JOE GRAHAM

Hello and welcome to the Investment Conversation. I’m Joseph Graham, head of the investment strategist group here at Lord Abbett.

In today’s podcast, we’ll ask three Lord Abbett Partners—our co-heads of fixed income, Rob Lee and Steve Rocco, and our head of equities, Matt DiCicco, to bring us up to speed on the risks and opportunities they see in 2024. This is an excerpt of our 2024 Investment Outlook webinar—please visit lordabbett.com if you’d like to register to view the full presentation.

So let’s just get started. Let’s dig into it. You know, in terms of 2023, I think it was surprising. A lot of people were surprised that at the performance, a lot of negative outlooks going into the year.

Then the S&P 500 was up 25%. You had Barclays [Bloomberg] Aggregate close to 5%, right around 5%. You had high yield somewhere, depending on which index, around 13%. Very surprising. Rob, what do you think was behind that surprising performance? What was going on economically and then, the market’s reaction?

ROB LEE

Okay. Well, if you think back to where we were a year ago, market consensus–this is economists, this is strategists, lots of market participants–they thought we were going to have a recession in 2023. And who could blame them, right? When you think about what happened in 2022, you had the Fed hiking very aggressively, more aggressive than they had in decades, 425 basis points of rate hikes in roughly nine months. You had the Fed also shrinking its balance sheet and withdrawing liquidity from the system. You had an inverted yield curve, which historically has been a pretty reliable precursor/predictor of recession.

So who could blame people and market participants for thinking a recession was likely or possible? Some of them thought a recession was going to happen in the first half of the year, some thought in the second half, but what do we get? We didn’t get a recession. And if you look at GDP growth in real terms, inflation-adjusted terms, talking about two, two and a half percent, depending on how we end up, you know, when we get the fourth quarter numbers. That’s certainly not a recession. The reason you had positive GDP growth is the labor markets were pretty resilient and strong.

The consumer stayed strong. The US consumer is roughly 70% of US GDP. And when the consumer is spending and when they have jobs, it’s hard to get a recession. Not impossible, but very hard.

Secondly, and this is also important, the housing market stayed strong and resilient. And when the Fed hikes rates so aggressively, what usually happens is the most interest-rate sensitive sectors of the economy, of which housing is kind of number one, often fall off a cliff. And activity levels in housing, think existing home sales, for example, and transactions. did take a hit.

But when you look at home prices, they dipped down for a period of time, but not that much–I think single-digit [percentages], and then started rising again. So for all of those reasons, we saw a pretty strong economy, solid labor markets, decent consumer spending, a resilient economy, and no recession. On top of that, we actually had inflation coming down from very lofty levels in 2022 but making noticeable, substantial, and I think pretty consistent progress downward.

The path of inflation was certainly positive for markets.

So, when you take a big step back, where do we get? Resilient economy. Housing–house prices. Pretty strong. Consumer spending, and inflation coming down. Well, that sure looks like Goldilocks. Perfect for markets, perfect for asset markets. And you saw the result.

JOE GRAHAM

And that makes a lot of sense, especially with that backdrop of such a negative expectation. Now, the other elements of that and I think, Steve, you can probably shine some light on this, was credit and just the performance of corporate [bonds], you know, over the course of the year. How did margins stay so strong? And just tell us about the kind of evolution of credit over the year?

STEVE ROCCO

Sure. You know, Rob, you know, articulated the story of ‘23 very well, if there were a hundred people in the room this time last year, 95 would say we’d been in a recession, and we weren’t. And that really was the story of ‘23. You know, as interest rates rose, there were certainly recessions–but recessions in asset classes. I think back to ‘21 and venture capital, I think back to ’21-‘22 in real estate that came back around, and then in ‘23, commercial real estate, clearly interest-rate sensitive, you know, parts of the market and the consumer didn’t have that level of interest rate sensitivity, mainly because they were, you know, finance long and locked in at low rates and their homes, and everybody was employed in the labor markets very strong. And because of that one, as it relates to credit, I think most people coming in would have said stay defensive, be up in quality.

It turns out coming off a very weak 2022, which mattered, it very much was a down-in-quality type of rally. So in high yield, triple C’s outperformed single B’s and double B’s and in investment grade, triple B’s outperformed single A and above. And I think that that was not expected, you know, kind of coming into the year and, you know, you have to point to margins. You know I think the same is true when it comes to interest rate sensitivity on the corporate side where, a lot of corporates were, you know, financed longer, right. And there was a lot of terming out of maturity as post-COVID. You didn’t have that interest rate sensitivity. So you didn’t have to worry there as much from a margin perspective.

So there’s been some margin degradation but still very, very healthy, healthy levels of margin.

JOE GRAHAM

Yeah, interesting. How about, Matt, on the equity side? Certainly, a great year for some of the mega caps and others. How about the rest of the equity market? What caused it to rally so, so strongly?

MATT DeCICCO

First and foremost, inflation coming in and moderating at better than expected and doing so without really any sort of economic slowdown. And the translation of economic activity to markets is earnings, corporate earnings. If you remember at the beginning of the year, a lot of people expected that S&P [500] earnings, which were estimated to be about $225 per share, there were there were suggestions that those numbers were too high. Many people thought that the number would come in closer to $200 per share. You had a few very outspoken bears suggesting the number would be more like $180 per share. We haven’t gotten Q4 earnings yet, but it looks like earnings for 2023 are going to come in right around $225 per share.

So you had earnings resilience, so that that would be the earnings resilience without with inflation coming down, I think would be the first two meaningful surprises compared to consensus at the beginning of the year. The third, you mentioned is the strength of mega-cap tech in the second half of 2022, mega-cap tech, or the Magnificent Seven. You know, for a lot of those companies, we’re seeing their earnings being revised down as the calendar turned, their revenues proved to be much more resilient.

Those companies also went on efforts to become much more efficient and saw meaningful margin expansion, which led to earnings coming in better than expected, in some cases, meaningfully better than expected. And I think that was really driven by, or a big a big aspect of that, was the thematic impact of generative AI, generative artificial intelligence. Chat GPT launched—exploded–onto the scene in late 2022.

We were bullish on the impact of generative artificial intelligence, but even I was surprised by how quickly companies translated that into meaningful revenue and earnings upside in in both 2023, and it looks like, into 2024. The Magnificent Seven, in particular, performed well, but you’re now starting to see that impact spread beyond the Magnificent Seven and I think it will be a driver of earnings and revenue growth in 2024 as well.

JOE GRAHAM

Interesting. Okay. So bunch of themes we talked about here. One was that with inflation, companies held margin. Now, as you see inflation kind of backing off, I guess one big question is can they continue to hold margin? And what’s your expectation on that is for next year?

MATT DeCICCO

I do. I think I think margins for 2024 for equities will continue to improve. I think the large mega-cap tech companies were the first to show that level of margin improvement. I think the story of 2024 will be that that margin strength can broaden out. But it’s more than just margin strength. I think there’s also there’s also going to be some nice revenue growth from companies beyond the Magnificent Seven.

So, I’ll pause there. But I’d expect that the margin expansion that we saw in the large companies, you’ll see that both in mid-cap stocks as well as small cap stocks.

JOE GRAHAM

How about on the credit side? Coverage ratios, I know, have weakened a bit. How do you see that developing story?

STEVE ROCCO

Right. I think we’re through the worst of goods, inflation and supply chains of healed, commodity prices have come down, that should all kind of help margins. I think, you know, we talk about coverage ratios. We are, and we’ll get to this. We are in a higher base rate environment, which is my expectation that will continue to some extent, which means that, as you know, you kind of roll through your refinance and your interest coverage kind of deteriorates assuming you don’t get, you know, any earnings growth.

My expectation is you will get more EBITDA growth. So the coverage ratio should remain relatively stable, flat, improve a little bit less if your outlook comes to pass.

JOE GRAHAM

Rob, how about rates–always a tricky one, I know. What what’s your view on rates next year, or this year, how that we’re here?

ROB LEE

Yeah, in 2024. So the calendar year of 2023, I’ll use the 10-year Treasury yield as a good example, ended 2022, started 2023 at around 3.9%. It actually ended 2023 at right around 3.9%, almost exactly.

So if you weren’t paying attention to the markets, you would think nothing happened but that, as you probably know, masked a lot of volatility during the year. Think back to what happened last March with the regional bank crisis–Silicon Valley Bank and Signature Bank and First Republic and others. The 10-year Treasury went to about 3.3% as a low in the spring of 2023.

Then over the course of six or seven months, peaking in October, a pretty steady rise. The economy was strong, third-quarter GDP printed at a very high level. Economic activity was strong. As I mentioned before, the labor markets were solid and stable and resilient and you got to about 5% in October on the 10-year Treasury. And then as you know, in the fourth quarter, we went back down, as I mentioned earlier, to 3.9%.

So actually a lot of intra-year volatility, the ebbs and flows of the economic data, inflation coming down offset in some ways by resilient economy and strong labor market. “What’s the outlook for 2024?” is your question. And that is a key one. What I would say is the way I think about it, the framework that I use is to point to three main things.

The first is, how strong is growth going to be? And I’m talking about both nominal and real GDP growth. I think the projections are about right, and we can talk about why, maybe some deceleration from 2023, but probably somewhere in the ballpark of 2% real GDP growth.

The second major pillar of that framework is, what’s inflation going to do? We talked about what’s happened. We peaked in 2022, depending on the measure you use, it’s somewhere between 7% and 9%. We’re down to three or 4% again, depending on whether you’re using CPI or the PCE or the headline or the core. The main question is are we going to keep going in that direction from three or four to two to three? The Fed’s target is 2%, and I think there’s a decent chance of that. The question is how fast does it happen?

So, the first pillar is economic activity and growth. The second is inflation, the trajectory of inflation. And I think there will be continued progress at some decent rate. And then finally, the Fed reaction function. Fed actions, think rate cuts, which are priced into the market already.

And here I think it’s possible, at least sitting here early 2024, that the market’s a bit ahead of itself. And what I mean by that specifically is roughly six cuts, 25 basis point rate cuts, are priced into markets right now. The Fed’s pushed back against that aggressive Fed cutting cycle. And I think the market may be a little ahead of itself.

So, when I take the big step back, we’re not 5% like we were in October of last year. We’re closer to 4% on the 10-year Treasury. So, what I would say is 4% is much higher yield obviously than the lows we reached during the COVID crisis, much more fairly priced when you really put it together, if you have 2% growth and 2% inflation and a 4% 10-year [yield], it could go up or down, obviously, depending on the evolution of the economy and Fed action.

But I think we’re much closer to fairly priced now.

STEVE ROCCO

So there’s a lot here. I think one of the things that contributed to the rally that we saw late, late last year was the Fed introducing the idea of kind of rate cuts outside of recession, which is extremely bullish. And I do believe that the Fed is restrictive now and they know that. So as hopefully if inflation continues to come down, they become more restrictive, they’re going to fine tune the problem, as Rob suggests, the market kind of extrapolated. Now you’re pricing in kind of six cuts to get to that. It’s probably a much more severe economic scenario than is my base case or probably Robert’s base case as well. And then the other thing you introduce is financial conditions, right? So if financial conditions loosen and that kind of may swing you back right the other way.

And some of this also and we’re talking a lot about the U.S. I mean, this is also predicated, you know, internationally, too, on international growth, right, China was a big disappointment as well as Europe last year, just trying to stimulate more manufacturing, recover–a smaller part of the economy, but I think relevant for next year’s outlook. And then, does that introduce either, you know, higher kind of growth expectation and bring the Fed back in and take out some of these cuts?

Not necessarily a negative kind of argument for some of the areas that we invest in, because you’d still be in a relatively high nominal growth environment which should benefit credit. That’s a good thing. But it may change the overall kind of composition of how you think about your portfolios and kind of what factors may work in that environment.

JOE GRAHAM

Yeah, that’s an interesting point. We actually recently put out a paper on this that high nominal growth and the inflation that can come along with that is actually good for credit. I think sometimes people think that it eats into credit, which it can, but if you keep up with it, you actually need credit more on a portfolio because the real value of that dollar is starting to weaken.

STEVE ROCCO

One of the biggest things was underestimated last year, especially as it relates to high yield. That high yield investor wants you what you would want, high nominal growth. Yeah, it’s great for down in quality exposure.

JOE GRAHAM

How about equities? How do equities survive? Matt in an inflation environment that is higher than it has been historically, but coming down, how do equities typically do?

MATT DeCICCO

Well, I think I generally agree with Rob’s assessment. I think a 2% real GDP world and a 2 to 3% inflation, four or 5% nominal corporate earnings generally grow faster than nominal GDP, so maybe 7 to 9% corporate earnings. With the Fed out of the picture after two years of extreme tightening, I think it’s a very good backdrop for equities because you can get that, you know, 7 to 10% earnings growth without the risk of significant [price-to-earnings] multiple compression from the Fed.

So I would view that that outcome is as a very favorable one for the equity markets.

JOE GRAHAM

Okay. How about, Rob, you mentioned 4% as a 10-year [Treasury yield], kind of a reasonable range to be in. How about the short end and maybe just a view of relative value along the curve?

ROB LEE

Right. Okay. So as I suggested earlier or mentioned earlier, the yield curve is still inverted. So the two-year Treasury yield is about is above the 10-year Treasury yield and above the 30-year Treasury yield. It is not as inverted as it got earlier in 2023, where it was at one of its most inverted points in a long time.

JOE GRAHAM

Over a hundred basis points.

ROB LEE

Over a hundred basis points, lots of different yield curve slopes if you use the two-year to the 30-year. Some people use two-year to 10-year. Some people use fed funds to 10-year, but it was very, very inverted. Right. The reason people would hide out in cash or buy T-bills and sometimes that makes sense was because of that yield differential, it was just you’re paid to wait, if you will. What we saw, quite frankly, later in 2023 was you can leave a lot on the table in terms of price appreciation, because we went from 5% to 4% on the 10-year Treasury and we turned, I’ll use the Bloomberg Aggregate index bond index, we were negative three or 4% in total return year to date at one point.

And very quickly you got 8% to 10% returns. Again, it’s hard to time those things perfectly, but the curve is much less inverted than it used to be. But yields are still reasonably attractive. If the Fed does cut aggressively, which is I think a lot is priced in already, but if it does cut aggressively, you get what we call a bull steepener, meaning the two-year Treasury yield comes down and prices go up, the 10-year Treasury yield goes down, not as much. And you kind of get back to quote unquote, a normal yield curve environment, which means positively sloped where longer maturities have higher yields than shorter maturities.

2024 will be an interesting year. We’ll find out.

JOE GRAHAM

As a reminder, listeners can get more insights on the market and economy in the coming year by registering to view our 2024 Investment Outlook presentation at lordabbett.com. Now back to our discussion.

Yeah. One thing you mentioned, Steve, was the consumer sort of reacted a little differently this time when rates went up. They didn’t necessarily have a lot of floating rate debt, Rob, you mentioned a lot of 30-year mortgages. So a lot of fixed debt. And I think that was one of the differences where the consumer just didn’t care whether rates rose that much–in certain sectors, yes. Are you still seeing that as the consumer starting to turn over now? I know we’ve seen a rise in delinquencies. What’s your expectation for next year for the consumer?

ROB LEE

Okay. So I’ll start and say structurally underestimating the U.S. consumer, as a blanket statement, is a risky thing to do, especially if the if people have jobs, if the labor market is stable, reasonably healthy, although I think it does normalize, it’s decelerated some. But a year ago it was running pretty hot, and two years ago was running pretty hot.

You can call it deceleration. That’s true. I would call it normalization. When people have jobs and real wages, by the way, we talked about inflation coming down last year and especially in the second half, real wages, inflation-adjusted wages started to turn positive. So, when people have jobs and they have real wage growth, consumer spending is pretty decent. That being said, the normalization, the deceleration, I think is fair. The fiscal stimulus that we got in in 2020 in response to COVID and 2021, additional fiscal stimulus, definitely helped the US consumer.

You can see it in deposit levels at banks, you can see it in everyone. We talk about excess savings. There is some element of that gets spent over time. But I’ll go back to my main point, which is you have a job, and you have real wage growth, and on top of that, prices at the pump, energy prices are lower, natural gas prices are lower, we’re going into the winter. So I think maybe some normalization/deceleration, but not falling off a cliff, not a collapse, is my view.

STEVE ROCCO

Again, this is a big subject, but I’d say there’s a couple of things here. And first, I apply it to like the U.S. economy, right? You know, economies don’t just roll over, right? There needs to be some sort of shock. One of them could be an oil price shock. If you remember in Q3, there was very much worry coming up, you know, Q3 heading into Q4, the consumer was going to roll over because oil prices were going to spike and excess savings was winding down. Rob was talking about some of those things. Since then, we’ve seen revisions to actually what that excess savings number actually is, which shows that it’s probably higher than people thought. And I’m not saying there are not parts of the consumer that aren’t weakening. There actually are. But then at the same time, we actually got lower oil prices, which matter, and there’s still a lot of job openings, rates coming down off, you know, I think March was the peak at 12 and a half million and job openings. Now you’re down to eight. That’s good. So the market is loosening somewhat, but still a very, very healthy labor market.

And as long as that remains the case, I don’t see it.

JOE GRAHAM

Yeah.

MATT DeCICCO

You know, I would just echo something Rob said earlier, which is the importance of–and I look at them too–weekly jobless claims to assess what Steve is talking about, if there is some sort of shock and what the impact would be on the consumer. If you saw a 40 or 50% rise in weekly jobless claims, a moving average, so from the low 200,000s up until the high 200,000s, close to 300,000, then I think you do have to worry about economic growth and you have to worry about the you have to worry about the consumer and then you have to worry about U.S. economic growth. You have to worry about S&P earnings. You have to worry broadly about corporate earnings.

You have to worry about markets. So that indicator to me is one that’s critical to watch, to see if the economy is in fact weakening. And we’ve been watching it for the last two years and like Rob said, it’s remarkably, remarkably consistent.

JOE GRAHAM

Yeah.

ROB LEE

Just to jump in here. So tying some of the themes together, one of the things that can cause layoffs and cutting of labor and thus, you know, a potential recession is if companies both large, medium, and small, their margins start to get squeezed too much. And then to preserve revenue and income and cash flow, they cut one of the main areas, one of the main expenses, which are people.

And that’s why it’s so important to watch margins. And if they stay pretty healthy, whether you’re talking about gross margins or operating margins or EBITDA margins, they stay pretty healthy, and we watch pretty carefully. It’s not impossible, but pretty unlikely that you’re going to get large job cuts.

MATT DeCICCO

And just tying it back to what I was talking about with the large technology companies and actually a number of technology companies hired a lot in ‘21 and ‘22. They then had to dial that back. And what was surprising was as they dialed it back, their growth rates really were only minimally impacted. Now we’ll see if in ‘24 and ‘25 that those growth rates are then impacted.

But again, Goldilocks is a bit of a theme here. A lot of these technology companies were able to reduce somewhat their labor force but not see it impact growth and still see a dramatic improvement in margins. Now, technology companies don’t employ nearly many people as other—retail, or manufacturing. So while those headlines were coming out, a lot of people are saying, oh, this is so bad for the economy.

But the numbers ended up not being in aggregate that meaningful across the overall economy because you didn’t see that outside of, well, you saw it, we did see it outside of technology, but not to the same degree. Not to the same degree that you saw within technology.

JOE GRAHAM

One last worry that I hear from a lot of people, and that is the election. Should that be something we’re concerned about this year as investors.

MATT DeCICCO

From an equity standpoint, it will create volatility. If you look back through the history of market cycles with elections, typically the third year of an election cycle is your best year for returns. The fourth year is not bad, though. Typically, your worst year is the midterm, the second year of the election cycle.

So there’s fairly good precedence that markets do well during presidential elections. But I will say this, though, that in a typical year, it’s normal to see a 10% drawdown and in some cases it’s normal to see at least one, at least two of those. So I wouldn’t be surprised if the election causes volatility. But historically, a presidential election is not any reason to be concerned about equity markets. I know this election cycle could be different, but every election cycle is different.

ROB LEE

Yeah, this is what I’d add. So, one of the things that gives me some comfort in for this particular year, in this presidential and congressional election year, is everybody is talking about is one of their main risks. People are already worried about it and it’s early in the year. So, 10 or 11 months is an eternity, as they say in politics and elections.

So that’s the first thing I’d say. The second, gets at, really the structural and foundational strength of the United States. I alluded to some of it before. You have a productive workforce. We have better demographics than many other large, developed nations. We have resilient institutions. I’m not making light of kind of polarization. I’m not making light of less trust in in many of the institutions, governing institutions at the federal level.

But I’d say their fundamental strength and the foundational level for the country–that’s currency, that developed capital markets, that’s rule of law, that’s property rights, that’s the intellectual capital. And I think that’s why generally any election, even though it can create volatility and those can create opportunities for professional investors like us.

JOE GRAHAM

All right. Let’s dig into asset classes a little bit and what your areas of opportunity are and possible areas of risk. Steve, you want to start with credit. What areas do you like this year?

STEVE ROCCO

Sure. So, let’s say it’s a couple of things here. Recognizing that we had a pretty large rally in in spreads to end Q4, which may have taken away some of the return that one would expect this year, because if you look at overall spread levels, let’s just take kind of large sectors like investment grade at 100 basis points or U.S. high yield that let’s say 325 to 350, that’s kind of a top decile environment for a tight spread.

However, you still have a lot of yield and I think yield and carry still matter here. And that’s how we’re trying to optimize our portfolios. And I think you may not want to take on too much of any kind of tail risk, default risk because you’re in a higher base-rate environment and there may be pressures that can kind of play through in certain parts of the market. So, we’re trying to avoid those things. But overall, I think you want to earn carry and if you can get very good carry in U.S. high yield, you get, you know, you can get decent carry in the front end of investment grade as well, in U.S. investment grade, and even parts of securitized product as well.

And so that’s kind of how we’re looking to optimize our portfolios.

JOE GRAHAM

So, you mentioned companies may have trouble refinancing in a higher rate environment. Does that mean you expect default rates to tick up this year or do you think they’ll be relatively flat?

STEVE ROCCO

I actually don’t. I actually think they’re going to drop. I think the market is priced for what we expect. Now, thinking about where default rates are right now, there’s two numbers. One is kind of, you know, just defaults, which is like three, 3%, give or take in U.S. high yield and a little bit higher in leveraged loans. Then there’s defaults including distressed exchanges, which gets you to about 4%, there’s actually a lot of distressed exchanges. But my expectation is those numbers will drop and the U.S. default rate will move closer to two and a half percent and in high yield and stay a little bit elevated in leveraged loans because the base rate effect is more prevalent there.

And when you add that all up and the amount of excess spread that one should expect from high yield, you’re kind of, you know, kind of your default expectation and your recovery rates, which is an important concept because we’ve seen is recovery rates have dropped in particular on the loan side and we’ve have a lot more loan only structures, which means there’s not a lot of cushion below you.

And that’s bled into high yield somewhat because you have a lot more kind of secured issuance in high yield, and then unsecured pieces being layered. So your recovery rates have moved lower. But even with those kind of elements at play, I think you’re kind of at a fair value spread level, based on our kind of default forecast.

And then what becomes very interesting and high yield is kind of the triple C’s. So usually you see a couple of good years in a row of triple C performance, you had a very bad 2020 to get a very strong 2023. We think there’s more kind of elements at play. It suggests some of that triple C spread can normalize closer to, let’s say, a pre-COVID environment. So, we’re looking a little bit more kind of down the capital structure there to see if there are opportunities while trying to avoid some of the, you know, some of that tail risk that we talked about.

JOE GRAHAM

That tightening you mentioned is also relevant for IG [investment-grade bonds], a great fourth quarter for IG. Do you expect that strength to continue and what kind of areas you looking at? Rob?

ROB LEE

Okay. So this is what I I’d say, and it will rhyme a lot with what Steve said. Spreads tightened. It was a bull market in 2023 after a bad bear market in 2022, in almost every asset class you had spread tightening in most sectors, spread sectors of fixed income, non-Treasuries, things with a yield that is higher than Treasuries at any given maturity point.

Did that steal from 2024 returns and carry? Maybe some. When you look at the long-term averages and current trading levels, we are definitely tighter than the long term. By long term I mean 20-plus years of history. We are definitely tighter, but I think that reflects the Fed quote unquote pivot, pretty solid fundamentals as we described earlier.

And therefore, one needs to be selective. And when I say selective, there are areas of the market that we like. One doesn’t need to be a hero to get some pretty attractive assets. So I’ll give you an example or two. Talk about short asset-backed securities tied to the consumer balance sheet and ability to repay. Talk about some of the largest and best-known companies, investment grade corporate issuers in the fixed income space.

You can still get 5% yields for short maturity, not a lot of volatility, those instruments. And that is pretty good. Remember back to the days, as I said, of COVID and think August of 2020, the two-year Treasuries yielding 0.1% and the 10-year Treasury was yielding 0.5%. I think the 30 year was just above 1%. I’m picking the low, but we’re a far cry from that.

So you get that pretty decent Treasury yield and you get some, I wouldn’t say incredibly all-time attractive spread levels beyond that, but you can still get 5% yields on the short end of the curve, very solid, very fundamentally sound, liquid instruments. I’ll talk about one other that we are looking at in the high-quality fixed income space, and that’s commercial mortgage-backed securities.

It has been a very difficult environment with such aggressive Fed rate hikes plus the regional bank crisis–regional banks lend to a lot of real estate borrowers, and that’s been a difficult environment. On top of that, you had COVID and the debates and the issues with return to office and office usage, a big segment and property type within commercial mortgage-backed securities.

Well, you might look at me and say, Hey, you’re crazy. You’re looking at CMBS. And as investors, that’s often a good place to look. You want the timing right, you want the level right and you want, very importantly, very strong security selection and fundamental research. But after such a crisis and so many headwinds, that’s often the best place to find, to create value.

And the newer vintages, the stuff that’s been issued since the COVID crisis and the Fed hikes, well, that is pretty cleaned up, well-scrubbed, much more conservatively underwritten and scrutinized by investors. And the spreads are still pretty attractive.

STEVE ROCCO

And usually when people tell you you’re crazy or it’s hard to buy, those are usually the best things to buy. And I agree with you in the 2024 vintage of CRE [commercial real estate] up in quality, I mean, I think I’d say just kind of around as if you go back to last year, I called it the year of panic. Right. Because and that’s kind of these frequent narrative shifts that you can get caught up in as an investor, right? That goes like the regional banking crisis, hard landing. Then it’s soft landing. It’s no landing, it’s re-acceleration and it’s Goldilocks. And I think trading those extremes, I think, if you do it, you know, countercyclically, right, it actually was a good thing for you.

But if you get caught up in any one of them, it becomes a very bad thing. And so we want to keep it kind of the big picture, you know, front and center. And if you believe in this idea that the economic environment is going to hold, then you’re going to earn your carry.

JOE GRAHAM

How about equities, Matt? What areas do you like?

MATT DeCICCO

Yeah, so I’ll start with some themes because I think there’s themes that cut across a number of different types of equities that are attractive. I mentioned generative artificial intelligence before, I think that will continue to be a theme not just in 2024, but beyond 2024. I think this technology is the seminal technology of this decade, like the integrated circuit of the seventies, like the personal computer of the eighties, like the Internet of the nineties, like the iPhone of the 2010s, like the cloud, excuse me, the iPhone of the 2000s, the cloud [computing boom] of the 2010s.

So I think this is going to have an impact for the next several years. And so generative artificial intelligence, there’s a number of different ways to play that beyond just technology stocks. So that’s I think that’s a big theme for 2024. I think the uptick in industrial spend due to the reorganization of manufacturing after COVID, due to fiscal spending, due to geopolitics, I think there’s companies that benefit from that.

Again, that cut across a number of different sectors that are very attractive. I think medical innovations. Last year, a big story was new innovations in metabolic diseases. I think medical innovations is going to be a big theme in 2024, in metabolic diseases, in neurological diseases as well as in in rare diseases. Other, more mature trends but still have a lot of runway left is the conversion to cloud computing, as well as the conversion from offline to online spending, whether it be for goods, whether it be for services, for streaming, for advertising.

So those are themes that really cut across a number of different areas. I think if you think about what types of stocks can do well in ‘24, I think growth stocks, based upon a 2% kind of real GDP environment, growth stocks tend to do well in that backdrop just because the scarcity of growth makes companies that can grow secularly 10, 15, 20% more attractive, they’re more scarce.

I also would highlight that some of those themes I mentioned tend to hit, they do tend to cut across all sectors, but they hit a lot of the growth sectors. I think quality stocks, I know that’s an evergreen recommendation and I do think quality stocks should be part of any good portfolio, but particularly in a normalized interest rate environment, companies with high return on equity, with low debt-to-capital, with good management teams that can allocate capital efficiently are particularly attractive. The third area is, we have to look at small cap stocks just because after a lackluster ‘23 for small cap earnings, certainly compared to what I described for large cap earnings, it looks like small cap earnings are set to rebound in 2024. And more importantly, you’re getting prices that we haven’t seen in small cap stocks, at least relative to large cap stocks, in 25 years. And I do feel good that that the earnings growth this year will be better than it was last year.

So growth stocks, quality stocks, small cap stocks, and those five themes would be areas I’d look to invest in.

JOE GRAHAM

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