Economic Outlook

July 2017

We see a favorable backdrop for equities and convertible securities through the remainder of the year, although late-cycle pressures may increase going into 2018. Global growth has rebounded significantly, and we maintain our expectation for sustained and balanced global expansion through 2017. PMIs are converging and expanding, there is little risk of the U.S. overheating, the recovery in Europe is strengthening, and many emerging markets continue on favorable trajectories.

Global monetary policy should provide a near-term tailwind to equities and convertibles while not creating stiff headwinds for fixed income. We expect the Federal Reserve to maintain a gradual approach to increasing short-term rates. Other central banks have also begun to assume less accommodative stances, but we anticipate slow and deliberate approaches across the globe. As long-term rates are unlikely to soar, there are ongoing opportunities within the fixed income market.

We remain mindful of risk. Populist pressures have lessened in Europe, but elevated political uncertainty and contentious fiscal policy negotiations in the U.S. persist. North Korea’s bellicose stance gives pause, as do strained U.S. ties with China and Russia, and evolving trade relationships. Central banks remain very accommodative, but unexpected shifts in monetary policy could have negative consequences for risk asset prices and real economic activity, particularly after years of unprecedented support. Corporate earnings are on the rise, but so too are levels of debt.

Market rotation is likely to continue, which may exact a steeper toll on higher-valued names. More broadly, we would not be surprised to see the market retrace ground in the midst of its advance— indeed, the absence of corrections over recent months is perhaps more surprising.

MARKET REVIEW

During the second quarter, market participants looked through global geopolitical tensions and U.S. fiscal policy challenges, focusing instead on generally improving economic survey data, strong corporate earnings, contained inflation and well-behaved long-term interest rates. Stocks marched higher and convertible securities participated in a healthy measure of these gains. Emerging markets set the pace to beat, with a weaker dollar providing a supportive tailwind. Globally, growth led value. Although the Fed continued to tighten and announced its intention to slow its bond-buying activities sooner than many anticipated, U.S. Treasury bonds demonstrated continued resilience.

FIGURE 1. GLOBAL ASSET CLASS PERFORMANCE, Q2 2017
Global-Asset-Class-Performance
Past performance is no guarantee of future results. Source: Morningstar and Bloomberg. Data shown in USD unless otherwise noted.

This material is distributed for informational purposes only. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the information mentioned, and while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable.

United States

We believe the U.S. is positioned for continued slow and stable expansion through 2017, framed by the larger synchronized global growth story (Figure 2). While many “hard” measures of economic activity are still less strong than “soft” measures, the near-term risk of recession is slight, and the pace of expansion could increase. Unemployment, leading economic indicators, capital expenditures, and PMIs are moving in the right direction; and inflation is well contained (Figure 3). Fiscal policy has encountered hurdles, but there has been more momentum on the pro-business regulatory front. Also, enacting tax reform—even to a lesser extent than originally expected—should boost corporate spending and bolster U.S. economic growth.

We see broad global economic expansion underpinning the U.S. sales and profit cycle. Earnings growth is likely to accelerate through late 2017 or even further (Figure 4). There is a good deal of variation among sectors, however. Apart from energy and materials companies (which are each coming off a very low base), financials and information technology have the brightest EPS prospects, while the more defensive sectors remain lackluster. Across our U.S. equity portfolios, we are favoring companies that should perform well in an environment of modest economic expansion and gradually rising interest rates. Financials are well represented in our portfolios as are technology names, although we are highly mindful of valuations.

FIGURE 2. GLOBAL GROWTH IS REBOUNDING SIGNIFICANTLY
Global growth is rebounding significantly

Source: Haver, Morgan Stanley Research as of 1Q17

FIGURE 3. U.S. INFLATION IS CONTAINED
US inflation is contained

Source: Bloomberg. Data from 3/31/95 to 5/30/17.

FIGURE 4. ACCELERATION IN S&P 500 EARNINGS
Acceleration in S&P 500 earnings

Source: Thomson Financial, Morgan Stanley Research as of 6/23/17.

Global and International

In our global and international strategies, we are favoring non-U.S. markets. Valuations appear more reasonable (Figure 5) and many countries are in earlier stages of economic recovery. We are emphasizing a blend of cyclical and secular growth opportunities, including in the financials and technology sectors. In contrast, we are underweighting defensive areas of the market, although we have found attractively valued securities within health care.

Our positioning reflects a constructive view of Europe. Growth fundamentals continue to improve, with the Eurozone several years behind the U.S in its economic recovery. Liquidity conditions are very accommodative, issues in the banking system have begun to be addressed, and loan growth has picked up (Figure 6). Many companies have seen steady positive revisions to earnings expectations this year. Valuations are relatively attractive, with margins still near trough levels with considerable room for pick-up as top-line growth improves.

In Japan, we continue to emphasize export-oriented companies positioned to benefit from improving global growth and a weaker yen. Reasonable valuations and accommodative liquidity conditions provide a favorable landscape for our bottom-up security selection. By not discussing reduced accommodation over the medium term, the Bank of Japan has set itself apart as an outlier among major central banks, thereby limiting potential yen appreciation.

In the emerging markets, many countries are benefiting from strengthening economic fundamentals. Liquidity conditions are improving across many economies as inflation has eased and higher interest rates have attracted capital flows. These factors, along with balance sheet improvements over recent years (Figure 7), should help many emerging markets navigate interest rate rises in the developed markets. Against this backdrop, we continue to identify a breadth of opportunities. Still, our positioning is selective, emphasizing consumption-oriented themes and countries with favorable economic reform trajectories, such as India and China.

FIGURE 5. GLOBAL VALUATIONS
Global Valuations

Source: Bloomberg. Data in USD terms.

FIGURE 6. IMPROVING CREDIT CONDITIONS IN EUROZONE
Improving credit conditions in Eurozone

Source: Gavekal Data/Macrobond. Data through May 2017

FIGURE 7. EM BALANCE SHEETS HAVE STRENGTHENED
EM balance sheets have strengthened

Source: Gavekal Data/Macrobond. Data as of January 2017, excluding Brazil (October 2014) and Russia (April 2017), the most recent data available.

Convertible Securities

Through the first half of the year, global convertible issuance has been solid at $41 billion, led by the U.S. at $23.2 billion. We expect healthy issuance over 2H 2017 as companies seek to raise capital for growth projects.

There is a strong case for convertible securities in this phase of the market cycle. Because convertible securities have equity characteristics as well as fixed income attributes, they have proven more resilient than non-convertible fixed income securities when interest rates rise. Conversely, fixed income characteristics can provide downside protection during periods of short-term equity turbulence. Additionally, in an environment where equity valuations in some areas give pause, convertibles offer a way to invest in some of the fastest-growing companies, with downside protection.

We have identified many companies in the technology sector where innovative businesses are capitalizing on cyclical and secular trends. Our security selection criteria have led us to companies in the consumer discretionary sector, as well. We are selective toward more defensive sectors, including REITs, utilities and consumer staples.

Fixed Income

Demonstrating that parallel shifts in the yield curve are rare, 10-year Treasury yields have remained contained in the wake of Fed hikes (Figure 8). We expect further flattening of the yield curve over these next months, with U.S. 10-year yields gently rising to 3% into 2018. That said, if the Fed does proceed with its intention to reduce its bondbuying activities before it finishes raising short-term rates, we would enter uncharted waters, and long-term rates could rise more quickly

The Fed is unlikely to raise short-term rates more than one more time before year end. As we noted, while the U.S. economy is growing, expansion remains moderate with inflation still below the Fed’s target. Further, although some other central banks are also moving to more normalized short-term rates, tightening is likely to be gradual, which should help contain long-term rates globally.

From a sector standpoint, we currently favor corporate bonds over Treasury and agency positions. In high yield, defaults are rising, but slowly and from historically low levels. Given range-bound interest rates and spreads over the first half of 2017, coupled with spreads trading well below long-run averages, we anticipate the high yield asset class is likely to generate a coupon-like return through the end of the year. However, our fundamental bottom-up analysis continues to lead us to opportunities that offer more attractive price return potential.

FIGURE 8. THE U.S. YIELD CURVE FLATTENS
The US yield curve flattens

Source: Macrobond.

Conclusion

Steady and balanced global GDP growth, deliberate central bank policies, and favorable corporate earnings prospects support our positive outlook for equities and convertibles for the remainder of the year. Given our expectation for contained long-term rates and low inflation, the current landscape should sustain select opportunities within fixed income as well. Despite this broadly constructive view, uneven valuations in the market, fiscal policy challenges and political uncertainties underscore the importance of risk management. We expect volatility to increase in the months ahead and believe our portfolios are well positioned for this environment.

CALAMOS INVESTMENT COMMITTEE

John P. Calamos, Sr.

John P. Calamos, Sr.

Founder, Chairman and Global Chief Investment Officer

John P. Calamos, Sr. is Chairman and Global CIO of Calamos Investments, a firm he founded in 1977. With origins as an institutional convertible bond manager, the firm has grown into a global asset management firm. Mr. Calamos is often quoted as an authority on risk-managed investment strategies, markets and the economy. He received his B.A. in Economics and an M.B.A. in Finance from the Illinois Institute of Technology. He joined the United States Air Force after graduation and served as a combat pilot during the Vietnam War.

Matt Freund

Matt Freund, CFA

Co-CIO and Senior Co-Portfolio Manager

As a Co-Chief Investment Officer, Matt Freund is responsible for oversight of investment team resources, investment processes, performance and risk. As Head of Fixed Income Strategies, he manages investment team members and has portfolio management responsibilities. He is also a member of the Calamos Investment Committee, which is charged with providing a top-down framework, maintaining oversight of risk and performance metrics, and evaluating investment process. Matt joined Calamos in 2016 and has 28 years of industry experience. Prior to joining Calamos, he was Chief Investment Officer of USAA Investments, leading the teams responsible for the portfolio management of USAA’s mutual funds and affiliated portfolios, including P&C and life insurance products, and overseeing more than $140 billion in assets. During this time, he also served as lead portfolio manager for several highly regarded fixed income mutual funds. Earlier in his career, Matt served as a senior investment analyst for MetLife in the Capital Markets Group. He received a B.A. in Accounting from Franklin & Marshall College and an M.B.A. from Indiana University.

Michael Grant

Michael Grant

SVP, Sr. Co-Portfolio Manager, Global Long/Short and US Growth Strategies

Michael Grant manages investment team members and leads the portfolio management teams responsible for our Global Long/Short and US growth strategies. He is also a member of the Calamos Investment Committee, which is charged with providing a top-down framework, maintaining oversight of risk and performance metrics, and evaluating investment process. He joined Calamos in 2015 and has 30 years of investment industry experience. Prior to joining Calamos, Michael founded Phineus Partners in 2002, where he launched a successful long/short strategy. Previously, he was a Managing Director of Schroder Investment Management with responsibilities over US equity mandates. During his tenure at Schroders, he also served as Head of the Global Technology Team and Head of the U.S. Equity Team in London. Prior to that, Michael was a portfolio manager for the National Investment Trust Co. in Taipei, Taiwan and a US equity analyst for the Principal Group in Canada. Michael earned a master’s degree from the London School of Economics, where he specialized in International History. He has Bachelor of Commerce from the University of Alberta, Canada.

John Hillenbrand

John Hillenbrand, CPA

Co-CIO, Head of Multi-Asset Strategies and Co-Head of Convertible Strategies, Senior Co-Portfolio Manager

As a Co-Chief Investment Officer, John Hillenbrand is responsible for oversight of investment team resources, investment processes, performance and risk. As Head of Multi-Asset Strategies and Co-Head of Convertible Strategies, he manages investment team members and has portfolio management responsibilities for those investment verticals. He is also a member of the Calamos Investment Committee, which is charged with providing a top-down framework, maintaining oversight of risk and performance metrics, and evaluating investment process. John joined Calamos in 2002 and has 24 years of industry experience. Prior to joining Calamos, he served as an equity research analyst at Credit Suisse First Boston and ABN AMRO and as an Account Manager - Business Credit Group at Continental Bank. John received a B.B.A. in Public Accounting from Loyola University and an M.B.A. in Analytic Finance from the University of Chicago Graduate School of Business. He is also a member of the American Institute of Certified Public Accountants.

Nick Niziolek

Nick Niziolek, CFA

Co-CIO, Head of International and Global Strategies, Senior Co-Portfolio Manager

As a Co-Chief Investment Officer, Nick Niziolek is responsible for oversight of investment team resources, investment processes, performance and risk. As Head of International and Global Strategies, he manages investment team members and has portfolio management responsibilities for international, global and emerging market strategies. He is also a member of the Calamos Investment Committee, which is charged with providing a top-down framework, maintaining oversight of risk and performance metrics, and evaluating investment process. Nick joined the firm in 2005 and has 14 years of industry experience, including tenures at ABN AMRO and Bank One. He received a B.S. in Finance and an M.B.A. from DePaul University.

Eli Pars

Eli Pars, CFA

Co-CIO, Head of Alternative Strategies and Co-Head of Convertible Strategies, Senior Co-Portfolio Manager

As a Co-Chief Investment Officer, Eli Pars is responsible for oversight of investment team resources, investment processes, performance and risk. As Head of Alternative Strategies and Co-Head of Convertible Strategies, he manages investment team members and has portfolio management responsibilities for those investment verticals. He is a member of the Calamos Investment Committee, which is charged with providing a top-down framework, maintaining oversight of risk and performance metrics, and evaluating investment process. He also is a member of the Calamos Office of the CEO, responsible for comprehensive oversight of business execution and strategic growth initiatives. Eli has 28 years of industry experience, including nine at Calamos. Prior to returning to Calamos in 2013, he was a Portfolio Manager at Chicago Fundamental Investment Partners, where he co-managed a convertible arbitrage portfolio. Previously, he held senior roles at Mulligan Partners LLC, Ritchie Capital and SAM Investments/The Hampshire Company. Earlier in his career, Eli was a Vice President and Assistant Portfolio Manager at Calamos. He received a B.A. in English Literature from the University of Illinois and an M.B.A. with a specialization in Finance from the University of Chicago Graduate School of Business.