December 31, 2020, based on total returns net of sales charge.
- We continued the work that began over the summer and fine-tuned the risk exposures in the portfolio. We reduced credit risk and shifted allocations to risk assets as COVID-19 cases rose, election-related volatility increased and leverage across corporations and governments continued to rise.
- Exposure to investment-grade corporate bonds was reduced as corporate spreads tightened from 135 basis points (bps) to the pre-crisis level of 96 bps. Positions in mortgage pass-through securities increased as we continued to find value in the sector while exposure in collateralized mortgage obligations fell as we sold into the rally and booked profits. Lastly, U.S. consumer-related asset-backed securities (ABS) helped boost quarterly results despite the concerns over government stimulus and unemployment.
Current Positioning and Outlook
Year-ahead outlooks are a required offering of the professional investing community. However, in our eyes, the key lesson of 2020 is the potential futility of predictions. That said, looking ahead into 2021, it’s highly likely that volatility across many asset classes will not be as extreme as 2020.
The central bank liquidity tsunami has had a powerful and long-lasting effect on markets. The aggregated purchases of securities by global central banks remain much higher in absolute terms, as well as relative to global GDP, than directly after the 2008 Great Financial Crisis. Moreover, most central banks have demonstrated the willingness to adjust this trajectory as conditions change.
Pundits have often joked about a Greenspan/Bernanke/Yellen “put” on the S&P 500 but it now appears the Federal Reserve put includes the credit markets too. Indeed, the Fed’s buying program ended with the turning of the calendar year, but we must not forget that Janet Yellen, whom President-elect Joe Biden has tapped to be the next Treasury Secretary, was quite the dove as Fed chair. Should current Fed Chair Powell ask for funding to reinstate the programs, odds are with him for a receptive audience.
No one knows exactly when the Fed will step in to bolster credit markets, but it’s difficult to imagine it wouldn’t be preceded by significant volatility in credit spreads. Such volatility could manifest itself if the new stimulus package fails to carry the economy through potential economic bumps and vaccine dissemination on the way to herd immunity. Even more disconcerting is the distribution plan is already behind schedule and the massive undertaking is fraught with pitfalls. While we hope for the best, we also prepare for the worst by positioning portfolios to be robust across many potential outcomes.
Global monetary policy has reduced nominal risk-free rates to zero or less across much of the developed world, with expectations of that broadly remaining the case for the years to come. As a result, investors in search of yield have been forced out the risk spectrum both in terms of duration and credit, which was problematic during the quarter as the waning effects of the first round of fiscal stimulus resulted in weaker economic data, or slowing improvement, causing risk assets to periodically stumble.
Governments, corporations and consumers are responsible for the significant rise in debt throughout the U.S. and global economic system. Significant liquidity and bond-buying programs have made money cheap once again, which has fueled a borrowing spree while Fed support has reduced risk in the mind of investors. While it may seem as if risk is absent from the current market, it seems instead that it has fallen dormant and is simply hiding, and as we’ve seen in the past, risk often hides in plain sight or just beyond our view.
Our job is not to shun risk in such an environment but rather remain vigilant and humble. Throughout our portfolios we have sought to reduce risk given current compensation and continue to adjust portfolios from corporates toward consumer ABS and mortgage-backed securities. We believe the structure and convexity profiles of our current allocation tilt will ultimately place our portfolios in a great position to tackle a dicey environment while balancing both upside potential and downside protection.
Consumers have continued to borrow, yet their collective financial position remains healthy. Monthly surveillance of payment activity has shown consumers to be performing well even as fiscal stimulus waned. With the new stimulus bill in place, consumers should remain in a solid position to continue making payments as the economy traverses the COVID-19 Gap.
As we march forward into 2021, inflation will remain the bond market’s bogeyman, particularly given the massive amount of monetary and fiscal stimulus. As the economy reopens with distribution of the vaccine, inflation certainly remains a risk. Within our portfolios we maintain an allocation to treasury inflation-protected securities, or TIPS, and floating-rate securities as a direct hedge. If inflation arrives due to a strengthening economy, credit spreads should continue to tighten, offsetting some of the rate move. That said, it seems unlikely inflation moves notably higher on a sustained basis.
We remind investors that the Fed kept rates quite low or accommodative over the past five-plus years, even in the face of historically low unemployment. But it still could not achieve its goal of 2% inflation consistently. This suggests ongoing structural (technological, demographic) changes in the U.S. economy that may be keeping inflation in check.
Perhaps COVID-19 will result in behavioral changes such that inflation can rise to the Fed’s 2% target. The new fiscal stimulus and ongoing monetary accommodation will create a market susceptible to inflationary scares, resulting in higher interest rate volatility. However, we believe we are appropriately positioned to take advantage of those opportunities, acquiring both risk-free and credit assets at more attractive levels going-forward.
Thank you for investing alongside us in Thornburg’s fixed income funds.
Performance data shown represents past performance and is no guarantee of future results. Investment return and principal value will fluctuate so shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than quoted. For performance current to the most recent month end, see the mutual funds performance page or call 877-215-1330. The maximum sales charge for the Fund’s A shares is 1.50%.