active insights: putnam’s 2019 outlook · yield curve* (right axis) the index of leading economic...

For dealer use only. Not for public distribution.

316314 3/19

Active Insights:Putnam’s 2019 Outlook

Chris GalipeauSenior Investment Director, Global Asset Allocation

2For dealer use only. Not for public distribution.

316314 3/19

Executive summary

• Macro: From great to good

• Equities: Large sell-off, large rally? Now what?

• Fixed income: What is next for rates and credit?

• Commodities: Back to a more neutral outlook

• Risks, realities, and conclusions

Macro

From great to good


316314 3/19

Global economies moving in the right direction, at a slower pace

Sources: World Bank, January 2019; Bloomberg, 12/31/18.

0%

1%

2%

3%

4%

5%

6%

7%

World United States China

2018e 2019f 2020f

Real GDP YoY Global and domestic PMIs still positive

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51

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57

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r-16

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r-18

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n-1

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-18

Dec-1

8

JPMorgan Global Composite PMI

Markit U.S. Composite PMI


316314 3/19

Fed has achieved its dual mandate

Source: Bloomberg, 12/31/18.

Core inflation YOY

0%

1%

2%

3%

4%

5%

6%

1985

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2015

2018

Hu

nd

red

s

U.S. Core PCE U.S. Core CPI

U.S. unemployment rate

0%

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4%

6%

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1985

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1994

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2018

Hu

nd

red

s

U.S. unemployment rate


316314 3/19

Yields around the world likely to grind higher, slowly


Global 10-year yields

-1%

0%

1%

2%

3%

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6%

Ja

n-1

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U.S. Germany Japan U.K.


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Recession

-5

-4

-3

-2

-1

0

1

2

3

4

-25

-20

-15

-10

-5

0

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2015

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LEI YOY Index — last price**(left axis)

Yield curve*(right axis)

The Index of Leading Economic Indicators and yield curve not signaling recession

* Yield curve represents yield difference between the 10-year and 2-year bond, as of 12/31/18.

** As of 11/30/18.

Sources: Conference Board, Bloomberg.

(%)

20

18

(%)


316314 3/19

Thoughts from the Portfolio Manager’s desk

•Global growth has slowed, but economic fundamentals remain healthy

and supportive of risk assets

•There is no sign of an economic recession. While an inverted yield

curve has preceded recessions in the past, flat yield curves should not

be interpreted as having equal predictive powers

•Major economic concerns are abating

Equities

Large sell-off, large rallyNow what?


316314 3/19

3,000

The stock market is not the economy: 20% drawdowns can happen absent an economic recession

Sources: Conference Board, Bloomberg, as of 1/3/19.

Historically, these events have been buying opportunities

S&P 500 (logarithmic scale)

100

1,000

1985

1986

1987

1988

1989

1990

1991

1992

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2019

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0.7

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0.9

1


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Equity valuations have come down

Source: Bloomberg, as of 12/31/18. Represented by the S&P 500 Index. Valuations use trailing 12-month data.

Past performance is not indicative of future results.

Price/earnings ratio Price/book ratio

Price/cash flow Price/sales ratio

0

2

4

6

1996

1998

2000

2002

2004

2006

2008

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2012

2014

2016

2018

Average

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2010

2012

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2018

Average


316314 3/19

Earnings growth remains strong

Sources: Bloomberg, Putnam, as of 12/31/18.

6.1%3.8%

-0.7%

-3.6% -3.3% -4.2% -4.3% -3.1%

-0.2%

4.9%

9.0%10.2%

11.9%

17.3%

10.8%

-10%

-5%

0%

5%

10%

15%

20%

S&P 500 trailing 12-month earnings per share growth


316314 3/19

Where we see opportunity for growth and value


• Value: The market appears to be

overshooting on the downside.

Looking for good businesses with

high cash generation, quality

balance sheets, and cyclical

exposure

• Growth: Preference for companies

with structural advantages: barriers

to entry, moat, and ability to

withstand market downturns.

Themes include e-commerce,

prepayment processing, and

personalized medicine-10

-5

0

5

10

15

Ja

n-1

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b-1

8

Ma

r-18

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18

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n-1

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l-1

8

Aug

-18

Sep

-18

Oct-

18

Nov-1

8

Dec-1

8

Russell 1000 Growth Russell 1000 Value


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China’s economic trajectory reverberates strongly in the rest of EM

Source: J.P. Morgan.

China’s share in exportsCountries represented:

TW = TaiwanCL = ChileKR = South KoreaPE = PeruBR = BrazilSA = Saudi ArabiaMY = MalaysiaVN = VietnamID = IndonesiaPH = PhilippinesTH = ThailandZA = South AfricaRU = RussiaAR = ArgentinaCO = ColombiaIL = IsraelIN = IndiaTR = TurkeyHU = HungaryMX = MexicoCZ = Czech RepublicPL = Poland


316314 3/19

Valuations outside the United States


Europe Japan Emerging markets

0

0.5

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1.5

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2.5

2000

2002

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2016

2018

Price/Cash flow relative to the United States

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316314 3/19


• The macro backdrop seems to have settled relative to Q4 2018. We have

passed peak rate of change in real GDP and earnings per share but we

anticipate earnings to be up year on year.

• China’s economy is slowing. All EM countries feed off of China, so expect

a domino effect for EM depending on how the trade war talks conclude

• We favor companies with strong balance sheets, cash flows, and secular

tail winds

• We expect the recent 20% move off the December lows to be digested

Fixed income

What’s next for rates and for credit?


316314 3/19

Where are rates headed next?


• With Fed tightening and continued

domestic growth, U.S. Treasury yields

may continue a modestly upward

trajectory

• However, low rates globally and U.S.

pension demand remain an important

constraint on how high yields can

actually rise

Global 10-year yields

-0.5

0.0

0.5

1.0

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U.S. Germany Japan U.K.


316314 3/19

Over the long term, a secular shift upward is likely underwayInterest-rate cycles span decades

Source: http://www.multpl.com/10-year-treasury-rate/table/by-month, as of 12/31/18.

U.S. 10-year yield: 1945–2018

0%

4%

8%

12%

16%

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316314 3/19

Investment-grade valuation

Sources: Bloomberg Barclays U.S. Corporate Investment Grade Bond Index, Bloomberg Barclays U.S. High Yield Corporate Update, Putnam, as of 12/31/18.

Past performance is not a guarantee of future results.

OA

S (

bp

s)

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1

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0

100

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400

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1,000

OAS Yield to worst

Bloomberg Barclays U.S. Corporate Investment Grade Bond Index

Yie

ld (%

)

Spread Yield

Average 168 bps 4.23%

High 618 bps 9.09%

Low 82 bps 2.58%


316314 3/19

Credit cycle:

1990–1999

Credit cycle:

2000–2009

Credit cycle:

2010–present

High yield credit cycles and default rates still behaving wellWithin the context of past credit cycles, current global spreads are near fair value and defaults remain low

* Current and average default rates include distressed exchanges.

** As measured by the BBG Barclays High Yield Index, as of 12/31/18.

Sources: JPMorgan High Yield Market Monitor, Barclays U.S. High Yield Update, Putnam. As of 12/31/18, unless otherwise noted. Past performance is not a

guarantee of future results.

0

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2000

0%

2%

4%

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20%

Sp

rea

d (b

ps)

De

fault r

ate

(L

TM

tra

ilin

g)

Default rate* Average default rate Spread to worst Average spread to worst

Current

spread

(bps)

571

Current

default

rate

1.87%


316314 3/19

34 56 89 130

573

425

123 129 15056 35 68

121

438

271

430

1364

550

50 75 1000

200

400

600

800

1000

1200

1400

1600

Agencies Agency MBS CMBS Investment-grade

corporates

High yield Emerging-market debt

Non-agencyRMBS

CMBS-Mezzanine

Agency IO

Average excess yield over Treasuries (OAS, 12/31/97–12/31/07)

Current excess yield over Treasuries(OAS as of 2/28/19)

We believe attractive opportunities exist outside of the indexCurrent spreads relative to historical period

Sources: Barclays, Bloomberg, Putnam, as of 2/28/19.

The chart above compares 10-year pre-crisis average OAS to current period OAS to illustrate the degree of liquidity premium we believe is embedded in the current OAS. Ten years of

pre-crisis data is used as certain sectors, such as CMBS, do not have a materially longer history.

Data is provided for informational use only. Past performance is no guarantee of future results. All spreads are in basis points and measure option-adjusted yield spread relative to

comparable maturity U.S. Treasuries with the exception of non-agency RMBS and mezzanine CMBS, which are loss-adjusted spreads to swaps calculated using Putnam’s projected

assumptions on defaults and severities, and agency IO, which is calculated using assumptions derived from Putnam’s prepayment model. Agencies are represented by BBG Barclays U.S.

Agency Index. Agency MBS are represented by BBG Barclays U.S. Mortgage Backed Securities Index. Investment-grade corporates are represented by BBG Barclays U.S. Corporate

Index. High yield is represented by JPMorgan Developed High Yield Index. CMBS is represented by both agency and non-agency CMBS that are eligible for inclusion in the BBG Barclays

U.S. Aggregate Bond Index; mezzanine CMBS is represented by the same index using the AA, A, and BBB components. Average OAS for Mezzanine CMBS is for the 2000–2007 time

period. Emerging-market debt is represented by the BBG Barclays EM Hard Currency Aggregate Index. Non-agency RMBS is estimated using average market level of a sample of below-

investment-grade securities backed by various types of non-agency mortgage collateral (excluding prime securities) and Agency credit risk transfer securities. Mezzanine CMBS is

estimated from an average spread among baskets of Putnam-monitored new issue and seasoned mezzanine securities, as well as a synthetic (CMBX) index. Agency IO is estimated from

a basket of Putnam-monitored interest-only (IO) and inverse IO securities. Option-adjusted spread (OAS) measures the yield over duration equivalent Treasuries for securities with different

embedded options.

In the index

We believe opportunities in the heavily traded

benchmark sectors are scarce

Outside the index

Non-benchmark strategies may be compelling,

but they require specialized research


316314 3/19

The opportunity set vs. the U.S. and Global Aggregate Bond indexes

Approximately 70%–80% of the indexes are composed of government securities

(Treasuries, agencies, and MBS)

Sources: Bloomberg, Putnam, as of 12/31/18, most recent available.

Bloomberg Barclays U.S.

Aggregate Bond Index

Bloomberg Barclays Global

Aggregate Bond Index

Out-of-index

opportunities

• $20.8 trillion market value

• Average yield: 3.28%

• Average OAS: 54 bps

• Average duration: 5.87 years




• Average duration: 6.96 years




Treasuries Gov't related

MBS Corporate

ABS CMBS

Covered

Treasuries Gov't related

MBS IG corporate

CMBS/ABS

Non-agency RMBS CMOs (IO/PO)

CMBS (ex-Agg) Global high yield

Bank loans EMD


316314 3/19


•Central bank divergence remains a major theme, with the Fed confident

in the U.S. growth outlook, while the ECB and BoJ remain a bit more

cautious. The Fed has hit pause, shifts to data dependent

•We remain constructive on investment-grade corporates given overall

strong fundamentals and fair valuation. We find spread levels to be

generally appropriate for the underlying fundamental risk

•We remain constructive on high-yield corporates given overall strong

fundamentals and fair valuation. We find spread levels to be generally

appropriate for the underlying fundamental risk

•We are constructive on RMBS and CMBS as spreads look attractive

with fundamentals constructive

Commodities

Back to range bound


316314 3/19

Bullish setup for crude

Note: Dotted line denotes 2007–2017 average (2.3 MMb/d). 2H18 and 2019 are projections.

Source: U.S. Energy Information Administration, 12/31/18.

Global spare capacity stretched thin

0

1

2

3

4

5

6

7

8

2008 2010 2012 2014 2016 2018

MMb/d


316314 3/19

North American production growth may underwhelm

Source: U.S. Energy Information Administration, 12/31/18.

U.S. oil inventories are finally trending lower Has the U.S. crude oil production peaked for now?

U.S. total crude oil production (’000 bbl/d) 2017–2018U.S. crude oil days of supply

20

23

26

29

32

35

Jan Mar May Jun Aug Oct Dec

2017

2018

Harvey

8,000

8,500

9,000

9,500

10,000

10,500

11,000

11,500

12,000

Jan Apr Jul Oct Jan Apr Jul Oct2017 2018

c


316314 3/19


•Slowing economic growth won’t cause a significant reduction in the

demand for oil

•We believe we have reached peak shale production in the United

States — now the biggest producer in the world

•Large percentage move off the December lows in oil argues for a

consolidation

Risks, realities, and conclusions


316314 3/19

Risks

•China’s economy decelerates significantly, causing a domino effect

ripple through the rest of EM and into Europe and the United States

•The Fed makes a policy mistake and inverts the yield curve

•The U.S. economy decelerates significantly, and earnings collapse

Realities

•Global economic growth is slowing, but still positive with major threats

abating

•The outlook for earnings growth in 2019 is positive

Conclusion

•We are constructive on risk assets in 2019 although we anticipate

digestion of the move off the December lows


316314 3/19

The views and opinions expressed are those of the speaker, Chris Galipeau, Senior Investment Director, January 2019, are subject to change with market

conditions, and are not meant as investment advice.

FOR DEALER USE ONLY. NOT FOR PUBLIC DISTRIBUTION.

Your clients should carefully consider the investment objective, risks, charges, and expenses of a fund before investing. For a prospectus, or a summary

prospectus, if available, containing this and other information for any Putnam fund or product, call the Putnam Client Engagement Center at 1-800-354-4000.

Your clients should carefully read the prospectus, or summary prospectus, if available, before investing.

Putnam Retail Management

Appendix


316314 3/19

Terms and definitions

Components of The Conference Board Leading Economic Index:

• Average weekly hours, manufacturing

• Average weekly initial claims for unemployment insurance

• Manufacturers’ new orders, consumer goods, and materials

• ISM® Index of New Orders

• Manufacturers’ new orders, nondefense capital goods excluding aircraft orders

• Building permits, new private-housing units

• Stock prices, 500 common stocks

• Leading Credit Index™

• Interest-rate spread, 10-year Treasury bonds less federal funds

• Average consumer expectations for business conditions


316314 3/19

Terms and definitions (cont’d)

Purchasing Manager’s Index: Measures manufacturing activity based on new orders,

inventory levels, production, supplier deliveries, and employment data; compiled by the

Institute for Supply Management.

Components of U.S. Real GDP (Federal Reserve Bank of St. Louis)

• Inventories

• Consumption

• Investment

• Government

• Exports

• Imports


316314 3/19

Terms and definitions (cont’d)

Consumer Price Index: Released by the Bureau of Labor Statistics; used as the

reference rate for Treasury Inflation-Protected Securities (TIPS) and to adjust Social

Security payments

Personal Consumption Expenditures Price Index: Issued by the Bureau of Economic

Analysis; preferred inflation index for the Federal Reserve

Both indexes follow domestic inflation trends, though the CPI has historically reported

slightly higher inflation.


316314 3/19

Real fed funds rate not signaling recession


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Effective federal funds rate — consumer price index for all urban consumers

De

c-1

8


316314 3/19

S&P 500 has already priced in economic slowdown

* Advanced two quarters.

-50%

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-20%

-10%

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Nominal U.S. GDP growth (YoY, left axis) S&P 500 return* (YoY, right axis)


316314 3/19

How rate shifts can effect the price of bond portfolios

Sources: Bloomberg, Barclays, U.S. Treasuries, as of 12/31/18.

Percentage change in bond price

0.25% 0.48% 1.94% 2.82%4.66%

8.50%

19.35%

-0.25% -0.48% -1.94%-2.82% -4.66%

-8.50%

-19.35%

3-month 1-year 2-year 3-year 5-year 10-year 30-year

When rates fall 100 bps

When rates rise 100 bps


316314 3/19

Interest-rate risk is unprecedented given the low level of rates

Sources: Barclays, Putnam, as of 12/31/18.

This chart uses yield to worst as the representation of yield, and modified adjusted duration as the representation of duration.

0

2

4

6

8

10

0

2

4

6

8

10

Du

ratio

n (y

ea

rs)

Yie

ld (

%)

Yield Duration

BBG Barclays U.S. Aggregate Index: historical yield vs. duration


316314 3/19

Recession indicator lead times

The average max drawdown for the S&P 500 during the five recessions shown

above was -22.8%.

Yield curve

inverts LEI hits 0 Recession begins

Lead time

(yield curve) Lead time (LEI)

June 2006 August 2006 December 2007 18 months 15 months

February 2000 October 2000 March 2001 13 months 4 months

December 1989 October 1989 July 1990 19 months 8 months

September 1980 June 1981 September 1981 12 months 2 months

August 1978 April 1979 January 1980 17 months 8 months

active insights: putnam’s 2019 outlook · yield curve* (right axis) the index of leading economic...

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