Economic Outlook

January 2019

Following a painful and broad fourth quarter selloff, risk assets rebounded in the first weeks of 2019 as optimism has grown about Fed accommodation, earnings, China stimulus and an eventual trade dispute resolution. However, investors should be prepared for choppy markets, especially through the first half of the year. We believe:

  • Although there will be softening in U.S. economic data, the U.S. is positioned for continued slow expansion. A recession in 2019 is unlikely.
  • The global economy will grow tepidly through these next months, with increased potential for acceleration in the second half of the year.
  • Volatility will remain elevated, due to softening global economic data, and elevated political, geopolitical and monetary policy uncertainties. Company-specific news is also likely to roil the markets.
  • The pace of earnings growth will slow from recent peaks, but equities and equity-sensitive securities—including convertible issues and high yield bonds—offer additional upside for the active manager.
MARKET REVIEW

As investors focused on slowing global growth, trade and Fed policy, risk assets succumbed to a fourth quarter selloff. A relaxation of sanctions against importers of Iranian oil and doubts about the effectiveness of OPEC production cuts led to a $30 per barrel selloff in crude oil prices, and a flight to quality fueled a Treasury rally. Sentiment through the first weeks of 2019 has improved, although volatility has persisted.

FIGURE 1. GLOBAL ASSET CLASS PERFORMANCE, TOTAL RETURN %
global asset class performance total return percent
Past performance is no guarantee of future results. Source: Bloomberg and Morningstar. Data shown in USD unless otherwise noted.

U.S. Equities

U.S. economic growth and data may soften during the first half of the year due to global growth conditions and the impact of a government shutdown. Even so, we do not expect a U.S. recession in 2019, particularly given the absence of high inflation, aggressive tightening and asset price “bubbles.” Employment data is strong and wage growth gives a boost for consumers. Inflation is subdued and the Fed has affirmed its commitment to a data driven approach, which should result in fewer rate hikes than markets anticipated just a few months ago.

Recent earnings announcements have boosted Wall Street sentiment, and we believe many corporations are positioned for additional upside as they benefit from deregulation, tax reform and a healthy U.S. consumer. The rate of corporate earnings growth is likely to be more measured due to weaker global demand, and more companies may guide downward, taking cover in Apple’s recent caution. Equity valuations in many areas of the market are not extreme based on earnings expectations—especially after the fourth quarter selloff.

In regard to potential headwinds, many of the same political and geopolitical unknowns that rattled the markets in 2018 are unresolved. A high level of global uncertainty (Figure 2) could foment volatility over these next months. We also believe uncertainty about policy and policy impacts have contributed to the recent weakness in sentiment driven “soft” data. While policy calls are impossible to make with certainty, we are hopeful that trade and fiscal policy move to a more accommodative stance as the year progresses, just as the tone of monetary policy has recently become more accommodative. We believe this could help stabilize growth at a more favorable level in the second half of 2019 and into 2020. Any reduction in uncertainty is also likely to be welcomed by the markets.

We are closely watching for signs of growing pressures in corporate credit as corporate profit growth decelerates. One risk on the horizon is that markets confront a significant wave of forecast downgrades— for economic activity, sales, and profit margins across the U.S. and other major markets.

Our U.S. equity positioning favors companies that offer pricing power, quality earnings and resilient balance sheets. We are monitoring the impact of slowing global demand on individual companies and sectors. Across sectors, we are mindful of security valuations. Growth-oriented companies are likely to lead at this point of the cycle, and technology innovators and companies positioned to benefit from U.S. consumer strength are well represented in our strategies. We have identified more cyclically oriented opportunities for growth as well.

inflation is still contained

Global and International Strategies

Our outlook on the global economy is more cautious heading into 2019 than it was in 2018. Signs of slowdown are plentiful, and weaker demand out of China has rippled across the global economy, taking a toll on export-driven economies such as Japan. The macro landscape in Europe gives less cause for optimism as political uncertainties mount (Brexit, populism in France, Italy’s budget) and fiscal policy has provided few catalysts for stronger corporate profitability.

That said, at current valuations (Figure 3), even a modest turn in global economic data could provide a significant boost to non-U.S. equity markets—and there are certainly factors that could set the stage for such improvements. Indeed, from a fundamental standpoint, we could see economic growth outside the U.S. accelerate in the second half of the year. If the U.S. Fed does turn more dovish and U.S. economic growth weakens at the margin, a depreciating U.S. dollar provides a tailwind to overseas markets. Also, China has just begun its easing cycle, stimulus has not been as strong as in 2015 and 2016, from either a fiscal and monetary perspective (Figure 4a and 4b, respectively). We expect a further ramp-up in activity, which could help the Chinese economy find a more stable footing.

Our global and international strategies are positioned to balance our cautious view of current conditions as well as our view of longer-term opportunities. We have consolidated around our higher-conviction names and find many opportunities in Emerging Asia, including China. The Chinese government’s stimulus in 2019 is much more likely to focus on removing regulations and fueling consumption, compared with previous stimulus programs that were more infrastructure-centered. So, we expect the beneficiaries will differ as well, and our positioning includes companies that can profit from consumption stimulus. We also have identified a growing number of bottom-up opportunities in other Emerging Asian markets. Given our philosophy that progress toward economic reforms can provide a tailwind for growth, we have increased our exposure to Brazil, where economic recovery is in a relatively early stage. Consistent with our view that China’s stimulus will be less focused on infrastructure, we are cautious on European cyclicals, which have historically garnered substantial profits from China.

attractive global valuations
china stimulus past vs present

Convertible Strategies

In 2018, convertible securities provided a degree of shelter from the storm in the equity markets, with U.S. and global indexes performing better than comparable equity benchmarks. Global issuance was strong for 2018, despite a year-end slowdown as volatility soared. For the year, U.S. issuance was a brisk $51 billion, followed by Asia ex- Japan at $16 billion. We expect another strong year of issuance in 2019 as companies seek capital in a still-expanding economy.

Convertibles tend to benefit in volatile but upwardly moving markets (as the value of their embedded option rises), which makes them compelling in this environment. However, because the attributes of individual convertibles and the convertible market are constantly changing, active management is essential. During the fourth quarter, we took advantage of market volatility to rebalance and enhance the risk/reward stance of our convertible portfolios. As market conditions have evolved in 2019, we have sought to capitalize on price weakness in oversold names, including adding additional equity exposure. However, our positioning continues to reflect a risk-aware approach—which translates into caution about securities with the highest exposure to equity volatility and those with weaker credit fundamentals. From a sector standpoint, we are emphasizing technology and consumer opportunities, and structures with a good balance of upside and downside participation.

Fixed Income

The Fed was a focal point of investor anxiety in 2018, but so far has been less of a distraction to market participants in 2019, thanks to comments that suggested that it would slow in its tightening. If equities sustain a grinding recovery off December lows, the Fed may feel it has an all-clear from the market to resume its tightening campaign and balance sheet reduction. Barring that, the Fed is likely to pause. Improving wage growth and employment gains might suggest that inflation pressures are building, but realized inflation is well contained. In fact, some data tracking the underlying drivers, such as the Federal Reserve Bank of New York Underlying Inflation Gauge, indicates that pressures peaked in mid-2018 and have since rolled over. As long as inflation remains subdued and given the probability of slower growth around the world, we believe the fed funds rate will settle in around 2.50%-2.75% by year end, with the 10-year yield in the range of 3.00%, or even a bit lower. Investor anxiety about yield curve inversion will persist. However, as we have discussed in past commentary, although inversions have been a reliable predictor of recessions, there is often a lag of several quarters between inversion and economic contraction.

During the fourth quarter, de-risking sent investors fleeing to the haven of the 10-year Treasury and high yield trailed. (Figure 5). We’ve seen a reversal of fortunes as 2019 opens. We believe high yield is positioned to outperform other fixed income sectors in 2019. The investment grade market has seen a deterioration in leverage and debt service metrics as shareholder-friendly stock buyback activity has increased. In contrast, the credit fundamentals of high yield issuers have been steadier overall. Similar to convertible securities, high yield bonds are economically sensitive and can thus benefit in a growing economy. Against this backdrop, we expect defaults in high yield to remain low (below the long-term historical average of 3%), but we could well see an increase in “fallen angels” (bonds that lose their investment grade status). Of course, when it comes to high yield issuers, the details matter greatly. This is why we take a bond-by-bond approach, employing rigorous research to invest where we believe we are well compensated for the risks we undertake.

fixed income reversal of fortunes

Conclusion

Although we expect the U.S. and global economies to continue expanding in 2019, the road ahead requires long-term perspective, attention to fundamentals, and a focus on risk management and capital preservation. Markets have delivered a respite in the first weeks of 2019, but volatility is likely to remain elevated. We are confident that this environment sets up well for our active and risk-aware approaches.

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.

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

Co-CIO, 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.