Markets take Fed talk on tapering, rates in stride

Markets take Fed talk on tapering, rates in stride

Q3 2021 Putnam Retirement Advantage Funds Q&A

  • Risk assets hang on to gains amid multiple headwinds, including inflation, Covid-19, and tighter policies.
  • Our outlook on equities is neutral due to higher seasonal volatility, a move past peak earnings growth, and central bank tapering.
  • We expect upward pressure on bond yields as the Fed gets ready to roll back its stimulus plan.

How were market conditions in the third quarter?

Global equity markets ended the period mixed. Stocks were buoyed by a recovering economy, the lifting of public health restrictions in some countries, and fiscal stimulus. However, risks including higher inflation, likely near-term asset-purchase tapering, China’s weaker economy, and the Covid-19 Delta variant percolated through the markets and pulled stocks down from recent highs. For the three-month reporting period, the S&P 500 Index — a broad measure of U.S. stock performance — gained 0.58%. But the MSCI World Index [ND], a broad measure of equity securities from developed countries, dropped 0.01%.

Interest rates fluctuated within a tight range over the last three months, ultimately ending the quarter slightly higher. Rates fell when the Fed called the rise in inflation “transitory” but moved higher when it signaled tapering could begin soon. In late September, the Fed indicated it was ready to scale back asset purchases as soon as November and could lift interest rates as early as next year. The European Central Bank also said it would conduct bond purchases under its emergency program at a “moderately lower pace” over the next three months.

The rate-sensitive Bloomberg U.S. Aggregate Bond Index, a measure of investment-grade [IG] corporate bonds, rose 0.05% for the period. The yield on the benchmark 10-year U.S. Treasury note rose to 1.52% at the end of September from 1.45% at the end of the previous quarter.

What role did the glide path play in performance?

The glide path of Retirement Advantage strategies is an important feature that distinguishes Putnam from our peers. Our glide path is more aggressive early on. It has a higher stock market weight than the average for our peer group for funds serving people retiring in the 2050s or 2060s. Our glide path becomes more conservative relative to peers for funds serving investors nearing retirement in the 2020s. Given some international and emerging-market equity weakness in the third quarter, longer-dated strategies experienced greater losses than more fixed income-oriented portfolios near retirement.

Longer-dated portfolio losses were a product of higher equity allocations and some equity market underperformance. Shorter-dated strategies still finished lower given negative equity market performance, but a lower allocation to equities meant smaller overall losses.

What investment decisions influenced the funds’ performance during the period?

Overall, our asset allocation decisions slightly enhanced benchmark-relative performance. The portfolios benefited most from our equity positioning during the period. The equity position ranged from modestly overweight to overweight relative to the benchmark early on before we moved the position to neutral at the end of August. In fixed income, our modest underweight position to interest-rate risk and modest overweight position to credit risk did not have a material effect on performance. We moved our credit position to neutral at the end of August. An out-of-benchmark long position to commodity risk contributed a tiny gain. We eliminated this position in mid-August.

Active implementation detracted from benchmark-relative performance. Strategic global macroeconomic trades were the primary source of weakness during the period. The portfolios also experienced a slight loss from our fundamental U.S. large-cap growth strategy. These losses were partially offset by small positive contributions from our fundamental U.S. large-cap value, international equity, and opportunistic fixed income strategies. Our quantitative U.S. large-cap equity and international equity strategies were also slightly additive. In quantitative strategies, our team analyzes stock market history to identify characteristics of stocks [factors] that have excess risk-adjusted returns. During the quarter, our momentum and short-interest factors outperformed.

What is your near-term outlook for the markets?

Despite recent volatility caused by concerns around central bank asset-purchase tapering, inflation, and Covid-19 variants, markets have recovered this year. The stimulative monetary and fiscal policy backdrop among the Group of Ten [G10] advanced countries, historically strong earnings, positive economic data, and ample liquidity fueled financial markets. While we remain optimistic about the recovery, we also anticipate more volatility ahead as investors weigh the impacts of a shift in central bank policy and the unlikely chance of further stimulus. The Fed’s rate-setting committee indicated in September that it could start to taper its $120 billion in monthly asset purchases as soon as its next scheduled meeting in early November. New projections released at the end of the Fed’s two-day policy meeting showed half of 18 officials expect to raise interest rates by the end of 2022.

Given the current environment, our outlook on equities is neutral. This position is supported by a combination of factors including seasonally increased volatility, a move past peak earnings growth, and the expectation for a shift in central bank policy. While we maintain a positive disposition toward equities, we feel risks have become more balanced.

In fixed income, our outlook on credit is also neutral. Given that spreads have been hovering at the tight end of their recent range, and volatility and defaults are extremely low, we expect an uptick in volatility and thus a lower risk-adjusted return as opposed to a substantial widening in spreads. Our outlook on interest-rate sensitive fixed income is slightly bearish, as we believe risks are skewed to higher yields given the expectations for continued economic momentum and inflation spikes. We expect upward pressure on yields as asset-purchase tapering and a shift in Fed rate policy approach. Against this backdrop, we continue to have conviction in our investment strategies based on their strong, long-term results.

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