Recession fears grow as central banks hike rates

Recession fears grow as central banks hike rates

Q3 2022 Putnam Retirement Advantage Funds Q&A

  • Volatility spread across global financial markets during the quarter, with all major asset classes suffering declines.
  • Yields have moved higher in recent months due to a significant shift in Fed policy.
  • We expect market volatility to persist and investor sentiment to waver given many uncertainties and fears of a recession.

How were market conditions in the third quarter?

Volatility spread across global financial markets during the three-month period, with all major asset classes suffering declines. Despite a bear market equity rally in July, stocks and bonds lost steam due to myriad macroeconomic headwinds. High inflation, weakening global growth, supply chain issues, and the Russia-Ukraine War fueled market volatility. China’s zero-Covid-19 policy also prompted extended lockdowns, further complicating global trade.

Persistently high inflation remained a top priority of the U.S. Federal Reserve. The Fed signaled its commitment to a restrictive monetary policy stance until inflation is brought back down to its 2% target. The Fed instituted a 0.75% rate hike in July and again in September, bringing the federal funds rate to a range of 3.00% to 3.25%. As a result, yields on U.S. Treasury bonds moved higher and their prices declined during the quarter. The yield curve remained mostly inverted over the three months, which in past economic cycles has been an indicator for recession. Investors sought safer-haven assets, fearing the Fed will not be able to execute a soft economic landing. Several other global central banks raised rates to control inflation, including the Bank of England, European Central Bank, and Bank of Canada.

For the three-month reporting period, U.S. stocks returned –4.88%, as measured by the S&P 500 Index. International stocks ended lower, returning –9.36%, as measured by the MSCI EAFE Index [ND]. Investment-grade [IG] bonds also posted losses, with the Bloomberg U.S. Aggregate Bond Index returning –4.75%. The yield on the 10-year U.S. Treasury note began the period at 2.97%. After peaking at 3.97% on September 27, the 10-year U.S. Treasury yield ended the period at 3.83%.

How did Putnam Retirement Advantage Trust perform during the three months ended September 30, 2022?

All vintages of Retirement Advantage Trust delivered negative returns, driven by weakness across all asset classes. For the quarter, U.S. fixed income fared better than global equities. As a result, fixed income-oriented portfolios for savers nearing their retirement target date finished ahead of equity-centric longer-dated strategies.

Longer-dated portfolio losses were a product of their higher equity allocations and weakness across equity markets. Shorter-dated strategies were also impacted by this decline but finished with higher returns as fixed income outperformed equities.

Putnam Retirement Advantage Trust invests in underlying Putnam collective investment trusts to create a diversified target-date portfolio. We use an important tool called a glide path to determine the funds’ allocations among asset classes and the underlying funds over time. With the glide path as a reference point, our portfolio managers make tactical decisions based on our analysis of current market risks and opportunities. Funds intended for investors further from retirement underperformed near-retirement funds during the period.

What strategies affected performance positively and what detracted?

Overall, our asset allocation decisions aided benchmark-relative performance. This result was primarily driven by our equity positioning. We entered the period with a modest underweight position to equity risk, which detracted from performance in July due to the brief market rally. We moved the position further underweight in August and held this position until quarter-end. This lifted performance as stocks moved into correction territory. An out-of-benchmark long position to commodity risk detracted from results. We decreased our position to be modest-ly long at the end of September. The portfolios were neutral with respect to interest-rate risk.

Overall, our security selection decisions boosted performance. Our quantitative U.S. large-cap core and international equity strategies experienced strength. In quantitative strategies, our team analyzes stock market history to identify characteristics of stocks [factors] that have excess risk-adjusted returns. Over the period, our price momentum and earnings momentum factors added value. Our fundamental U.S. large-cap value strategy also aided results. The portfolios experienced a modest gain from our fundamental international equity strategy. The emerging market equity strategy posted a small positive return, benefiting portfolios furthest from retirement.

What is your near-term outlook for the markets?

Volatility has been a major constant across markets year to date. Rising inflation, supply chain disruptions, monetary policy tightening, and the war in Ukraine have weighed down most asset classes. Looking ahead, we expect market volatility to persist and investor sentiment to waver given many uncertainties and fears of recession.

Our near-term outlook for equities is bearish. We think the equity market has yet to bottom given the Fed’s hiking bias and the lack of improvement in labor market tightness. We believe the brief equity rally in July 2022 was not justified by economic activity. Our breadth thrust signals [a technical indicator that determines market momentum] also have not confirmed the start of a new bullish trend.

Our near-term outlook for rate-sensitive fixed income is neutral. We have believed for a while that the Fed will need to hike faster and more than the market anticipates to reduce inflation. This is negative for duration exposure. How-ever, this view is tempered by the reality of deteriorating economic data and heightened recession risk, which could be a catalyst for interest rates to move lower.

Our view on commodities is slightly bullish. A strengthening U.S. dollar, rising real yields, and building recessionary forces exist as headwinds for commodities. However, in the medium term, we still believe that supply constraints are a reason to be bullish.

Against this backdrop, we continue to have conviction in our investment strategies given our ability to adapt the portfolios to changing market conditions.

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