By virtually any metric, the U.S. economy is looking good. Unemployment is low. Job creation is on a roll. Businesses are enjoying robust earnings and the benefits of a large reduction in the corporate tax rate. The consumer remains confident. And inflation is measured. So if everything’s roses, why does it feel like we’re living under a pall of unease?
In part, this may reflect the 24-7 news cycle where everything, especially dire news, is magnified. On top of that, investors are still coming to grips with the unconventional communication style of President Trump, and there’s no denying that this has heightened uncertainty and volatility. Take, for example, the verbal exchanges regarding trade agreements between the U.S., China, and major European economies, as well as Canada and Mexico. It seems apparent that President Trump is willing to go to the mat in order to level the playing field, but it also injects potential risk to the economic outlook. Fortunately, this does not appear to be impeding business activity—for the moment—but the situation is fluid to say the least.
Trade war concerns, geopolitical tension (North Korea, Iran), and outright political risk (Italy) have been weighing on fixed income investors’ minds. Leaders around the world have exacerbated the sense of uneasiness as they dig in their heels and ramp up the retaliatory rhetoric in defense of their own political/national interests. Add to this a strengthening dollar, higher short-term U.S. interest rates, and a more hawkish tilt from the Fed, all of which contributed to emerging market weakness and volatility. And more recently, a downward spiraling of the Turkish Lira has even raised concerns of contagion.
To some degree this is a story of domestic bliss versus global tumult. Although nobody can predict the future, one thing is certain. The low level of volatility the financial markets experienced in 2017 is behind us, and the bumpiness experienced throughout 2018 may well be with us for the foreseeable future.
Nevertheless, the current economic expansion is now the second longest in U.S. history, and given that real GDP increased at an annual rate of 4.1% in the second quarter of 2018, it appears to have plenty of gas in the tank. We remain positive on the domestic economy; however, we are taking a more cautious view on risk and believe that fixed income investors may want to do the same. Risk premiums, as measured by credit spreads and the yield curve, continue to give us pause with regard to their ultimate risk/reward relationship. Thus in the current environment, credit quality appears more critical than ever. As a result, we continue to reduce our exposure to BBB-rated credit in favor of A-rated credit and agency mortgage-backed securities. In fact, it is likely that our BBB risk reduction could accelerate in the near term.
So while the domestic economy looks good, we think it’s prudent for investors to acknowledge the elevated risks and adjust their fixed income approach accordingly. For INCORE, yield curve positioning and duration will be tactically managed based upon our short-term proprietary signals as opportunities arise.
This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future results.
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All investing involves risk, including potential loss of principal. There is no guarantee that a fund will achieve its objective. Past Performance does not guarantee future results. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
The information and statistical data contained in this material were obtained from third-party sources believed to be reliable; however, Victory Capital does not guarantee the accuracy of the information or data, and the information and data may differ from information provided by Victory Capital. Any opinions, projections or recommendations in this report are subject to change without notice and are not intended as individual investment advice.
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