As we enter 2021, Thornburg Investment Management’s Jeff Klingelhofer and Ben Kirby, portfolio managers and co-heads of investments, review the current state of the market, offer an outlook for the next twelve months, and discuss investment ideas to prepare for a year which poses many uncertainties, especially regarding inflation.
What should we expect from emerging markets in 2021?
Klingelhofer and Kirby, who both see emerging markets as an allocation that “can help reduce portfolio volatility, while generating potential upside performance,” say they are bullish on emerging markets for the year ahead. According to the Thornburg co-heads of investments, these markets are undergoing a process of profound transformation, marked by “a structural transition towards a model based on increasing disposable income in emerging markets and guided by domestic consumption,” in which other cyclical factors such as “the global fall in interest rates or the acceleration of GDP growth, particularly in relation to developed markets, are also involved.”
We must add to this the positive impact on global sentiment that both Biden’s victory in the U.S. and the first vaccination campaigns against Covid-19 are having. “In our opinion financial markets have underestimated the degree to which emerging countries have implemented thoughtful policies to stimulate their economies in the face of Covid, as well as the scale on which they are already returning to normality,” Kirby said. He noted that the combination of these elements makes many emerging markets very attractive.
However, Kirby observed that the pandemic is perpetuating a market environment of individual winners and losers. This dynamic requires careful stock picking to separate those businesses that have started 2021 heavily indebted, or whose operational quality has fallen, from companies with durable business models that are well positioned to weather different environments.
Will we witness inflationary pressure in 2021?
Thornburg’s Klingelhofer doesn´t believe so. He sees a lot of slack in the economy and notes that structurally there haven´t been any sustainable improvements. Therefore, while he expects that the return to normality from widescale deployment of the vaccine should boost consumption, driving the CPE up, he does not believe it will translate into a sustained rebound in inflation for some time yet. He cites the U.S. housing market as an example: “We have some asset price inflation, but labor and commodity price inflation do not seem to pose a threat in the short term.” Therefore, he recommends that investors watch consumer spending and inflation as the key leading metrics this year.
Klingelhofer notes that the Fed’s new inflation framework and the concept of average inflation targeting may be difficult to manage. The question is whether the Fed will be able to comply with this new framework and what will happen if inflation does indeed return, as the new target “suggests that there could be more volatility in rates and inflation going forward.” In conclusion, Klingelhofer doubts that the Fed will be able to meet an average inflation rate above 2% in the short term.
The portfolio managers propose investors should address the eventual inflationary environment through investment in TIPS (U.S. Treasury Inflation-Protected Securities). Alternatively, they recommend short duration equities that pay dividends or investing in equities with pricing power, gold, bitcoin and hard assets.
In order to provide further useful information for investors, Thornburg presents the following table with all its macro forecasts, focusing on the development of the U.S. economy in 2021.
Which is the biggest macro risk over the next twelve months?
Now that Brexit is behind us, there are still several concerns on Klingelhofer and Kirby’s list: the Covid-19 hangover and ongoing challenges from China, but also whether Biden’s agenda will be negative for long-term growth.
Added to this is the situation of a global savings glut, accrued during the months of confinement, because it could trigger a stock market bubble. “When it bursts, we could have collateral damage,” Kirby warns.
What role does fixed income play in the context of a diversified portfolio? Can fixed income continue to generate returns above inflation?
Both managers are very clear about this asset class: “Investment teams need to provide protection, not chase yields.” They refer to the fact that, with their investments, they can generate returns, but the fundamental mandate is not to lose money. “Fixed income has not been a great source of return for a long time. You have to think of it in a portfolio context first as protection and secondly as a source of income,” they conclude.
Therefore, the view of the experts is that, as with equities, we could be moving towards a more favorable market environment for bond selection, with tactical allocations that could add value to the asset allocation.
