SBNY - Calamos Investment Team Outlooks January 2024

2024-01-05 06:05:00 ET

Summary

• Last year may have ended on an especially upbeat note, but we caution investors to remain mindful of risk. After a year of robust gains in the markets, it would be quite normal to see more measured performance in 2024.
• After the fourth quarter rally, many investors may be wondering if the good times can last, especially with the unknowns on the horizon.
• Our teams are finding many opportunities across asset classes. They are following disciplined, and research driven approaches to turn volatility into long-term opportunity.

Introduction from John P. Calamos, Sr., Founder, Chairman and Global Chief Investment Officer

Investment Outlook and Strategies for Asset Allocation in 2024

Investors will likely remember 2023 for its many ups and downs, which included several leadership rotations, along with double-digit total return selloffs and rallies. The roller-coaster ride reflected investors’ shifting views on Federal Reserve policy, inflation, and views of the health of the US economy. Investors also responded to a variety of events, including the failures of Silicon Valley Bank and Signature Bank ( SBNY ) in the US as well as Credit Suisse overseas, an autoworkers strike, and contentious debt ceiling negotiations in a polarized US Congress. Emerging secular themes—most notably advances in artificial intelligence and weight loss drugs—disrupted the markets as investors considered which companies and industries were positioned to win or lose.

As autumn approached, the mood in the market was turning gloomy as investors grappled with the prospect of higher-for-longer interest rates and inflation that was still elevated despite some declines. Although the Federal Reserve paused its rate tightening in September, the central bank dashed hopes of imminent rate cuts by reinforcing prior guidance that rates would be higher for longer. The yield of the US 10-Year Treasury Bond reached multi-decade highs, while the onset of the Israel-Hamas war intensified geopolitical uncertainty.

The tide turned dramatically in the final months of the year. In late October, moderating economic and inflation data and a continued Fed pause set stocks on an upward trajectory. The markets cheered even more loudly in December when the Fed indicated that it would not be unreasonable to expect multiple rate cuts in 2024—a stark departure from its previous stance.

Moderating Economic and Inflation Data Drives Strong Equity Rally

S&P 500 Index

Fueled by this broad rally, stocks, bonds and convertibles all posted healthy gains for the year. Growth stocks posted the most impressive gains within the stock market, led in large measure by a group of large cap stocks referred to as the Magnificent Seven, while high yield bonds led the bond market.

An Upbeat End to a Turbulent Year

Global Asset Class Performance (%): 4Q 2023 and 2023

What’s Next in 2024?

Last year may have ended on an especially upbeat note, but we caution investors to remain mindful of risk. After a year of robust gains in the markets, it would be quite normal to see more measured performance in 2024.

• We expect saw-toothed and volatile markets to continue. Markets hate uncertainty, and there’s plenty on the horizon.
• Although a good amount of data points to a soft landing for the US economy, the fiscal policy landscape is extremely uncertain with the US presidential election looming large.
• The Fed will continue to be a focal point for investors. Although the markets are increasingly pricing in rate cuts, there are no guarantees, and we’ve seen market sentiment—and asset prices—shift dramatically.
• I believe we are in a stock-pickers’ and a bond-pickers’ market . Not all companies will find the environment equally hospitable. Individual security selection, fundamental research, and the identification of growth themes will be extremely important.
• Market leadership is likely to broaden out. Although we still see attractive potential for the narrow group of mega-cap tech companies that dominated the market for much of 2023, it’s unlikely they will drive the market as they did in 2023. We expect different and more diverse leadership in 2024.
• With new and exciting innovations and disruptions always underway and as further interest rate hikes are likely no longer to be the market’s great concern, we see tailwinds for growth companies , as our Calamos Growth Fund team explains in their commentary, “ We See Continued Upside for Quality-Oriented Growth Stocks in 2024 .”
• We believe 2024’s landscape supports the case for alternative approaches . For example, Calamos Market Neutral Income Fund ( CMNIX ) has served as a compelling alternative to traditional bonds, outpacing the bond market in 2023 as well as for longer periods, as our Co-CIO Eli Pars discusses in his commentary, “ Charting a Steadier Path as Bonds Deliver a Wild Ride .”* We also believe private credit offers attractive risk/reward and yield potential beyond what’s available in public markets, given stable company fundamentals we see today. (You can learn more about private credit, our capabilities, and Calamos Aksia Alternative Credit and Income Fund here .)

7 Principles for 2024 … and Beyond

After the fourth quarter rally, many investors may be wondering if the good times can last, especially with the unknowns on the horizon. Some may be wondering if they should adjust their portfolios in the new year. Here’s some key points that I believe investors should keep in mind—and not just for 2024. I believe they’ve stood the test of time.

1. Don’t time the market or chase performance. Jumping in and out of the market is a dangerous strategy—investors tend to capture the downturns and miss the upturns. During the fourth quarter, the markets took off suddenly, and investors who were on the sidelines found themselves behind the curve. Instead, put a plan in place and rebalance periodically.
2. Your goals—not the markets—should drive your asset allocation. It’s easy to forget about risk when markets are moving up, but your asset allocation should reflect your long-term risk tolerance and goals, not near-term market conditions.
3. Benchmark your asset allocation to your own goals. Indexes are useful barometers, but they usually don’t tell the whole story. For example, during much of 2023, the performance of the S&P 500 Index ( SP500 , SPX ) reflected the outsized performance of a small pool of stocks, while most of the index’s constituents were delivering much more measured performance. Also, indexes generally track one type of investment, while an asset allocation will include different types of investments, with different levels of risk and reward.
4. There is no perfect time to invest, but there is opportunity in all markets. I’ve been investing for more than 50 years, and there’s always been uncertainty. Between the election cycle, the Federal Reserve, and geopolitics, I’m ready for plenty of short-term volatility in 2024. But uncertainty doesn’t preclude opportunity. Our teams are focused on individual security selection across asset classes, including innovative companies that are disrupting the status quo, and fundamentally strong companies that have fallen out of short-term favor with the market.
5. Maintain a long-term perspective. There are up days in down markets and down days in up markets, and your investments aren’t going to move in a straight line every day. Prioritize long-term results over short-term moves.

6. Alternatives provide an edge. A well-diversified asset allocation can provide a potentially steadier ride. As most investors know, stock and fixed income strategies can provide a sound foundation, along with cash for liquidity and short-term needs. From here, many investors may benefit from adding alternative funds, which can employ a wider array of strategies than traditional funds to enhance returns and provide additional ballast.

   Convertible securities, which have often been considered alternatives, can provide powerful benefits to investors. As hybrid securities combining features of stocks and bonds, convertibles can offer upside participation in the stock market, with potentially less exposure to downside. Additionally, they have historically been less vulnerable to shifts in interest rates than traditional bonds. With active management, convertibles can be used in a wide array of ways.
7. Think globally. Although economies are interconnected, there are important differences among countries and regions in terms of fiscal policy, monetary policy, demographic trends, and cyclical and secular growth themes. This creates distinct opportunity sets around the world and supports the case for global diversification, in both emerging and developed markets.

Thank You for Your Trust

Entering a new year, all of us at Calamos Investments would like to thank the investors and investment professionals who have placed their trust in us. As you will read in the commentaries below, our teams are finding many opportunities across asset classes. They are following disciplined, and research driven approaches to turn volatility into long-term opportunity.

---

Nothing Is Obvious

By Michael Grant - Calamos Phineus Long/Short Fund ( CPLIX )

2023 was an uncommon year. The US economy turned out to be much stronger than most forecasters expected, equity returns were dominated by the so-called Magnificent 7, the rebound of cryptocurrencies implied speculative liquidity remains abundant, and interest rate volatility was the highest since the Global Financial Crisis. To cap this, the Federal Reserve wrote itself an impressive encore in December that surprised many.

Pivots by central bankers are typically positive for financial asset prices, and investors have learned as much. However, Powell’s deterministic influence on markets in the absence of any economic breakage has raised eyebrows. The end of deflation created the conditions for the Federal Reserve to leave center stage and let other factors play the leading role in determining asset prices. Instead, it feels as if the impulse for interventionist central banking remains a prevalent part of the financialized welfare state.

Chair Powell did highlight a dramatic change in thinking about the 2024 outlook. Not only has US inflation declined rapidly, but the Fed’s Beige Book survey of regional economic conditions drawn from businesses around the country points increasingly to moderating activity. On the other hand, the Fed’s preferred index of inflation, the core personal consumption ('PCE') expenditure deflator was still rising 3.5% in October, substantially above the 2% target. What happened to looking at the “totality of the data?”

Powell did insert the caveat that further rate increases could still be required, perhaps reflecting the reality that the Fed’s own forecasts have been miserably wide of the mark. That so many forecasters have underestimated the resilience of the US economy implies they may still not see what is actually driving events. And yet, confidence is high that the inflation dragon has been slayed. Amidst all of this, Powell suggested that quantitative tightening ('QT') would continue even after the Fed gets to the point of actually reducing its policy rates.

Some suspect the “Christmas Pivot” was politically motivated, and in one peculiar sense, this may be correct. By raising interest rates paid on excess reserves held by commercial banks in their accounts at the central bank, the Fed’s interest expense rises by ~$30 billion per annum for each 100-basis point rise in the policy rate. This sharp rise in expenditures adds directly to the fiscal deficit by reducing the profits that the Fed has been remitting to the Treasury since it commenced its Quantitative Easing ('QE') program under Bernanke.

This dominance by the Fed’s unelected technocrats over what is considered the citizens’ remit could become an election issue, especially when both parties’ current frontrunners are populists. Some will wonder if a central bank that is directly impacting the nation’s finances can be allowed to remain independent if there is no way for voters to influence its decisions. In this light, Powell is purchasing valuable time. The economy needs to stay out of trouble long enough so that the remaining few trillion dollars of excess reserves can be mopped up as quickly as possible.

The Fed may therefore have no more insight into 2024 than the rest of us, but its political underbelly needs to ensure that “Fed independence” does not become part of the political debate. The wild card remains the inflation dynamic that could boomerang on the Fed. Key shortages in labor and housing point to sustained demand, with greater-than-usual financial flexibility across the private sector. This contrasts with the Fed’s prior mantra that it would not relent until economic growth moved below trend in a sustained fashion.

If 2023 can be summarized simply as a year of disinflation amidst a resilience economy, how might 2024 unfold for investors?

The script has flipped from a year ago. 2024 will be different because the balance between inflation, disinflation and the rising possibility of deflation is much more nuanced. Meanwhile, a broad consensus is coalescing around immaculate disinflation amidst a soft landing or no landing for the economy. The latest rally in equities and bonds has eased financial conditions and reduced the likelihood of imminent policy easing, even as this rise in risk appetite is being partly fueled by rising expectations of such.

Of course, Powell could be proven right in his outlook and his actions—even the blind squirrel finds a nut. We suspect the revived bullish mood climaxes in January, giving way to a (possibly hard) consolidation into spring as the varied moving pieces that underpin these debates lead to investor skittishness. We see US economic growth, inflation, and monetary policy all proving “sticky” through H1, pointing to little upside for the S&P 500 Index beyond January and into the election.

---

Charting a Steadier Path as Bonds Deliver a W1ild Ride

By Eli Pars , CFA - Calamos Market Neutral Income Fund ( CMNIX )

Getting There a Different Way

During the fourth quarter, bonds and stocks bounced back sharply in anticipation of a soft landing and Fed rate cuts in 2024. The Bloomberg US Aggregate Index gained 6.8% for the quarter, and the S&P 500 Index rose 11.7%. Calamos Market Neutral Income Fund ( CMNIX ) was also up for the quarter, rising 2.3%. However, for the first three quarters of the year, CMNIX was up 6.7% versus a loss of ?1.2% for the US Aggregate Index. Looking at these two periods together, the fund gained 9.2%, well ahead of the index, which was only up 5.5%. Overall, the year demonstrated that CMNIX has little interest rate risk or opportunity. We simply reached our destination in a different way, one that we believe can appeal to investors seeking a steadier course in a volatile interest rate environment.

CMNIX: Long-Term Outperformance Versus Traditional Fixed Income

CMNIX is designed to enhance a traditional fixed income allocation. The fund combines two complementary strategies—arbitrage and hedged equity—to pursue absolute returns and income that is not dependent on the level of interest rates. This approach has proven effective over the long term but also through periods of extreme change in the markets (For more, see our post “ Consistency Through Uncharted Waters .”)

CMNIX Versus Bonds: Leading the Way Over the Long Term

Arbitrage and Hedged Equity: Well-Balanced Opportunity

We monitor and manage the fund’s allocation between arbitrage and hedged equity and have maintained a roughly equal balance in recent months based on our view of strong relative opportunities in each. Over the course of the year, we have increased our allocation to convertible arbitrage and also boosted the fund’s allocation to merger arbitrage while paring the fund’s book in special purpose acquisition company (SPAC) arbitrage.

CMNIX Allocation

Arbitrage Strategies: A Closer Look

Convertible arbitrage. Our arbitrage strategies continued to perform well in the fourth quarter and for the full year. As we have discussed in our past commentaries, the returns of these strategies are traditionally linked to overnight money, with higher rates providing a boost. For example, convertible arbitrage is linked to overnight rates in a couple of ways. The most direct link is the rebate we get on our short positions, which is typically at the fed funds rate, less a fee for borrowing the stock (generally around 50 basis points). Slower to come through, but just as important, is the rise in coupons that we’ve seen as new issues come to the convertible market and old, lower-coupon bonds mature or are refinanced.

We believe new issues will be a potential bright spot for the convertible market over the next year or two. For 2023, global convertible issuance totaled $79 billion, close to the long-term trend and a significant bounce back from the soft market of 2022 when just $40 billion of issuance came to market. With large maturity walls approaching in the investment-grade bond, high-yield debt and convertible markets, there should be plenty of opportunities for convertible bankers to keep busy.

Global Convertible Issuance: Regaining Momentum in 2023

($ bil)

The investment-grade opportunity in the convertible market is particularly intriguing. In exchange for the conversion feature, convertibles typically offer lower coupons than comparable nonconvertible debt, which can be an appealing option for issuers to keep borrowing costs low. However, in the zero-interest rate world of years past, there was little incentive for investment-grade issuers to come to the convertible market. If a company can issue straight debt with coupons of 2% to 3%, why bother with a convertible? But now that those companies are looking to refinance and are seeing straight debt quotes from their bankers north of 5%, we believe that we will see some of them come to the convertible market to lower that coupon back closer to 2% to 3%. For CMNIX, this will likely mean an increased opportunity set, potentially with higher coupons and better credits.

Merger arbitrage. We’ve also found opportunities to increase our merger arbitrage book. We like merger arbitrage because it’s another way to pursue absolute returns with little correlation to the equity and fixed income markets. We expect to see more opportunities on the horizon once interest rates stabilize. For more on our views of merger arbitrage, see Co-Portfolio Manager Jason Hill’s commentary, “ Stabilizing Interest Rates Can Set the Stage for a Merger Surge .”

Hedged Equity Strategy

Despite running the strategy with minimal exposure to the S&P 500 Index’s downside, we still captured what we believe is a reasonable portion of the S&P 500’s upside. One driver of this favorable asymmetrical capture was the positive standstill yield our current hedge generates, due in part to the higher short-term interest rate environment. As we have discussed, the recent rise in the Fed funds rate flows through to the option market in higher call and lower put prices. (Co-Portfolio Manager Dave O’Donohue’s video blog “ Higher Rates are an Opportunity for Hedged Equity Strategies ” provides a good overview on the impact of higher rates on option pricing.) Although we always adapt to what we believe is most attractive in the options market, we will likely retain the higher hedge delta in 2024, as long as it is still available in the option market.

---

Focused on Capitalizing on—Not Capping—Equity Upside

By Eli Pars, CFA - Calamos Hedged Equity Fund ( CIHEX )

Tailwinds Persist for Hedged Equity

As an equity alternative, Calamos Hedged Equity Fund employs an options-based strategy to seek upside participation in the equity market while limiting downside exposure. We believe our depth of options experience (a core capability of Calamos since its founding in the 1970s), our flexible approach, and our commitment to being favorably positioned for as many market outcomes as possible provide us with key potential advantages over static approaches over the long term and as market conditions change.

Last quarter, we wrote about one of the attractive trades available in the option market—more specifically, a trade structured to pursue 65% of the market’s upside and 35% of the market’s downside at its expiration in December 2024. This trade exists in part because today’s higher interest rate environment provides an attractive environment for us to sell calls, and these opportunities continue to be available to us. (If you’d like to learn more about the impact of higher rates on option pricing, check out Co-Portfolio Manager Dave O’Donoghue’s video blog, “ Higher Rates are an Opportunity for Hedged Equity Strategies .”)

A Flexible Approach Positioned CIHEX for the Equity Rally

The flexibility to take advantage of the trades we find most attractive is the core of our approach.

We believe the third quarter demonstrated the potential benefits of our approach in constructing CIHEX’s option hedge. As the S&P 500 Index gained more than 12% this quarter, CIHEX was positioned to capture 60% of the market’s upside, as it did during the first nine months of 2023.

However, strategies with static, rules-based approaches may have found this quarter to be less accommodating. For example, some strategies may have found that their upside participation was capped when the equity markets took off suddenly during the fourth quarter. Although our current 65/35 trade could be considered a rules-based strategy on its own, our ability to adjust it as market conditions warrant is what makes the difference. We believe this trade has rarely been as appealing as it has been recently.

---

Stabilizing Interest Rates Can Set the Stage for a Merger Surge

By Jason Hill - Calamos Merger Arbitrage Fund ( CMRGX )

As investors know all too well, diversification strategies built exclusively around traditional stock and fixed income funds are not failsafe asset allocation approaches. To address the challenges of an environment that we believe increasingly warrants enhanced diversification (e.g., liquid alternative strategies), Calamos recently introduced Calamos Merger Arbitrage Fund (CMRGX).

The Mechanics Behind Merger Arbitrage Opportunity

When mergers between companies are announced, there’s typically uncertainty around the consummation of the deal and the timeline of the merger’s completion. As a result, the stock price of the acquisition target is normally lower than the announced acquisition price. Our team seeks to provide absolute returns that are largely uncorrelated to equity and fixed income markets by taking advantage of dislocations between potential and proposed merger-and-acquisition deal prices and where companies’ stocks are publicly trading before the deals are completed.

The Calamos Edge: Experience and Proprietary Research

We can go about capturing this arbitrage spread in a variety of ways, and we believe our decades of experience with comprehensive capital structure research gives us an edge in altering risk/reward through different securities and trade structures. In some situations, equities provide what we believe are the most attractive opportunities, and in other instances, we will choose convertible bonds or other fixed income securities. Liquid options provide additional tools for tailoring risk/reward.

We believe CMRGX is well positioned to take advantage of the merger landscape. As of the close of the reporting period, CMRGX held securities associated with 33 deals or potential deals. Equities made up 57% of the securities in the fund, followed by convertible securities and high yield at 37%, and options at 6%. We have used fixed income and options positions to manage downside risk, and we believe these positions can continue to provide valuable benefits.

CMRGX: Finding Opportunities across Target’s Capital Structures

Finding Opportunity in Fluid and Even Volatile Conditions

We are always mindful of the political and regulatory backdrop. As it relates to mergers, the Biden Administration has taken a more holistic approach to identifying harms, which has played out through government agencies making additional requests for information and through lawsuits trying to block deals that in the past might not have garnered scrutiny. Although this has made for a bumpier ride, the volatility has provided us with opportunities to make money.

That said, a tighter regulatory environment and a volatile interest rate world have negatively impacted the quantity of deals in our universe, which is typically US targets with market caps of more than $500 million. However, we believe there is substantial pent-up demand among companies that are ready to sign deals once rates settle down. We expect significant activity when rates simply stabilize; in our opinion, they don’t even have to fall to create a tailwind for a ramp-up in merger activity.

---

Bright Prospects for Convertibles in 2024

By Jon Vacko, CFA, and Joe Wysocki, CFA - Calamos Convertible Fund ( CICVX )

Markets ended 2023 on a high note with risk assets benefiting from a perceived US central bank policy pivot toward a more balanced monetary approach. Heading into 2024, we are cautiously optimistic that the Fed’s inflation-fighting efforts have largely achieved its goal, and the economy remains on a solid footing. We believe this most likely sets up a soft landing scenario that can provide a further tailwind for risk assets.

That said, we will continue to monitor conditions closely as soft landings have been historically difficult to achieve, and investors have recently been quick to overshoot to both the up and down, which can contribute to heightened volatility in markets. Additionally, the New Year carries unique risks, including what will likely be a contentious US presidential election that could impact fiscal policies for years to come.

Given the macro backdrop, we remain vigilant as we actively manage the risk/reward tradeoffs within Calamos Convertible Fund ( CICVX ). A broadening of equity market leadership could be particularly beneficial to small and mid cap growth companies, which are well represented in the convertible universe. We believe balanced convertibles—those that provide a favorable asymmetric payoff profile by offering attractive levels of upside equity participation with less exposure to downside moves—offer the most attractive way to gain exposure to this segment of the market.

Technology, health care and consumer discretionary are CICVX’s largest sector allocations. Reflecting our strong focus on bottom-up company analysis, we favor companies that are executing well despite macro uncertainties, with improving margins and free cash flow, accelerating returns on invested capital and attractive equity valuations. We also focus on identifying innovative companies positioned to benefit from cyclical and secular themes that can serve as a beacon in uncertain times. These include companies advantageously positioned as businesses seek solutions to higher labor, manufacturing, and interest costs in the current economic environment as well as trends such as artificial intelligence, productivity enhancement, cybersecurity, and electric vehicle adoption. We expect the convertible market will provide opportunities to participate in these fast-growing trends for years to come.

We are excited to see convertible new issuance accelerated to longer-term historical trends in 2023. Investment-grade companies were particularly active and came to the convertible market at a more rapid pace than we have seen in many years. We believe the issuer base in the convertible market will broaden in 2024 as a sizable amount of bonds in traditional debt markets mature in the coming years. Much of this debt carries low coupons and companies will face higher refinancing costs given increased interest rates across the curve. We believe the stage is set for win-win scenarios because issuers can benefit from lower borrowing costs by issuing convertibles instead of traditional bonds, and investors can benefit from more normal coupon rates and lower conversion premiums.

---

A Sunny 2024 Outlook for Global Convertibles

By Eli Pars, CFA - Calamos Global Convertible Fund ( CXGCX )

The global convertible market had a good year in 2023, and Calamos Global Convertible Fund ( CXGCX ) had a better one. The Refinitiv Global Convertible Bond Index posted a strong return in absolute terms, gaining more than 12% for 2023, and CXGCX beat its benchmark by more than 100 basis points and its peer group by more than 450 basis points. Throughout the year, we focused on actively managing the fund’s risk/reward, favoring issues that we believed offered an attractive blend of upside participation in global equity upside and reduced vulnerability to market pullbacks.

We believe new issues will be a potential bright spot for the convertible market over the next year or two. For 2023, global convertible issuance totaled $79 billion, close to the long-term trend and a significant bounce back from the soft market of 2022 when just $40 billion of issuance came to market. And with large maturity walls coming in investment-grade bonds, high-yield debt and convertibles, there should be plenty of opportunities for convertible bankers to keep busy.

Global Convertible Issuance: Regaining Momentum in 2023

($ bil)

The investment-grade opportunity in convertibles is particularly intriguing. In exchange for the conversion feature, convertibles typically offer lower coupons than comparable nonconvertible debt, which can be an appealing option for issuers to keep borrowing costs low. However, in the zero-interest rate world of years past, there was little incentive for investment-grade issuers to come to the convertible market. If you can issue straight debt with coupons of 2% to 3%, why bother with a convertible? But now that those companies are looking to refinance and are seeing straight debt quotes from their bankers north of 5%, we believe that we see some of them come to the convertible market to lower that coupon back closer to 2% to 3%. For CXGCX, this will likely mean an increased opportunity set, potentially with higher coupons and better credits.

Both equity and bond markets are taking the recent positive inflation data and running, pricing in multiple rate cuts starting as early as March. We will see what the future brings, but any backsliding in the data will likely be taken poorly by the markets. We remain focused on keeping a good risk/reward profile in the portfolio. The fund remains overweight the US and the technology sector and underweight Europe.

---

A Normalizing Economic Backdrop Offers Capital Appreciation Opportunities

By John Hillenbrand, CPA - Calamos Growth and Income Fund ( CGIIX )

We believe 2024 will be the beginning of the end of the normalization process as the extraordinary measures put in place in response to the pandemic unwind. Real GDP and employment growth have in aggregate slowed to more normal levels, although growth dispersion continues across industries. Inflation continues to slow but not yet to a normalized level, again exhibiting dispersion across consumption categories. We believe central banks will start to normalize short-term interest rates over the next year, one of the last pieces of the normalization process. Aggregating these factors with the corporate cost management that occurred in the past 18 months, we believe corporate profit growth should also return to more normalized levels.

Return to Normal: Mean Reversion of Inflation and GDP Growth

% change year-over-year

Although we have framed 2024 economic growth in terms of the disruption caused by Covid, there are other factors that should influence short-term economic growth, including improving corporate spending in select IT categories, continued infrastructure spending, healthcare innovation, continued spending from higher end consumers and tightening US fiscal budgets.

More Opportunities Are Emerging

Given our expectation of slowing but positive economic growth over the next year, we are assessing the investment opportunities with a continued focus on real growth and return improvement areas. In addition to areas with favorable cyclical factors, we believe companies that can improve profitability in a slower-growth environment are good investments. Many companies are focused on improving their returns on capital through improved efficiencies, normalized supply chains, and revised investment strategies based on the current interest-rate environment. The pace of corporate cost-cutting and restructuring has increased over the past several quarters across several areas, providing more opportunities to identify companies with improving returns on capital. Over the short- and intermediate-term, improved real returns on capital should drive higher equity prices.

Calamos Growth and Income Fund pursues lower-volatility equity participation through an equity-oriented multi-asset-class approach. We believe the best positioning for this environment is a neutral risk posture, focusing on specific areas that have real growth tailwinds, on companies with improving returns on capital in 2024, and on equities and fixed income with valuations at favorable expected risk-adjusted returns. We see compelling prospects for companies that have exposure to new products and geographic growth opportunities (examples can be found in health care, electric vehicles, and AI-related infrastructure and software), specific infrastructure spending areas (in materials and industrial sectors), and the normalization of supply chains and parts of the service economy. We are selectively using options and convertible bonds to gain exposure to some higher-risk industries. From an asset-class perspective, cash and short-term Treasuries remain useful tools to lower volatility in multi-asset-class portfolio, given their yields.

---

We See Continued Upside for Quality-Oriented Growth Stocks in 2024

By Matt Freund , CFA, Michael Kassab, CFA - Calamos Growth Fund ( CGRIX )

There is a Wall Street saying that “attitude follows price.” This can clearly be seen in the actions of the market in 2023. The year started on a cautious note, with the Federal Reserve in the midst of its hiking campaign and equities well off their all-time highs. Fears peaked in March when a banking crisis was considered all but certain to push a softening economy into recession.

Long-term investors were well rewarded for ignoring this wall of worry. The economy proved to be much more resilient than most economists expected. Jobs remained plentiful, and the US consumer continued to spend despite higher interest rates. At the same time, inflation continued to moderate (although still remaining above the Fed’s 2% target), and falling energy prices provided relief. By the end of the year, growth stocks recovered all of their 2022 losses, driven by two significant trends: the emergence of artificial intelligence (“AI”) and the mainstream launch of revolutionary weight loss drugs.

Much of this year’s turnaround came on the back of a handful of established technology powerhouses that demonstrated they could still be innovation leaders—and massive cash flow generators—all these years later. While the “Magnificent Seven” fueled strong returns in the US equity market for much of the year, the final three months of 2023 saw a significant broadening of the rally as expectations of a Fed pause and eventual rate cuts took hold.

Within the health care sector, one theme was particularly noteworthy: the emergence of breakthrough therapeutics in the battle against obesity. These medicines, known as GLP-1s, have the potential to change the landscape of health care overall and provide substantial long-term benefits to patients. Investors were quick to speculate on widescale implications for the broader economy and questioned what a world with less obesity would mean for diabetes treatments, medical devices, and fast-food restaurants.

Looking ahead, we believe easing financial conditions and a soft-but-still-positive macroeconomic environment should provide a constructive backdrop for growth stocks. The fundamentals for the technology sector remain strong, with enterprise spending in the early phase of recovery and the semiconductor inventory correction entering its latter stages.

Given the recent surge in stocks and valuations that are almost back to early 2022 levels, we believe it is reasonable to expect more muted returns ahead. Ultimately, we expect the new year to be more of a stock picker’s market, with individual stock price appreciation driven by company-specific factors. Although growth leadership will likely continue to broaden, Calamos Growth Fund maintains its emphasis on profitable companies with strong balance sheets and self-funding business plans.

As the past year has shown, being a successful growth investor requires a long-term orientation, a discipled approach to risk management, and the ability to see past the ever-present wall of worry. We believe our approach meets these criteria. Whatever the new year brings, growth equities have earned their place in a well-diversified portfolio.

---

The Fed’s Dovish Pivot: A Catalyst for Sustained Small Cap Strength

By Brandon Nelson, CFA - Calamos Timpani Small Cap Growth Fund ( CTSIX ) , Calamos Timpani SMID Growth Fund ( CTIGX )

Reversing the third quarter’s weakness, stocks surged in the fourth quarter. Small caps came back with a vengeance, with the Russell 2000 Index’s ( RTY ) gain of nearly 17% surpassing the S&P 500 Index’s 12% return. Overall equity performance continued to be tightly linked to 10-year US Treasury bond yields. When yields rose in October, stocks fell sharply. Yields collapsed in November and December, and stocks rallied.

Federal Reserve Chairman Powell’s dovish pivot was one of the most important catalysts during the quarter. On December 13, he made public comments that suggested the Fed had interest rate cuts on its mind, saying cuts were “a topic of discussion [among Federal Reserve members].” Compare that to the public comments he made only a few days earlier on December 1: “It would be premature to speculate on when policy might ease.” This reframing was a true pivot.

The implications of this pivot in rhetoric are potentially extremely bullish for stocks overall and especially for small cap stocks. Think back to November 2021 when Powell made hawkish comments for the first time, telegraphing higher federal funds rates down the road. Stocks took notice and sold off sharply for the next several months, even before the first actual Fed funds rate hike in mid-March 2022. Small cap stocks were hit especially hard during this time and are still in recovery mode, unlike large caps, which fell less and rallied more off the overall market bottom.

The mid-December dovish pivot seems to have marked the inverse of the November 2021 pivot. Thus, logic would suggest small caps could disproportionately benefit from this pivot, especially given how attractive valuations have become relative to large caps in recent years. (Valuations of small caps versus large caps ended the year in the 10th percentile, according to Jefferies.)

Things can always change, but it seems likely to us that the Fed will be cutting interest rates in 2024. Historically speaking, stocks tend to perform very well after the first rate cut, especially small cap stocks.

Rate Cuts Have Tended to Give the Biggest Boost to Small Caps

Performance after first Fed rate cut

Thus, the set-up for small caps seems extremely favorable, in our view. For several years, small caps have looked cheap. But with the Fed changing its tune, there is now a specific catalyst that has created urgency to invest in small caps. Combine this urgency with unusually high levels of cash on the sidelines (buying power), a robust M&A environment (where takeover premiums are likely), and presidential cycle tailwinds (the fourth year of a presidential term is usually relatively strong), and the outlook gets even better.

Historically, Stocks Have Done Fine in Election Years, Especially Small Caps

Large cap versus small cap, election year of a presidential cycle, historical comparison annual seasonality, 1980?2020

We believe Calamos Timpani Small Cap Growth Fund ( CTSIX ) and Calamos Timpani SMID Growth Fund ( CTIGX ) are well positioned. Both funds are tilted toward stocks that we believe offer above-average growth prospects and very visible fundamental strength. Stocks with these characteristics sometimes lag at critical market turning points but tend to play catch-up as new stock market upcycles mature. We see this scenario playing out once again and thus have high hopes for absolute and relative-to-benchmark returns for both funds in 2024.

---

Headwinds to Tailwinds: An Improved Horizon for Overseas Markets

By Nick Niziolek, CFA, Dennis Cogan, CFA, Paul Ryndak, CFA, and Kyle Ruge, CFA - Calamos Evolving World Growth Fund ( CNWIX ) Calamos Global Opportunities Fund ( CGCIX ) , Calamos Global Equity Fund ( CIGEX ) , Calamos International Growth Fund ( CIGIX ) , Calamos International Small Cap Growth Fund ( CSGIX )

Currency Headwinds Become Tailwinds for Overseas Markets

The opportunities for non-US equities are growing. Our constructive case reflects a variety of factors, including abating currency headwinds. Overseas markets have typically experienced their strongest relative performance during periods of US dollar weakness (for example in late 2022), more mixed performance during periods of consolidation (as in 2023), and underperformance during periods of dollar strength.

We continue to believe we are in the early innings of a multi-year weak dollar cycle. Valuations continue to favor foreign currencies on the basis of purchasing power parity and real effective interest rates, and the dollar remains one of the most expensive currencies on the planet.

Of course, valuation is just one component of an investment thesis and things can remain expensive for a prolonged period. Relative real yields have supported the US dollar as global investors have favored the higher relative returns and perceived safety of US Treasuries. But this may be changing. Over the past year, several Asian countries have reduced US Treasury purchases, and there are reports that at least one European central bank has diversified its balance sheet into US equities in recent years. As it becomes clearer that the US dollar is entering a weakening cycle, its perceived status as a preeminent safe haven will likely be increasingly questioned.

One of the more significant factors influencing the near-term dollar outlook is the relative economic growth prospects for the US versus overseas markets. Although the US consumer remains resilient, the fiscal support provided during the Covid crisis is waning, inflation remains sticky, interest-rate costs have increased, and year-over-year growth comparables for companies have become more challenging.

In contrast, many overseas economies are still in the earlier stages of their reopening cycles. Friendshoring initiatives support new capital expenditure cycles, and local housing markets benefit from increased demand driven by changing consumer preferences, supply deficits, and improving living standards.

The chart below illustrates how relative growth indicators are beginning to inflect in favor of overseas markets. As growth differentials tip in favor of overseas markets, we anticipate improved capital flows into these markets and a natural bid for their currencies.

US Versus Overseas Markets: Signs of an Inflection in Economic Growth

Citi Economic Surprises

Additionally, different monetary policy stances may contribute to a weakening dollar. The Federal Reserve has a dual mandate of price stability and maximum sustainable employment, and it may have most recently signaled that the risks between price stability and employment are now more balanced, increasing the probability of rate cuts on any signs of weakening growth. In contrast, the European Central Bank’s mandate is solely price stability, so it may have more flexibility to hold rates and watch for inflation to recede while Europe’s growth picture gets less bad. Meanwhile, the Bank of Japan may be on the verge of abandoning the negative interest rate policies in place since 2016.

Economic Reforms Provide Another Pillar to Support Emerging Market Opportunity

We’ve often cited valuations and improving macroeconomic backdrops as factors supporting the case for emerging markets, but they certainly aren’t the only ones. We’re also optimistic about the domestic economic policy environments in several countries, which we believe set the stage for healthy growth and development. The adage that “capital goes to where it is treated best” can provide a north star for us as we consider which countries offer the best investment conditions. Some of the most important determinants of where capital goes include ease of doing business and attracting foreign direct investment (FDI), deep or deepening financial services industries and capital markets, low taxes, fiscal soundness, monetary discipline, and strong private property rights.

Some of the most developed markets forget these guiding principles from time to time. In fact, we believe that several developing economies are among those setting the best examples, including the following:

• • India. India’s favorable demographics and highly educated population are key drivers for achieving world-leading economic growth. Also important are economic policies introduced over the past decade, including tax simplification, bankruptcy code reforms, improved access to banking and other financial services, and FDI liberalization.

  • Greece. A poster child for economic policy dysfunction in the 2000s, Greece has restored fiscal and financial stability and improved competitiveness through tax and pension reforms, bank recapitalizations, and key labor market and product market reforms that have eased business conditions. As a result, the country has made great progress toward restoring economic health, which has been rewarded with higher FDI.

    Greece: Foreign Direct Investment Is on the Rise in the Wake of Economic Reforms

• World Bank Greece FDI inflows as a % of GDP, 3-year moving average
• Indonesia Like India, Indonesia has attractive demographics and some of the strongest economic growth globally. Encouraging economic reforms of the past decade include tax simplification, compliance incentives, and policies to ease business conditions, promote trade, and protect property rights.
• Argentina. Argentina and the policy proposals of newly elected President Javier Milei offer the most recent case study in reforming a broken economy. His “radical” ideas to restore economic stability and prosperity include fiscal discipline, monetary policy stability, deregulation, privatization of state-run industries, and reduced trade barriers. Milton Friedman would have been hard pressed to prescribe more capital-friendly policy objectives. Argentina has a long way to go, but the policy direction can help unlock this country’s tremendous potential.

Emerging Markets Opportunity Spotlight: Real Estate

This past year, we identified investment opportunities in India and Mexico real estate that benefited from underlying secular and cyclical tailwinds. We see continued upside as the global rate environment should be more hospitable, and secular and cyclical tailwinds persist.

India. India’s residential real estate market benefits from strong underlying secular tailwinds and economic growth trends. Rising incomes, increased urbanization and declining household sizes are all fueling increased demand. The cycle bottomed out over the past few years with the lowest inventories in over a decade and the greatest affordability in two decades. As in other markets around the world, Covid was a catalyst that sparked what we believe will be a multiyear upcycle in the residential real estate market. In addition to the strong underlying tailwinds, policy and regulatory reforms and tighter financing conditions are driving a consolidation wave that is boosting the large, listed developers whose share of the organized residential development market has increased significantly over the past five years.

Mexico. Given its proximity to the US, competitive labor costs and specialized manufacturing, Mexico has been a clear beneficiary of a nearshoring trend that has been supercharged in recent years by increased tensions between China and the West. The ramp-up in nearshoring has created new opportunities for the real estate market, with occupancy and rent levels rising to historically high levels near the US border. With China still accounting for approximately 18% of $4 trillion-plus in annual US imports, we believe the secular shift in demand for industrial property in Mexico is still in a relatively early stage. In addition, the larger listed developers are well positioned to gain share in a highly fragmented market where most local and private developers lack the scale, capital or expertise to satisfy the demand ramp-up.

---

Risk Management Will Matter More in 2024

By Jim Madden, CFA, Tony Tursich, CFA, and Beth Williamson - Calamos Antetokounmpo Sustainable Equities Fund ( SROIX )

After taking a breather in the third quarter, equities resumed their climb in the fourth to close out the year on a strong note. The powerful rally in the final quarter of the year was propelled by the expectation of interest rate cuts in 2024. Traders bet that central banks will cut interest rates sooner rather than later, with contrarian views centered on the magnitude of the easing and the timing. Ten of the 11 economic sectors within the S&P 500 Index appreciated both in the fourth quarter and for the full year. Generative AI and GLP-1s weight-loss drugs were the dominant themes, and stocks associated with them were among the best performing globally.

The Federal Reserve may be done with rates hikes, but higher rates may not be done with us. The impact of higher rates has only begun to take hold. It can take up to 24 months for a change in interest rates to be fully reflected in the economy. Consumers and businesses are beginning to feel the pinch of higher rates. Whether the US economy and corporate earnings can withstand the lagged effects of monetary tightening next year is unclear. As always, we shall see.

The worst decisions are made during the best of times. We’ve seen a secular bull market over the past decade when investors often made more by dipping further down in quality. Can this continue? The chart below suggests it is unlikely. Cash returns will probably not be negative as they were for the past 10 years, and dividends tend to stay steady. So, if returns are to stay at the current level, it will take even more multiple expansion and even faster earnings growth. Going forward, good risk management is likely to be better compensated than brazen risk taking. Because the past 10 years are unlikely to be repeated, we believe diversification will pay off as investors return their focus to fundamentals and valuations.

US Equity Return Decomposition, January 1, 1950, to June 30, 2023

Excess returns

We position Calamos Antetokounmpo Sustainable Equities Fund ( SROIX ) to provide a core allocation to quality growth companies that can thrive as the global economy evolves. Even if we cannot predict with certainty how economic and market conditions will unfold in 2024, we believe investors will be best served over the long term by a diversified portfolio of industry leaders with strong operating fundamentals and reasonable valuations. We view this as the optimal formula to attain desirable risk-adjusted returns over time. Accordingly, we are committed to managing SROIX with a time-tested integrated approach that uses traditional financial data and alternative data to make better investment decisions.

Sustainable criteria are one key set of this alternative data. Investors should take the resolution of COP28 as a clear indication of how important sustainability has become and how important it will be going forward. Declarations and pledges by 130 countries to double energy efficiency by 2030 are deliberate and present investment risks for some companies and industries but exciting opportunities for others. SROIX includes a broad array of quality growth companies that are at the forefront of innovation. Regardless of whether countries can meet their Paris Climate goals, we believe companies purposefully moving to become more resource- and energy-efficient in their operations, products, and services are positioned to win.

---

The Fed’s Pivot: Clear but Not an “All-Clear”

By Matt Freund, CFA, Christian Brobst, and Chuck Carmody, CFA - Calamos High Income Opportunities Fund (CIHYX), Calamos Total Return Bond Fund (CTRIX), Calamos Short-Term Bond Fund ( CSTIX )

Despite the headlines, interest rate hikes, AI excitement, energy volatility and an increasingly unsettled geopolitical environment, 10-year US Treasury yields ended the year less than 1 basis point from where they began. However, the year was nothing if not eventful for the fixed income markets.

The Fed started the year with the intention of doing whatever it would take to push inflation to its 2% target, even if unemployment was rising. Nevertheless, although inflation was still well north of the Fed’s target, a softening in inflation data and moderating job growth prompted the Fed to pause its rate hiking campaign in the summer. The Fed’s decision to extend the pause in the fourth quarter, combined with particularly dovish commentary from Chair Powell in December, left the market largely convinced that the Fed’s next move would be a rate cut—and potentially the first of many. Powell’s holiday pivot led the markets to quickly price in six rate cuts in 2024 with the first potentially occurring in March.

Market participants continue to be surprised by the consumer’s resilience. Rewind to a year ago, and it would have been quite difficult to find economists or market participants who expected growth in the second half of 2023 to accelerate, let alone run at a 5% clip as it did in the fourth quarter. Hotter-than-expected November retail sales data already has the Atlanta GDPNow’s fourth-quarter forecast for economic growth back above trend in the mid-2% range.

Recession Expectations Have Been Pushed Further Out

Evolution of Atlanta FedGDP Now real GDP estimates for Q4 2023, Quarterly percentage change

We believe the forecast of six rate cuts in 2024 is the market’s average of two very different outcomes. If systemic stress or employment weakness show up relatively quickly, it is possible that the Fed could cut rates far more than what markets are currently anticipating, but we assign a low probability to this outcome. In alignment with our base case, the second outcome is that the economy avoids recession altogether in 2024 and instead maintains a shallow growth trajectory with inflation falling below 3%. If our base case is correct, this allows for slight eases in monetary policy closer to the end of 2024, supporting our expectation that the Fed funds rate will end the year roughly 100 basis points lower than its current level, in the 4.0%?4.5% range.

The yield curve will likely steepen because the Fed’s moves will have more influence over short- and intermediate-term maturity rates. Long maturity rates (those applied to maturities of 10 or more years) should face greater difficulty falling materially from current market rates near 4%. A combination of factors, including continued government deficit spending and its resulting debt issuance, the return of term premium,* and a lack of marginal buyers, should mean long rates remain “sticky” at higher levels. Credit spreads present a conundrum. The spreads we see today have historically been more aligned with the early or middle innings of an expansionary cycle. In our view, spreads are too tight today, given the consensus—and our team’s—expectations for decelerating growth. Additionally, although credit fundamentals remain solid, they have been deteriorating as leverage increases and interest coverage and balance sheet liquidity decline. Given these mounting pressures, we expect credit spreads to move wider in the coming year, particularly in the investment-grade market, where spreads are only 25 basis points away from their tightest points of this millennium.

Although we believe growth will continue decelerating, it is too soon to call for a recession in 2024. Despite signs that the environment is more balanced than early in the calendar year, employment conditions continue to appear robust, leading us to assign a low probability to a labor-driven recession. Liquidity conditions also remain favorable, and access to capital is not a challenge for all but the most stressed borrowers. Our thesis has been that the impact of higher rates would take longer to flow into the economy because consumers and businesses were able to refinance debt at low levels during the pandemic, and this view appears to be holding.

That said, we do not profess to have a crystal ball, and we are mindful that recession signals are present, whether it is 19 consecutive months of negative leading economic indicators, the persistently inverted yield curve, or low consumer confidence survey results. In this environment, we continue to scrutinize company and industry results, looking for the excesses that typically surface ahead of recessions.

Positioning Implications

The November and December bond rally reloaded expectations for more meaningful cuts in the coming year, but we believe the Fed will have a difficult time justifying that level of accommodation unless the economy falls into a recession. Typically, when the markets anticipate more rate cuts than we believe possible, we would position the funds with durations shorter than those of their benchmarks. However, our expectation for a steeper curve where short maturities benefit from Fed easing and long rates are stickier at higher levels has led us to position Calamos Total Return Bond Fund and Calamos Short-Term Bond Fund with neutral to slightly long duration. The duration of Calamos High Income Opportunities Fund remains below its benchmark, but interest rate sensitivity in the high yield market is a smaller driver of risk and return.

Credit spreads are the most challenging piece of the puzzle to square with other economic realities. We believe the risks to credit spreads are asymmetrically unfavorable at these levels. Our fundamental research continues to identify high yield issuers and industries where investors are well compensated for the current risk profile, but we have continued to migrate portfolio credit quality higher across the Calamos fixed income funds as we prepare for what we expect to be a weaker 2024.

---

Before investing carefully consider the fund’s investment objectives, risks, charges and expenses. Please see the prospectus and summary prospectus containing this and other information which can be obtained by calling 1-866-363-9219. Read it carefully before investing.

Diversification and asset allocation do not guarantee a profit or protect against a loss. Alternative strategies entail added risks and may not be appropriate for all investors. Indexes are unmanaged, not available for direct investment and do not include fees and expenses.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The views and strategies described may not be appropriate for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.

Duration is a measure of interest rate risk. Dovish refers to accommodative monetary policy.

*The term premium is the amount by which the yield on a long-term bond is greater than the yield on shorter-term bonds. This premium reflects the amount investors expect to be compensated for lending for longer periods.

Important Risk Information. An investment in the Fund(s) is subject to risks, and you could lose money on your investment in the Fund(s). There can be no assurance that the Fund(s) will achieve its investment objective. Your investment in the Fund(s) is not a deposit in a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The risks associated with an investment in the Fund(s) can increase during times of significant market volatility. The Fund(s) also has specific principal risks, which are described below. More detailed information regarding these risks can be found in the Fund’s prospectus.

The principal risks of investing the Calamos Total Return Bond Fund include: interest rate risk consisting of loss of value for income securities as interest rates rise, credit risk consisting of the risk of the borrower missing payments, high yield risk, liquidity risk, mortgage-related and other asset-backed securities risk, including extension risk and portfolio selection risk.

The principal risks of investing in the Calamos High Income Opportunities Fund include: high yield risk consisting of increased credit and liquidity risks, convertible securities risk consisting of the potential for a decline in value during periods of rising interest rates and the risk of the borrower to miss payments, synthetic convertible instruments risk, interest rate risk, credit risk, liquidity risk, portfolio selection risk and foreign securities risk. The Fund’s fixed income securities are subject to interest rate risk. If rates increase, the value of the Fund’s investments generally declines. Owning a bond fund is not the same as directly owning fixed income securities. If the market moves, losses will occur instantaneously, and there will be no ability to hold a bond to maturity.

The principal risks of investing in the Calamos Short-Term Bond Fund include: interest rate risk consisting of loss of value for income securities as interest rates rise, credit risk consisting of the risk of the borrower to miss payments, high yield risk, liquidity risk, mortgage-related and other asset-back securities risk, including extension risk and prepayment risk, US Government security risk, foreign securities risk, non-US Government obligation risk and portfolio selection risk.

---

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

For further details see:

Calamos Investment Team Outlooks, January 2024