Osterweis Capital Management

Much has been made of the market’s relationship with the Fed in recent months.

In downward trending markets as we have seen for much of 2022, it is important to distinguish price declines which may present similarly.

Equity markets have struggled so far in 2022, but in our view the declines are largely due to “The Great Normalization” – the unwinding of the Covid economy that was defined by excess liquidity, unusually high demand, and extremely low interest rates.

Despite the Fed’s aggressive tightening policy, we think inflation still has a ways to run, though we remain cautiously optimistic about the economy.

With investors wondering whether we are finally through the worst of the selloff, our latest Strategic Income outlook tries to answer the question, “Are we there yet?”

Many of the participants in the short-term credit market use it as a place to deploy cash while waiting for higher risk opportunities.

For the better part of the last decade, interest rates have been near zero and leverage has driven asset prices higher.

Concerns about the Ukraine war, inflation, and the Fed were top of mind last quarter, but a lesser appreciated long-tern headwind is the de-globalization of the labor force, which could have profound effects on the economy.

Russia’s invasion of Ukraine has exacerbated inflation, which was already rising. The big questions now are how far will the Fed be willing to go to slow inflation, and how will the market react as rates increase?

The war in Ukraine has further complicated the investment backdrop, and fears of a recession are rising now that the U.S. yield curve has inverted. Given so much uncertainty, we are focusing on what we can control and maintaining a defensive posture

Bonds have started slowly in 2022 due to persistent inflation, a looming Fed tightening cycle, and the Russia/Ukraine conflict. We believe the Osterweis Strategic Income Fund is well-positioned to address these challenges, as its flexible mandate and defensive approach help to protect against rising rates and market volatility.

The Ukraine conflict has escalated rapidly, creating a massive humanitarian crisis and increasing volatility across financial markets. In this piece we review the major economic implications of the war and discuss the steps we are taking to manage the impact on portfolios.

In our latest outlook we examine the long-term implications of the pandemic, particularly changes to the labor market and the supply chain, and we discuss why we will be focusing on companies with pricing power in 2022.

Now that the Fed has officially stopped referring to inflation as “transitory,” the question is whether they can bring it under control without slowing the economy. In our view, they have the right tools – reducing the balance sheet and raising the fed funds rate – they just need to trust their data and keep a steady hand on the wheel.

As we reflect on 2021, we can’t help but feel it was quite a year. Looking ahead, we think many of the same headwinds and tailwinds are likely to persist in 2022, so we are trying to find the right balance between offense and defense.

Small cap growth stocks lagged for most of 2021 as the market simultaneously dealt with the pandemic, inflation, and tightening Fed policy. Given these challenges, we have been focusing on high quality companies trading at attractive valuations, and we have also been looking at non-technology businesses that are embracing digitization.

The fund is rated 5 stars in the Small Cap Growth category for the 5-Year, 3-Year, & Overall Periods. As of November 30, 2021, the fund was rated against 507 small cap growth funds in the 5-year category and 574 funds in the 3-year and overall categories, based on total returns.

Interest rates were mixed in November, as shorter maturity yields continued to rise while longer maturity yields fell further. The continued flattening of the yield curve reflects the market’s expectation that the Fed will be more aggressive in their tapering of official purchases and potentially raise the fed funds target rate more quickly and aggressively than previously thought.

Interest rates were mixed in October, as shorter maturity yields rose while longer maturity yields fell. The dramatic flattening in the yield curve reflects the market expectation that the Fed will begin tapering its bond purchase program imminently and has pulled forward expectations for rate hikes once the taper is completed.

Concerns about inflation and a looming Fed taper weighed on markets during the third quarter, but in our view the post-pandemic economy is well-positioned for extended cycle of capital investment, providing the impetus for broadening economic growth and job creation.

The investment grade market was relatively calm in the third quarter, but we are concerned about undercurrents lying beneath the surface. In particular, we feel the dual threats of persistent inflation and a less accommodative Fed have the potential to impact pricing over the near to medium term.

Despite multiple headwinds, including increasing inflation, rising rates, and tight labor markets, our view is that the U.S. economy is in good shape. Markets may experience higher volatility as the Fed begins to taper its bond buying program, but we expect that to be a short-term issue.

The Fed continues to assert that elevated inflation is largely due to “transitory factors,” but the Underlying Inflation Gauge, which is published by their own New York branch, tells a different story. To understand where inflation is heading, we advise investors to pay close attention to UIG data, even it if the Fed doesn’t.

U.S. Treasuries ended their 4-month streak of positive returns and falling yields in August. Intermediate maturity yields rose more than shorter and longer maturities, as the market began to see through the impact of the Delta variant and focus more on the Federal Reserve’s plan to scale back their bond buying program.

Longer term Treasury yields fell for a fourth consecutive month in July, as concerns around the resurgence of coronavirus weighed on forecasts for continued economic growth. Agency MBS underperformed investment grade corporates and Treasuries. While some inflation metrics set generational highs, and other economic data indicated a continued recovery, investors were focused on the potential impact of viral spread.

Equities continued to rally in the second quarter, but the market remains undecided about whether the recent uptick in inflation is more likely to be transitory or persistent.

Despite a strengthening economy in the second quarter, investors were highly focused on the Federal Reserve’s response to the recent spike in inflation data.

Our economic outlook remains constructive, though we recognize it’s still too soon to know whether the current bout of inflation is transitory. Given the potential for rate increases, particularly after the Fed’s comments in June, we continue to prefer non-investment grade bonds, as they have lower duration and higher yields.

Rising interest rates generated negative year-to-date returns for investment grade bonds in 2021, but the second half of the year looks more promising. We believe the combination of reduced supply and strong demand will create attractive opportunities, and we are constructive on corporate credit and asset backed securities (ABS).

Following the June Federal Open Market Committee (FOMC) meeting, the Treasury curve flattened as the market reacted to a more aggressive hiking schedule than previously expected. Risk continued to perform well as investment grade (IG) corporates outperformed again and tightened through levels not seen since 2018. Economic data continues to improve showing the reopening remains on track, but investors remain focused on elevated levels of inflation.

Growth stocks have lagged cyclicals so far in 2021, but we remain steadfast in our belief that secular growth is the key to generating long-term returns. In this piece, we discuss how we find attractive opportunities in the small cap universe.

After idling for decades, electric vehicles (EVs) are finally ready to charge ahead. Changes in the regulatory landscape, decreasing costs, and a substantially wider range of buying options have transformed the industry and created a powerful secular growth trend. One little known electronics supplier, Aptiv PLC, is particularly well-positioned to take advantage of the opportunity.

Treasury yields fell again in May and credit spreads approached recent tights as the virus continued to recede, allowing the reopening of the economy to progress. Economic data was noisy this month, largely due to base effects, but confirms the ongoing trend of renewed growth and signs of inflation.

Inflation has been top of mind for investors throughout 2021, as a combination of supply chain disruptions and pent up demand have led to higher prices throughout the economy.

Although we remain constructive about the economic outlook, the recent increase in speculative activity gives us some pause. We continue to favor a cautious approach in the near-to-medium term.

Investors aggressively sold off Treasuries in the first quarter in favor of risk assets. We think this is likely to continue as the economy strengthens and inflationary pressures build, and we are maintaining a defensive duration profile to protect against rising rates.

Despite a volatile first quarter, economic fundamentals appear to be improving. We are constructive on the equity market in the near-to-medium term, but we are closely monitoring inflation and interest rates.

Defining a quality business is easier said than done. We have found that the highest quality businesses either consistently exercise pricing power while maintaining market share or consistently grow market share by undercutting incumbents. A choice few companies we call “compounding machines” can both raise price and increase market share.

Treasury yields rocketed higher in February, with the move again concentrated in longer maturities. Volatility spiked as liquidity dried up in the Treasury market, especially after a very weak 7-year auction that briefly pushed 10-year Treasury yields to 1.60%. The news flow was largely the same direction: an improving economy, increased vaccine rollout with deaths and hospitalizations turning sharply lower, and a continued march toward a substantial fiscal stimulus plan.

Treasury yields continued to march higher in January, with the move again concentrated in longer maturities. Mortgage spreads tightened slightly, while corporate bond spreads were mostly mixed. The market remains stuck between the push/pull of the prospect for greater fiscal stimulus and ongoing vaccine rollout versus continued lockdowns and the greatest one-month mortality rate since the pandemic began nearly a year ago.

Several pundits have raised the possibility that the current Covid-recession will be followed by a boom reminiscent of the Roaring '20s. Although we think that may be a tad too optimistic, we think the recovery will continue and feel “real economy” stocks could fare particularly well.

2020 was a remarkable year, to say the least. As we begin 2021, we are faced with as many questions as we have answers. While the global pandemic caused economies to come to an abrupt halt in early 2020, we are now seeing some recovery, albeit tempered by recent spikes in infections.

As the new year begins, the investment grade (IG) market faces multiple challenges, including a recovering economy, low yields, tight spreads, and record high duration. At the same time, market technicals remain favorable, fundamentals are improving, and there are attractive sectors in the index. Overall, we are modestly bullish about 2021 and feel there are compelling opportunities for those who know where to look.

The coronavirus pandemic was a once-in-a-lifetime event that transformed society and the economy almost overnight. We believe some of the most significant changes are likely here to stay, and we are focusing our investments on the secular growth trends we expect to strengthen as life returns to normal.

Although investors don’t normally think about trash when they’re looking for growth stocks, we believe the solid waste industry is well-positioned to outperform. In our view, the combination of high barriers to entry, stable demand, and opportunities for consolidation should provide reliable revenue growth for the foreseeable future.

Despite ongoing weakness in the economy, stocks continued to rally in the third quarter. At first glance it seems perplexing, but a deeper analysis reveals that the market drivers are both rational and sustainable. In our view, the pandemic has created profound shifts in demand that have generated strong tailwinds for a wide range of firms.

Markets have continued to rally despite the ongoing economic impact of the pandemic and the uncertainty of the upcoming U.S. election. We’re expecting increased volatility in the near term, and we think a cautious approach is the best course of action.

Markets continued their recovery during the 3^rd quarter, but the narrative transitioned from concerns about the pandemic to the U.S. election – a trend that we expect to continue in October. The outcome will likely have a material impact on both fiscal stimulus policies and Treasury yields.

The investment grade fixed income market has been unusually active in 2020. Initial concerns about Covid-19 triggered a sharp selloff, but sentiment abruptly reversed when the Fed announced plans to purchase corporate bonds. Spreads have nearly returned to their pre-pandemic levels, but not all sectors have recovered equally, creating interesting opportunities for savvy investors.

Following decades of investment and cost reduction, electricity from renewable energy should be cheaper than most existing fossil- and nuclear-fueled electricity within the next three-to-five years. We believe selectively investing in operators with scale and cost advantages in this sector should be rewarding given the increasing demand for clean energy.

Thus far the market has shrugged off the recent rise in Covid cases, but the situation remains fluid. In our view, the best strategy is to invest in companies that are able to grow during this time of stress, either organically or by increasing market share as weaker competitors fall by the wayside.

Markets rebounded during the second quarter, aided by monumental support from the Fed. We expect the economy to continue improving, but given the recent wave of Covid cases we also expect some bumps along the way.

While we appear to have averted the worst pandemic outcomes so far, a resurgence in recently reopened states shows that we are not yet out of the woods. In our view, the economy will not fully recover until there is a vaccine or a reliable treatment.

In the era of social distancing, technology has become even more integrated into our personal and professional lives. We believe this trend will persist even after the pandemic passes, and we expect it will particularly benefit firms that support remote working arrangements and eCommerce, two areas where we anticipate accelerating adoption and sustained growth.

Rarely has market performance and sentiment changed so quickly than what has been observed in the first quarter of 2020. The start of the year was promising, with the S&P 500 climbing above 5% through the middle of February...

According to John Sheehan, the recent selloff in Investment Grade fixed income was exacerbated by technical factors. In his view, regulatory changes implemented after the 2008 crisis removed a critical shock absorbing mechanism that caused spreads to spike.

As we have written several times over the last 10 years, inflation has been kept down by the twin forces of globalization and technology (particularly digital technology). These forces are not going away, and in fact, digital technology is becoming increasingly pervasive throughout the economy, dramatically increasing efficiency and lowering costs in industry after industry. We do not see this trend abating.

2019 proved to be a very strong year for almost all financial assets, as equities and bonds rallied in tandem. The Federal Reserve (the Fed) was compelled to play defense against a weaker global economy (particularly in Europe) and continued uncertainty related to the trade dispute between the U.S. and China.

2019 was a very good year for investors. Surprisingly, both offensive and defensive sectors did well, which is a marked about-face compared with 2018. We believe this is mostly due to a central bank shift to policy easing, especially in the U.S., coupled with a relatively steady economy.

The venture capital industry has created a robust pipeline of new public companies, but in our view discipline is the key to finding the best opportunities.

The venture capital industry has created a robust pipeline of new public companies, but in our view discipline is the key to finding the best opportunities.

The fixed income market benefited in the third quarter as both global growth fears and the trade dispute continued to drive uncertainty in financial markets. With Europe remaining in an economic rut and China showing signs of slowing from the protracted trade conflict, investors sought the safety of U.S. Treasuries, pushing up prices and reducing yields.

Looking at the beginning and ending levels for equities and fixed income during the third quarter, one might erroneously conclude that it was another summer snoozefest. However, there was volatility during the quarter as the equity markets shrugged off a sloppy August awash in second quarter earnings disappointments and staged a solid comeback rally through September.

During the third quarter, the stock market, as measured by the S&P 500 Index (S&P 500), posted a modest 1.70% gain, while the U.S. economy enjoyed a continuation of the recovery begun in 2009. Both achievements were remarkable...

In our experience, family-owned private firms and small-to-medium sized public companies are most likely to borrow responsibly and prioritize bondholders ahead of other investors.

According to John Sheehan, accommodative Fed policy and favorable market technicals drove the investment grade credit market’s strong start to 2019.

In our view, the specific market dynamics that influence a company's sales growth prospects have a greater impact on equity returns than the overall direction of the economy.

Fixed income markets will be hard pressed for an encore performance of the second quarter. Risk assets of all flavors rallied in conjunction with Treasury yields falling – whether this is causal or simply concurrent remains to be seen.

The financial press is replete with stories about what possible calamity awaits if the Federal Reserve (the Fed) does not cut the fed funds rate soon. Services that track the odds of a cut (at this writing) are calling with near certainty for one in July.

During the second quarter, the stock market continued to rebound from last year’s fourth quarter swoon. This reflected the recognition that neither the trade war nor Federal Reserve (Fed) monetary policy was about to torpedo the long, slow recovery from the 2008 housing debacle.

Seizing on the success the equity market had in forcing Federal Reserve (“Fed”) chairman Powell’s hand in January 2019, the bond market decided to take its own swing at dictating Fed policy.

Last year’s fourth quarter selloff was largely triggered by fears that the Federal Reserve (the “Fed”) had overshot the mark with its December rate hike, and that elevated borrowing rates would cause a recession. The Fed’s subsequent pivot back to accommodation and calming suasion was very well-received by investors in the first quarter, as risk assets such as equities and high yield bonds snapped back nicely.

After suffering a tumultuous fourth quarter last year, the stock market rebounded nicely in the first quarter of 2019. Fears of an economic slowdown, escalating trade wars and monetary tightening gave way to optimism over continued economic expansion, low unemployment, a trade deal with China...

2018 marked the end of an era for fixed income investors. The combined tailwinds of quantitative easing and an accommodative Fed policy that defined the past decade were replaced by rising rates and increased market volatility. The path forward for fixed income in 2019 is less certain than it has been at any time in recent memory.

During this presentation, Eddy Vataru, lead portfolio manager of the Osterweis Total Return Fund (OSTRX), will share his current economic outlook and provide practical insights into developing an investment grade strategy that is flexible enough to handle today’s new realities. Eddy will explain how to combine duration management, sector allocation, and security selection to respond to a wide range of market conditions as well as the risks that need to be considered. Finally, he will discuss how this type of strategy fits into client accounts.

The fourth quarter of 2018 saw U.S. equities decline materially, with especially steep falls in December. During the fourth quarter the equity market as measured by the S&P 500 generated a total return of -13.5%, bringing full year S&P returns to -4.4%. While disappointing, these results need to be seen in the context of a broader and much more severe downturn in global equity markets.

The markets have not been kind to investors lately. There were precious few bright spots in the recent quarter, and it seems there was nowhere to hide, except cash. Our instincts, however, tell us that cash is not a long-term solution.

The past quarter has had its fair share of market moving events, including another Federal Reserve (Fed) hike, a flattening yield curve, geo-political events and potential tariff wars. As we wrote last quarter, separating the signal from the noise remains challenging, but we feel it is the key to keeping perspective.

During the second quarter the equity market as measured by the S&P 500 Index had a total return of 3.4%, bringing the year-to-date total return to 2.6%. Second quarter performance reflects the continued low-inflationary expansion of the U.S. economy and the attendant growth in corporate profits. All else being equal, we would expect these trends to persist. The question, of course, is whether “all else is equal.”

Written in 1606, Shakespeare’s words are just as relevant today. Tweets and eye-catching headlines dominate the news cycle and many conversations, but when you parse them for impactful content, you realize it’s mostly just white noise.

During the first quarter of 2018, the stock market, as measured by the S&P 500 Index, had a total return of minus 0.8%. Despite the roughly flat performance for the quarter, volatility spiked to levels not seen in several years.

2017 was a year characterized by low volatility, a flattening yield curve and narrowing corporate bond spreads. The economy grew modestly and the Federal Reserve (the Fed) began to pull back its monetary accommodation. 

During the fourth quarter, the stock market, as measured by the S&P 500 Index (the S&P 500), rose another 6.64%, propelling its full year 2017 total return to 21.83%. This reflects the continued low inflationary economic expansion, rising corporate profits and a very clear pro-business agenda in Washington.

In sum, while there are certainly signs of excessive risk-taking in some areas, we feel that they are not systemic risks such as we saw in 2008. A healthy tailwind to corporate profit growth aided by the recent corporate tax rate cuts means that we will not likely see signs of economic weakness for a few years.

During the third quarter, the economy continued its slow, low inflationary expansion and the equity market continued to gain ground. Real Gross Domestic Product (GDP) expanded by an estimated 2.5%, and inflation hovered around 2.0%.

In a nutshell, we believe that the slow growth, low inflation trajectory will continue a while longer and, as a result, the Fed can maintain a very measured pace unwinding its unprecedented monetary ease.

“It is a Riddle, Wrapped in a Mystery, Inside an Enigma: but Perhaps There is a Key” - Winston Churchill

“Not see the forest for the trees” is an idiom derived from British English that describes someone who is so focused on the minutiae that they miss the larger picture.

During the first quarter of 2017, the stock market (as measured by the S&P 500 Index) enjoyed a 6.07% total return. The gains reflect (1) the steady, persistent, non-inflationary economic recovery that has characterized the post-2008 period and (2) investor enthusiasm for President Trump’s pro-business, pro-growth policies.

Since the election of Donald Trump as our next President and the Republicans’ win of both the House and Senate, much has changed in regards to our economic and investment outlooks.

Investors would have done well in 2016 to heed the words of Heraclitus, paraphrased: “Expect the unexpected.” Brexit and the U.S. election results were two glaring examples of the unexpected becoming reality.

We still believe our economy is likely to remain in a slow growth and low interest rate environment for some time. If rates do indeed get pushed lower by the relentless search for “safe-haven” yields, then other markets, such as high yield bonds, may follow. Since shorter duration, high yield bonds currently offer meaningfully higher yields than Treasuries, a further boost caused by a rally in Treasuries accompanied by flat or even tighter spreads could have a further positive impact on total returns in high yield bonds. Given the possibility for higher market volatility going into the election and beyond, we are keeping our defensive, shorter-duration bias and maintaining ample liquidity. Hopefully we can take advantage of bouts of market weakness to acquire both convertible and high yield bonds at attractive yields.

We are now seven years into both an economic recovery and a bull market. Because the 2008 Great Financial Crisis and the subsequent economic recovery were unlike any other since the Great Depression, it makes sense to look back and see from whence we came and to look forward and try to see whether current trends can be sustained.