Markets pin hope on vaccines and stimulus

Putnam Investments, 01/22/21


Q4 2020 Putnam Dynamic Asset Allocation Funds Q&A

  • We are mildly bullish on equities but tactically wary of overextended sentiment and virus-related setbacks.
  • Credit markets, supported by the Fed's ongoing quantitative easing, will continue to recover.
  • Rising COVID-19 cases across the globe will create challenges for policymakers.

How were market conditions in the fourth quarter?

Despite some weakness during the three-month period, global financial markets advanced overall. Equity indices reached record highs, continuing the market's run from the downturn earlier in the year. The rally was fueled by the development of COVID-19 vaccines, signs of economic recovery, and the U.S. election results. President-elect Joe Biden will be sworn in as the 46th president of the United States in January 2021. As equity markets trended higher, COVID-19 infection rates surged, and new travel and business restrictions went into effect. The S&P 500 Index, a broad measure of stocks, rose 12.15% during the period. International stocks, as measured by the MSCI EAFE Index [ND], gained 16.05%.

Fixed-income assets finished with mixed results in the fourth quarter. U.S. Treasury bond yields moved slightly higher, and prices fell as the passage of a $900 billion pandemic relief package boosted investor optimism. Investment-grade bonds ended the period roughly flat, after months of strong gains. The rate-sensitive Bloomberg Barclays U.S. Aggregate Bond Index rose 0.67% during the period. High-yield bonds finished with strong positive re-turns as credit spreads tightened, reflecting equity market strength.

The three Dynamic Asset Allocation Funds gained during the quarter. The Conservative Fund, with its more fixed-income-centric investments, rose 4.98%. The more equity-centric Balanced Fund and Growth Fund advanced 9.04% and 11.81%, respectively. The Growth and Balanced Funds slightly underperformed their custom bench-marks. The Conservative Fund finished in line with its custom benchmark.

What strategies affected performance?

All of the Dynamic Asset Allocation funds finished with positive returns, reflecting equity market strength. Over the quarter, our tactical allocation calls resulted in a positive contribution from dynamic allocation. On balance, the portfolios were slightly overweight to equity risk, neutral to credit risk, and slightly underweight to interest-rate risk relative to their benchmarks. Early in the period, we moved our equity position from neutral to modestly overweight. This aided performance as stock markets soared to record highs. In fixed income, our slight underweight position to interest-rate risk led to a small positive contribution. We moved that position to neutral toward the end of the quarter. Our slight overweight position to credit risk at the beginning of the period led to a small positive contribution. We moved our position to neutral about midway through the period.

Our active implementation decisions detracted from performance relative to the benchmarks. Security selection within U.S. large-cap equities drove this negative result as there was significant weakness across both our quantitative and fundamental strategies. Fixed income selection experienced strength, specifically a strategy focused on structured mortgage credit. These gains helped to mitigate the loss from equity selection. International equity selection slightly added to performance. In the Growth Fund, emerging-market equity selection was a slight detractor.

What is your near-term outlook for the markets?

While rising virus infections could lead to weaker-than-expected economic activity in the coming months, the vaccine progress has reduced the chances of much slower growth in 2021.

In November, several drug makers released positive news about vaccines against COVID-19, including vaccines with efficacy in excess of 90%. The U.S. Food and Drug Administration in December approved two vaccines just as infection rates and shutdowns were spiking globally. The financial markets are now pinning hope on widespread vaccinations by the middle of 2021.

As we enter the new year, we are mildly bullish on equities but tactically wary of overextended sentiment and additional virus-related setbacks. We believe credit markets, supported by the Fed's promise to maintain quantitative easing, will continue to recover. With interest rates pinned near zero and asset purchases becoming the main stimulus tool, Fed officials said they wouldn't lift rates before the labor market recovers. And there is risk to growth over the next few months amid rising COVID-19 cases across the globe. That will continue to create challenges for consumers, businesses, and policymakers.