Linda Duessel: Hello, and welcome again to the Hear & Now podcast from Federated Hermes. I'm Linda Duessel, Senior Equity Strategist. And today I'm joined via phone by Phil Orlando, Chief Equity Market Strategist, and RJ Gallo, Senior Fixed-Income Portfolio Manager. First let's spend a few minutes on 2020. I know everyone wants to get through it and forget about it, but there were some great moments this year, too. So I want each of you to share what was the best thing and the worst thing to happen in the market this year. Phil, should we start with you?
Phil Orlando: Delighted. Thank you, Linda. I actually have two best things. The first is the pace, the speed of vaccine development. Ordinarily it might take four or five years from start to finish to get a vaccine approved by the FDA. In this case, it's happened in nine months. This has been unprecedented in terms of speed. So you've got Pfizer. BioNTech's drug has been approved by the FDA. Moderna's drug has been approved by the FDA. AstraZeneca and Oxford University's drug is probably next. And we're already starting to distribute them, both here and abroad. So that's phenomenal.
Phil: But the second best thing was the speed of improvement in the labor market, coming out of the deepest recession in history. The rate of unemployment, I guess, topped out at about 14.5%, 15%. The Federal Reserve thought that if everything broke right, maybe you get to 9% or 10%, by the end of the year. Our forecast at Federated was a little more optimistic. We thought maybe we could get to 7% or 8% by the end of the year. And as of November, we're already at 6.7%. So the labor market has come back much more quickly than expected.
Phil: The worst thing that happened this year, in my opinion, was the complete lack of cooperation in Congress from May through, I guess, yesterday, in terms of getting this phase four fiscal stimulus bill passed. We got the ball rolling back in May. The Congress had proposed a three and a half trillion dollar package and it went nowhere, back and forth through the election. Now we finally got a 900 billion dollar deal passed, but the fact that we had this congressional intransigence over that entire period of time. Over the last couple of months, the claims data has backed up retail sales. The last two months, sequentially hasn't been that great. Regional fed indices have gone the other way, confidence has eased. I think the lack of cooperation in Congress, hurt the economy here, the last couple of months.
Linda: Yeah, that's interesting Phil, because, unfortunately, of course, it happened during an election year and we all know they don't get along so well anyway. I'm intrigued by your positive. Your two of them. I think it's so ... all things tech are so great. Both the biotech that you referred to, and of course the technology that has allowed us to work from home, so many of us. And to even be allowing us to do this, now.
Linda: I was curious about your comments with regard to the labor market, because as fast as it's come back, don't you think perhaps Phil, though, that it's coming back with less participation and maybe that second round of people to come back, may have a tougher time in terms of getting a job. Permanent losses.
Phil: Well, it's that so-called K-shaped recovery. That we're able to do this call today because of technology. Our laptops, our iPhones, whatever. So folks that have experience, education, skills, we've thankfully been managing fine through this pandemic, but individuals on the other side of the boat didn't have education or as much education, lacking in skills, didn't have the experience. Restaurants, retail stores, those things were shut down by order of, of state governors. They've been struggling.
Phil: So in a lot of ways, technology was a benefit to those of us that could avail ourselves to the technology. But there are other parts of the economy that really needed that congressional help, because the laptops and the iPhones, weren't going to be able to get them through this.
Linda: Mm-hmm (affirmative). Yeah. Yes. And thankfully, we got that. How about we'll turn to you now, RJ. What do you think were the best and worst things to happen in your markets this year?
RJ Gallo: Well, one of the best things is probably very much in contrast to what Phil was discussing, it may have taken too darn long for the United States Congress and president to strike a deal for what they signed yesterday. The little over 900 billion dollar phase four phase five of COVID relief. That was disappointing. It just took too darn long, but it's contrast with what happened in the spring is very stark.
RJ: One of the best things that happened was the bipartisanship and the rapid action that we saw to pass the CARES Act in late March 2020 as the COVID-19 crisis was fully emerging. A bipartisan effort within a couple of weeks unleashed over 2 trillion dollars, the largest single fiscal relief or aid package from the US federal government in history. It was inspiring, actually, that bipartisanship could even happen.
RJ: Again, the second act was disappointing, as Phil described. The CARES Act was huge. It allowed The Fed to set up programs that supported deeply stressed and dysfunctional financial markets, including both corporate and muni bonds for the very first time. It also was a wide ranging fiscal measure, including money for small businesses, for individuals, for suddenly dormant airports and airlines, for state and local governments. It really spanned over many facets of the economy that had been profoundly and negatively effected by the pandemic. So the CARES Act was a real highlight. Again, the second act, which just got signed yesterday, took too darn long, probably was too small and left out some key components that maybe they'll be picked up in 2021.
RJ: In terms of the worst thing. The malfunctioning of markets. The fixed income markets in particular, were extraordinarily stressed in March. There was a massive and record size flight to quality and flight to cash. On certain days in March, long-term treasury yields were going up, which is not normal. The reason was, people wanted cash, they wanted money in the bank. They wanted money in bills. They didn't want 30 years treasury bonds. The markets themselves were gapping in huge increments. With treasuries, largely posting positive returns, with some strange days along the way, but everything else posting deeply negative returns and gapping higher yields, lower in price, very rapidly in disorderly markets. The securities dealers were overwhelmed and it showed the stresses and the strains of our financial marketplace, where in many cases, the scale of the investors, whether they be mutual funds, hedge funds, endowments, whatever, can actually dwarf the scale of the market making in between, and necessitated bold action from the Federal Reserve, which was supported by the CARES Act and ultimately did in fact emerge. But that was a very difficult and eye-opening time.
Linda: Gotcha. Yeah, yeah. RJ, it just kind of reminds us that we went up against the abyss probably a few times in 2020, and good riddance.
Linda: Let's now look ahead to 2021. And start again with you, RJ. Now, we've got a few major market movers to look forward to in the upcoming year. Widespread vaccinations as Phil has outlined, and a new president here in the US, among them. What, RJ, is your overall outlook for 2021?
RJ: In terms of economic growth, we think that the recovery which got underway with a very large albeit still partial bounce from the economic of the second quarter, we think Q4 an economic expansion is already underway. Q3, it was a massive bounce, albeit partial. We think in 2021, it will persist. Phil and I participate on the Federated Macro Committee. Phil's, the chair. We're relatively optimistic with growth expected to be north of consensus. I'll probably let Phil fill in those numbers since he chairs that committee.
RJ: In a world like that, focusing on fixed income, we feel that prospective returns for high quality sovereign bonds, treasuries or bunds, it's relatively poor. Yields are not far from record lows in the US and much of the developed world. In the case of German bunds, they're negative. So for treasuries and bunds, you just can't expect to make much money. So within a fixed income portfolio, our base case is expecting yields to edge higher, and the way to make money, the way to outperform the otherwise poor returns of high quality fixed income, is to take credit risk. We think credit risk is a way to generate the best relative return in fixed income in an ongoing economic expansion that 2021 will probably produce, as the us economy benefits from the vaccination and the continued fiscal and monetary policy expansion.
Linda: So Phil, what do you say? RJ thinks we should take on credit risk. That sounds bullish for stocks. What's our outlook for the equity market next year?
Phil: In a word, you hit the nail on the head, Linda. It's bullish.
Phil: Now, you look at the equity market this year, from the bottom of the market in March to the record high we hit just the other day, the S&P 500 is up 70%. So spoiler alert, we are not going to see another 70% rally next year, but we do think we can see a 20% to 25% rally. You know, the market's at about the 3,700 level right now, we think we could be up at the 4,500 level by the end of calendar 2021. That's pretty good.
Phil: As RJ alluded to, our GDP forecast for next year is constructive. We've got a 4.5% growth rate. That seems like a big number, but the federal reserve at their FOMC meeting last week, embedded in their SOEP, their summary of economic projections, they're now looking at a 4.2% rate of GDP growth for the full year. So whether you're Federated or the Federal Reserve, next year's going to be a above trend year.
Phil: As you sort of dig into that, you talked about Linda, the aggressive vaccine roll out over the course of the year. Started this month, and it's going to play out over the course of next year, that's positive. You talked about the fact that we've got a new president, so all of the divisiveness and the uncertainty regarding the election, come January 20th, all of that'll be behind us. So that's great. The new Congress, the new president, maybe there'll be some more fiscal stimulus or some more infrastructure spending next year. That's possible.
Phil: You look at the year to year comparisons, GDP growth First half of this year were negative. Corporate earnings, the first three quarters of this year were negative. So the year over year comparisons in calendar '21 versus calendar '20, is going to be very easy. Finally, sort of delving back into RJ's world. Chair Powell of the Federal Reserve has promised us that we're going to stay zero bound with the funds rate, through the end of calendar '23.
Phil: I don't know if that's going to happen or not, but I think we're likely to stay unchanged over the course of calendar '21. That sets you up in a TINA (there is no alternative) environment. There is no alternative. If interest rates are zero, where are you going to get your returns from? I think you've got to get your returns from the equity market. I think the fundamentals suggest that we're going to have a pretty good year next year.
Linda: So I think you're saying in so many words, what I have been saying all year long together with our other friends here at Federated Hermes, it's dangerous to be a bear. That 4,500 may be raising eyebrows, but not if the earnings rise as much as we think they very well may do with a booming economy next year.
Linda: I think we have time to fit just one more question in gentlemen. And that would be to look at your top three things that you would be watching for next year. You could be talking trends that'll start to pick up steam and become big, maybe sectors that you like, or events that they have a major impact on the markets.
Linda: Let's see what you think about that. RJ, what are the three things that you will be watching?
RJ: First would be the direction of US Treasury yields. Looking at the 10 year treasury yield. The benchmark, for instance, we expected to end the year probably around one and a quarter. That's a manageable backup from where we are right now in the low nineties. I don't think that's a taper tantrum or any other sort of market dislocation that generates too much fear, but we got to watch that carefully. If in fact there are unforeseen complications in distributing vaccines, or they're not as effective as we think they will be, then that will be an economic challenge and it'll keep rates lower.
RJ: Conversely, if inflation starts to pick up and huge treasury issuance could drive treasury yields a little bit higher than that. So watching the tenure is key. We think it'll be a relatively manageable risk, albeit one that will be heading higher.
RJ: Second key thing is the credit dynamics. We think spreads should keep tightening, and as I mentioned previously, we're overweight corporate investment grade and high yield bonds. A key focus for a bond investor, as Phil mentioned, when treasury yields are as low as they are, you can't have a high quality fixed income portfolio and expect to get much return. So within the fixed income space taking credit risk is key, and we're keeping a keen eye on the direction of corporate profitability and spreads.
RJ: And then lastly, The Fed. The simple fact of the matter is, The Fed under Powell is committed to being as highly accommodated as, I would suggest, the institution has ever been. I don't think that's an overstatement. And as such, it's possible that treasury will start rising too fast, say the tenure starts going above 125, 140, 150. We could actually get The Fed becoming, yet again, more innovative and trying to employ some form of what we would call, yield curve control. Either targeting a level of rates or substantially altering their asset purchases to drive rates back. So we keep a close eye on The Fed and see, if they in fact, get off the sidelines with respect to their current standards. Right now they're buying a lot of bonds. They could turn that up if they think yields are rising too far, too fast.
Linda: Okay. Strap ourselves in for next year. What do you think Phil for next year? Three things.
Phil: First issue, I guess, does the equity market rotation, does it have legs? You know, we've made a big call back in the middle of August, the S&P 500 large cap growth stocks, technology had a big move. We cut those back to neutral and added dollars into the lagger categories. Domestic large cap value, small cap and international. We felt that with the economy out of recession, the catalyst to get earnings and revenues going again, the market would start to narrow the gap between those three categories and domestic large cap growth, which had really done well. Well, that rotation worked in between, say, Labor Day and now. So the question is, does that rotation have legs into calendar '21? We think it does. We'll have to see.
Phil: The second issue, I think is Washington. We've got these two run-offs, these Senate runoffs in Georgia on January 5th, and not to overstate this, but they will determine the balance of power in Washington. Whether or not we have divided government or whether or not we have this blue wave. That will determine things like fiscal policy and additional fiscal stimulus.
Phil: So we're going to be watching that pretty closely. And then I guess finally, there was some bearish prognosticators out there, that think we're looking at a double dip. That because of the timing of the passage and the size of this phase four fiscal stimulus plan, and the rollout of the vaccine, et cetera, that the next couple of quarters, they think, could be negative. We disagree. We think that as we inoculate people at a pace of about 25 million a month starting this month, we're going to get to herd immunity by the middle of next year. And we think that allows people to sort of get back to living a normal life, traveling, going to restaurants, and that will actually strengthen the economy in the back half of the year, not weaken it. Obviously, we want to see, is that forecast prove accurate. Double or no double dip?
Linda: Well, gosh, excellent. As exciting as 2020 was in a negative way, fingers crossed '21 will be exciting and we'll all be very happy for it. So thank you so very much, Phil and RJ, and thank you to our listeners. We look forward to you joining us again on the Federated Hermes Hear & Now podcast. If you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Hear & Now episode. Plus our other series' Amplified and Fundamental. For a global perspective on the issues, challenges and trends shaping the investment landscape.
Views are as of December 22, 2020, and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. The value of equity securities will rise and fall. These fluctuations could be a sustained trend or a drastic movement. Past performance is no guarantee of future results. Federated Advisory Services Company. 20-10190 (12/20)