Consumer strength bears watching as we head into the fallAugust 26, 2020By Vishal Khanduja, CFADirector of Investment Grade Fixed-Income Portfolio Management and Trading, Calvert Research and Management and Andrew GoodaleInstitutional Portfolio Manager, Eaton Vance ManagementBoston - With summer coming to a close, we wanted to take stock of where we are today and what we see as potential market catalysts and drivers of future relative value among bond issuers. As active managers, we continually monitor economic, consumer and geopolitical trends to identify areas of risk and opportunity in the markets. Today, bond market yields have dropped for several months, credit spreads have compressed and risk is back on — but, the general economic outlook is far worse and more uncertain than it was at the beginning of the year.In our view, the Fed's goal of moving investors away from short-term, higher-quality assets toward longer-term, lower-quality areas of the market appears to be succeeding. As a recap, in July, the US bond market performed well overall, with the Bloomberg Barclays US Aggregate Bond Index posting a total return of 1.49%. Lower-quality areas of the market largely drove returns, with BBB-rated bonds gaining 3.5%, while AAA-rated bonds returned only 0.75%.Fed supporting the marketThe disconnect between the financial market rebound and economic uncertainty continues to be at the forefront of many investors' minds. In our view, the dogged stance of the Federal Reserve (Fed) via its policies and Primary and Secondary Market Corporate Credit Facilities (PMCCF and SMCCF) programs has significantly helped support market technicals and limit near-term risk. Another sign of the Fed's success has been the continued strength of the corporate new-issue market. Initially, firms were concerned about having enough liquidity, but the trend for issuance has shifted. Companies now appear less concerned about shoring up cash on their balance sheets and, just like consumers, are more focused on refinancing debt at lower rates. These refinancings should serve as a tailwind for the corporate sector as it deals with changes in the economy over the next 12-18 months. Bondholders will likely be helped by corporate managements' newfound focus on balance-sheet strength rather than shareholder returns. Recent bondholder-friendly actions include aggressive cost cutting, prefunding of upcoming debt maturities, and material reductions in short-term debt. Surprising consumer strength may weakenOne concern we have is around the potential shift in the health of the consumer. While lapsed jobless aid benefits have now been extended under a Presidential directive, it is at a significantly reduced rate. The prior stimulus had a very strong, positive effect both on the consumer — who in some cases, actually prepaid their loans — and corporate earnings. Overall, we remain pleased with the strength of the consumer, but believe it's prudent to carefully watch consumer-related economic indicators for signs of future weakness ahead. During the depths of the crisis, we increased our allocation to consumer-focused securitized credit at attractive levels. Now that these bonds in many cases have rebounded to par, or even above par, we think it is prudent to trim or exit these positions and reinvest a portion of those proceeds elsewhere. In terms of overall risk, we have been slowly seeking to raise the credit quality of our portfolios by increasing our exposure to short US Treasurys and cash, and we are extending portfolio duration. We have been looking to acquire positions in higher-quality, more defensive sectors on the margin, and we believe that both fiscal and monetary responses have stabilized the US economy to date. In our view, however, increased caution is warranted as we move from summer into a fall season that features already choppy school and college reopenings and a contentious presidential election. Bottom line: Although aggressive Fed actions and fiscal response appear to have stabilized the US economy, we believe consumer strength, which underpins economic health, deserves renewed attention. We therefore are positioning our portfolios more defensively as we approach the fall.