Policy makers’ response to the economic turmoil of the COVID-19 pandemic has profoundly affected income markets. Eagle Asset Management Managing Director James Camp discusses navigating a changing investment landscape.

How has the COVID-19 pandemic and related economic crisis affected fixed income investing?

You can’t separate the economic impact of COVID-19 from the response of central banks and our government. There are two diametrically opposed forces. The real economy suffered its sharpest downdraft in history, with financial assets going through an unprecedented period of volatility in March 2020. Then the policy responses followed in largescale fashion. The result has been a recovery in nominal gross domestic product (GDP), which is now higher than pre-pandemic levels. S&P 500 earnings are expected to eclipse their pre-pandemic peak later this year. The recovery across asset classes has been extraordinary. Investors are now faced with a conundrum: Consume some of their gains in the face of low interest rates, go further out on the credit risk spectrum to search for yield, or modify their budgets and expenses in retirement. Frankly, we recommend a combination of all three.

What is your team’s outlook on interest rates beyond the near term?

We’ve seen a meaningful increase in intermediate- and long-term interest rates this year, and we believe this trend is likely to continue over the next two to three quarters. In the U.S., 34% of all household income is attributable to government programs such as Social Security, Medicare and Medicaid, unemployment insurance, stimulus payments, and veterans’ benefits. The percentage has more than doubled over the last 12 months because of the stimulus. Think about that for a minute. Labor shortages are materializing across the country. This is partially attributable to less monetary incentive for workers to return to work as a result of the unprecedented fiscal rescue packages that have been passed. To fill positions, some companies are going to have to pay higher wages to offer more competitive wages relative to government stimulus. The marginal propensity to spend has accelerated, and we see that in retail sales data as well as supply chain disruptions, the latter of which is unlikely to resolve itself completely within the next few quarters. These are all telltale signs of inflation. Interest rates have historically followed inflation, and real interest rates (interest rates adjusted for inflation) remain below 0%. To be clear, we do not believe interest rates or inflation will become unhinged. However, we believe interest rates remain biased higher.

The U.S. Federal Reserve (Fed) has signaled emphatically a do-whatever-it-takes policy. That can exist for extended periods, as we saw after 2008. But how will the Fed react if inflation stays above the 2% target for multiple consecutive months? Our forecasts show the Consumer Price Index (CPI) is likely to exceed 3% and possibly 4% in the May and June time frame. This will level off in the back half of the year as the year-on-year comps become tougher, but CPI will still likely remain above 2.5%. If inflationary forces persist into 2022, we believe the Fed may be forced to act more quickly than it has indicated up to this point. As we move through the summer, the Fed has a tightrope to walk with regard to messaging on interest rate policy and inflation.

What advice are you giving fixed income investors now?

We are advocates for multi-asset class approaches and an active approach to income-producing stocks, income-producing fixed income instruments, and, from time to time, cash as a risk diversifier. We also believe in tax-aware investing where non-qualified monies are in play. The municipal and taxable markets move to different sets of stimuli. The Federal Reserve directly engaged in the Treasury market, and tangentially engaged in the corporate and municipal markets. The further we get away from direct Fed control, the better opportunities we have to achieve relative value. Fixed income investors are going to be, over the next five to 10 years, not only consuming their income stream, but consuming a part of their capital. In that case, we have to make sure there’s a growth component to their portfolio income allocation. That’s why some of our product designs have an equity component built into them. The trailing 12-month returns in the fixed income market are well above the long-term mean. An active approach aims to harvest some of those gains in the form of distribution with the goal of protecting those gains so they can be used for lifestyle and expenses instead of evaporating when interest rates do an about-face.

For clients seeking income, how do you recommend allocation among asset classes?

We are firm believers in a dynamic asset allocation within fixed income. Those now in cash markets or in pure Treasuries are going to have purchasing power eroded at these yields. We believe it is wise to step out from the risk-free and cash world. For many companies, the yield on their equity is now higher than the yield on their corporate bonds. Moreover, corporate earnings have improved dramatically from the depths of the pandemic, and financial conditions remain incredibly supportive. These are positive developments for equities in our view. A flexible or agnostic approach to income generation can attempt to optimize the income stream within blue chip American companies.

How can active management offer benefits in the current income environment?

The biggest advantage I think Eagle has is a meshing of the teams between the Equity Income and Fixed Income groups. This is a security picker’s market. An active manager can position a portfolio to protect the downside, but also benefit from a positive outcome by sector rotation and security selection. Much is being written about the death of 60-40 balanced portfolios. We essentially killed balanced portfolios a decade ago. And in their place we offered a thoughtful and robust tactical asset allocation to balanced investment which we think will continue to benefit investors going forward.

The last thing I will say is it’s okay in your conversations with your financial professional to discuss the third part of the ledger, which is expense modification. We are in a lower income-producing environment. Eagle is managing risk. We are managing income and income growth. But when the opportunity set for income production changes, you either manage expenses, consume some of the capital, which can be fine, but you don’t simply reconfigure the risk to make it all balance. Everything has to work in unison.

ABOUT Eagle Asset Management

Eagle Asset Management provides a broad array of fundamental equity and fixed-income strategies designed to meet the long-term goals of institutional and individual investors. Eagle’s multiple independent investment teams have the autonomy to pursue investment decisions guided by their individual philosophies and strategies.

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About Carillon Tower Advisers

Carillon Tower Advisers is a global asset-management company that combines the exceptional insight and agility of individual investment teams with the strength and stability of a full-service firm. We believe providing a lineup of institutional-class portfolio managers — spanning a wide range of disciplines and investing vehicles — is the best way to help investors seek their long-term financial goals. Ultimately, this structure allows investment teams to focus on what they do best: managing portfolios.

Carillon Tower Advisers provides support services, including marketing and sales, to affiliated financial professionals. Carillon Tower Advisers’ affiliates (Eagle Asset Management, ClariVest Asset Management, Cougar Global Investments, Scout Investments, and Reams Asset Management, a division of Scout Investments) manage a broad range of investment vehicles, including separately managed accounts, mutual funds, closed-end funds, UCITS, and other types of products.

Risks associated with Fixed Income investing: Many investors consider bonds to be “risk free” investment vehicles. Historically, bonds have indeed provided less volatility and less risk of loss of capital than has equity investing. However, there are many factors that may affect the risk and return profile of a fixed-income portfolio. The two most prominent factors are interest-rate movements and the creditworthiness of the bond issuer. Bonds issued by the U.S. government have significantly less risk of default than those issued by corporations and municipalities. However, the overall return on government bonds tends to be less than these other types of fixed-income securities. Investors should pay careful attention to the types of fixed-income securities that comprise their portfolio and remember that, as with all investments, there is the risk of the loss of capital.

This material may include forward-looking statements. These statements are not historical facts, but instead represent only beliefs regarding future events, many of which, by their nature, are inherently uncertain. You should not place undue reliance on forward-looking statements as it is possible that actual results and financial conditions may differ, possibly materially, from the anticipated results and financial conditions indicated in these forward-looking statements. There are uncertainties, unknown risks, and other factors that may cause actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these statements.

The statements above are based on the views of the advisor and are subject to change.

The information presented is for discussion purposes only, is not an offer, and should not be relied upon as the sole factor in an investment-making decision.

The information presented is not tax, investment or legal advice. Prospective investors should consult with their advisers.

Be sure to consider your financial needs, goals, and risk tolerance before making any investment decisions. Eagle does not provide legal, tax, or accounting advice. Any statement contained in this communication concerning U.S. tax matters was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Before making any investment decisions, you should obtain your own independent tax and legal advice based on your particular circumstances.

The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The U.S. Bureau of Labor Statistics bases the index on prices of food, clothing, shelter, fuels, transportation, doctors’ and dentists’ services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected each month in 75 urban areas across the country from about 6,000 housing units and approximately 22,000 retail establishments.

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