Dubbing the theme of Thursday’s call “We haven’t come this far to just come this far,” Calamos Co-CIO Michael Grant, Senior Co-Portfolio Manager and Head of Long/Short Strategies, presented a positive outlook on the case for further upside in equities. Listen to call here.
“The uncertainty is clearing with the business cycle expanding and risks diminishing, with gains in the first half to be driven by a strong earnings cycle," he said.
Grant's positive outlook is notwithstanding his expectation of one 10% or greater correction sometime between February and April and possibly a second correction this year.
He outlined two risks for the market:
Calamos Phineus Long/Short Fund (CPLIX) returned 19.81% for the year, exceeding the 18.4% S&P 500 return—and despite an average net equity exposure during the year of only about 50%.
“A key factor in this outperformance,” Grant said, “was our preemptive move to shield clients from the historic disconnect between the safety/defensive/quality parts of the market on the one hand, and the beneficiaries of cyclical recovery on the other.”
Grant believes that preemption—which he described as “the antithesis of momentum investing”—will be decisive for return outcomes in the coming decade.
Momentum has worked for the last 10 years because the economic expansion has been slow and stable. “For momentum to work for investors, you have to be willing to say, 'I’m going to miss the first big part of the move because I believe that move will be sustained over time'…You have to believe that trend will persist.
“Our belief,” Grant explained, “is that if we do see more cyclicality in the economy and real interest rates do create reflation, that means everything will be moving a bit faster and with a bit more volatility. It will be much harder to play the momentum game because once the momentum emerges, by the time you buy it, there’s a real risk the momentum will get reversed. That’s why I argue we’re going to have to be much more preemptive in both buying and selling our positions versus the last decade.”
Grant structured his discussion around what he described as five central debates.
Grant reviewed five points he’d emphasized in previous CIO calls (see the summaries from calls held in September and April.)
Equities were not “disconnected” from reality. From the onset, Grant advocated thinking of the COVID crisis as having the same sharp but temporary effect on the economy as a natural catastrophe might.
This is most relevant to what happened to unemployment last year. As economists look back at 2020, Grant said, one key feature of this cycle will stand out: the rapid drop of the unemployment rate from above 10% to the 6% range in just six months. In contrast, it took four years to reduce the unemployment rate by a similar amount after the downturn in 2008.
The point: when the employment shock is temporary, everything happens very quickly. This was key to much of what unfolded last year.Society would learn to live with the coronavirus. “There is much that we misunderstood about the pandemic,” Grant acknowledged. “While we viewed the virus as not particularly lethal compared to the pandemics of the past half-century, it has proven capriciously contagious. It has proven capable of easy mutation and could become vaccine-resilient over time, by a process of natural selection.”
But he called his expectation that society would adapt to the virus “a decisive insight” that encouraged the team to “lean into the opportunity created by an incalculable and chaotic shock.” By June, the fund had completely recovered from its drawdown. This was half the time that it took the major benchmarks to recover, and well ahead of its peers in the Morningstar Long-Short Equity category (see this post).According to Grant, drivers of the current market rally are:
What’s more, he believes that the unprecedented fiscal and monetary policy shift will continue after the pandemic dissipates.
The late March to May revival of cyclical and value faded from June through September. It was too early in the recovery, Grant said, and it wasn’t accompanied by any pickup in bond yields, nor by any improvement in cyclical earnings revisions.
Since November, both pieces are now in place and the CPLIX team believes that the rotation to cyclical has legs. Grant cited several catalysts that support the rotation to cyclical opportunities.
“Last week, Fed Chair Powell noted that the FOMC will not raise rates until there is ‘troubling inflation,’ nor will it raise rates to ward off threats of inflation. Meanwhile, bond yields are grinding higher because wage growth and the velocity of money have bottomed. This backdrop amidst $2 trillion of fiscal stimulus is steepening yield curves.”
“Inflation expectations are rising, resulting in negligible increase in real interest rates as inflation breaks higher. This negative interest rate setting is the fundamental support for reflation and thus, the move in cyclicals,” he said.
Acknowledging that investor positioning is stretched in the short term, Grant sees the potential for approximately $1 trillion of equity inflow this year. This alone could provide an important tailwind for cyclicals. Most portfolios are still heavily weighted to the traditional growth, quality and long duration sectors, he said.
He also believes that pension funds (“still overexposed to bonds”) and quant strategies will drive flows.
“We do not believe equities in general are in bubble territory,” said Grant. “Equities have suffered outflows for the past decade, for the past five years, for the past 18 months. If a bubble is the footprint of excess and unsustainable capital flows, we should be worried about bonds rather than equities.”
The pandemic has resuscitated the role of big government across many developed societies, resulting in a surrender to the impulse for higher public spending, higher debt levels and greater government interference in many walks of life. This may be the pandemic’s lasting effect, Grant believes.
An “overreliance” on monetary tools may be shifting to a new and unprecedented partnership between central banking and fiscal expansionism—a convergence Grant refers to as “monetary and fiscal profligacy.” It’s symbolized by the appointment of Janet Yellen as the new Treasury secretary, he added.
“Today’s race to spend without any consideration of the cost, without any coherent exit strategy is a policy of capitulation. It is a product of expediency and a confession of failure…What matters today—for the investment horizon that matters for your clients—are the conditions for a strong cyclical catch-up in economic activity through 2021 into 2022.
“These conditions are fermenting pricing pressures as the deflationary effects of the pandemic fade,” Grant continued. “In this respect, the behavior of the American consumer through this year will be decisive.”
“What happens to interest rates when the pandemic is perceived to be over? How do central banks react to the unleashing of pent-up demand?” Grant asked.
Prior to the pandemic, 10-year Treasury yields were 1.5% to 2% versus about 1% today. CPLIX’s equity targets assume a 10-year yield of 1.5%. As long as yields are rising in anticipation of better economic activity, the equity risk premium can move lower and equities can move higher because the downside tail risks are reduced, Grant said.
When the yield approaches the 2% level, however, the team’s models imply no valuation upside for the S&P 500.
Interest rate risk is what will eventually constrain the new policy regime in the U.S., Grant said.
“Financial markets rather than governments will eventually change the rules of the game…The investment regime is in transition, the controversy concerns its duration,” he said.
Negative interest rates imply more cyclicality, according to Grant. “Investors will need to preempt these moves because they will be sharper and shorter and reverse more quickly. Investors must be prepared for greater active allocation across sectors and styles in coming years.”
The team’s base case calls for an S&P 500 price range of 4000 to 4400, with heightened risk beyond May. “The backdrop could remain constructive in the second half, but the market will have priced in a full recovery. In financial markets, it is invariably better to travel than arrive,” Grant said.
While 2020 was a year of managing beta, 2021 will be more about how much recovery has been priced across subindustries. He looks for equity upside to be dependent on earnings potential.
As positive as he is about a sustained cyclical upswing as the developed world returns to normal in the second half of the year, Grant ended his remarks with a caution.
This “bullish capitulation into equities” can continue to work for a time, Grant said, “but the fault lines of the past decade are beginning to fade. Investors should prepare for the sector and style turmoil that appears inevitable…The real problem for equities will emerge when the pandemic passes and the debate over how to withdraw all of this stimulus begins. The world beyond the pandemic will not be a return to the prior status quo.”
Investment professionals, for more information about Grant’s perspective or CPLIX, contact your Calamos Investment Consultant at 888-571-2567 or caminfo@calamos.com.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Please see the prospectus and summary prospectus containing this and other information which can be obtained by calling 1-866-363-9219. Read it carefully before investing.
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Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe information provided here is reliable, but do not warrant its accuracy or completeness. The material is not intended as an offer or solicitation for the purchase of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only and is not intended to provide—and should not be relied on for—accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. The securities highlighted are discussed for illustrative purposes only. They are not recommendations.
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The principal risks of investing in the Calamos Phineus Long/Short Fund include: equity securities risk consisting of market prices declining in general, short sale risk consisting of potential for unlimited losses, foreign securities risk, currency risk, and geographic concentration risk, other investment companies (including ETFs) risk, derivatives risk, options risk, and leverage risk. As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.
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The S&P 500 Index is generally considered representative of the U.S. stock market.
Morningstar Long/Short Equity Category funds take a net long stock position, meaning the total market risk from the long positions is not completely offset by the market risk of the short positions. Total return, therefore, is a combination of the return from market exposure (beta) plus any value-added from stock-picking or market-timing (alpha).
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Archived material may contain dated performance, risk and other information. Current performance may be lower or higher than the performance quoted in the archived material. For the most recent month-end fund performance information visit www.calamos.com. Archived material may contain dated opinions and estimates based on our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions at the time of publishing. We believed the information provided here was reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
Performance data quoted represents past performance, which is no guarantee of future results. Current performance may be lower or higher than the performance quoted. The principal value and return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance reflected at NAV does not include the Fund’s maximum front-end sales load. Had it been included, the Fund’s return would have been lower.
Archived material may contain dated performance, risk and other information. Current performance may be lower or higher than the performance quoted in the archived material. For the most recent month-end fund performance information visit www.calamos.com. Archived material may contain dated opinions and estimates based on our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions at the time of publishing. We believed the information provided here was reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
Performance data quoted represents past performance, which is no guarantee of future results. Current performance may be lower or higher than the performance quoted. The principal value and return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance reflected at NAV does not include the Fund’s maximum front-end sales load. Had it been included, the Fund’s return would have been lower.
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